Independent Investment Counsel
At Barnett & Company we do not pool client funds. Portfolios are individually crafted to address the goals, time horizon, risk tolerance and tax circumstances of each unique client. If we were a clothing company instead of an investment firm, we would be a custom tailor as opposed to a mass merchandiser.
We assign to each of our clients a specific portfolio manager who is also that individual’s primary contact with our firm, thereby avoiding any confusion over where the responsibility lies for a portfolio’s management and performance. While our staff does screen, research and distill potential investments into a current list of recommended buys, only the manager of each client’s account has the authority to make a decision on what investments are made.
Barnett & Company’s focus is on marketable securities such as stocks, bonds, and real estate investment trusts, and for smaller accounts and unique situations, exchange traded funds and mutual funds. We generally shy away from investments that cannot be priced by the marketplace, since marketplace pricing implies the ability to sell an investment, if need be, with minimal transaction costs. Far higher costs are associated with the sale of less liquid investments, such as hedge funds partnerships and insurance products. Lack of access to information about sales can also jeopardize the objectivity of the valuation of a potential investment.
Rather than taking custody of our clients’ assets, Barnett & Company works with third-party brokerage firms and trust companies that hold the assets and value them independently. We will work with any firm our client chooses. If he or she has no preference, we will provide a list of firms with their relative costs and attributes.
Separating custody from management and making them independent of each other helps further safeguard the clients’ assets. As custodians send out their own monthly or, in some cases, quarterly statements, which the client can use to reconcile an account with the firm’s own reports. In contrast, a company that performs both investment and custody functions fails to provide its clients with such an external check in verifying account information.
Everyone has his or her own plans and dreams, so part of Barnett & Company’s initial process in setting up a portfolio is working with our client to articulate and quantify investment goals and objectives.
If the investor has funds in both taxable and tax-deferred accounts, we often recommend that he or she consider putting income-oriented assets into existing IRA and tax-deferred accounts and appreciation-oriented assets into personal accounts.
Theoretically, there is no difference to an investor whether returns generated from a tax-deferred account come from income or from appreciation since, with the exception of Roth IRAs, all returns are taxed as ordinary income when they are distributed. In reality, however, income is generally more predictable than appreciation.
Should appreciation become depreciation, capital loss from a taxable account can be used to offset capital gains elsewhere. No such offset is available to a tax-deferred investor.
Since capital loss in a tax-deferred account cannot be replaced by larger contributions in future periods, any principal lost in a tax-deferred investment represents an immediate loss as well as a loss of the capital’s earning power during future periods.
For these reasons, we recommend that IRA and tax-deferred accounts be invested in income-oriented assets, with the level of income being a function of the individual investor’s level of risk-tolerance. Clients who are retired and living off the income from their retirement accounts may be able to fund their distributions using cash flow from these investments if the investments contain sufficient capital.
Barnett & Company looks at taxable accounts as vehicles primarily for appreciation-oriented assets if the need for income from the portfolio is minor, taxes are an issue, and tax-deferred assets are material. Since current tax law provides for lower tax rates on assets held for the longer term, a strategy of ownership for at least twelve months, if possible, represents a very cost-effective form of tax shelter. If an investor’s income needs are covered by cash flow from either tax-deferred assets or another source, of course, it becomes easier to be more philosophical about the inevitable fluctuations of the stock market in general.
We find this construct to be a useful starting point in our initial discussions with a new client, although there would have to be modifications to the approach if assets are to be more oriented to either taxable or tax-deferred accounts. Factors such as risk, time frame, income needs and tax exposure are all determinants in settling on the investment objectives that fit an individual investor’s exact needs.
Our Investment Philosophy
At Barnett & Company we believe it is typical in the world of investing for perception to change faster than reality. We recognize the wisdom in buying investments that are believed to be the ones other investors will want to own in the future and avoiding those that are over-popular in the present. This approach sets our investment philosophy apart and categorizes us as value managers. In the greater scheme of things most fund managers are known as either growth or value types. The terms are misleading since one cannot have value without growth nor growth without value. What they do imply is an investment managers approach to investing.
Growth managers tend to look primarily at the big picture in anticipating the next investment fad or fashion, paying less attention to the current price and specifics of a stock. Growth investing can be characterized as momentum investing in that growth managers try to buy stocks that are increasing in value faster than the overall market and then attempt to sell before they turn down. By contrast, value managers tend to approach investing more from the bottom up. By screening for certain attributes the value manager attempts to discern the case that can be made for purchasing a given stock. A stocks investment value is viewed as a cushion for any downside it may exhibit. Its upside is determined by looking at a number of other factors that are not currently priced into the stock.
Today, for example, many investors tend to focus primarily and perhaps obsessively on earnings forecasts when deciding what to buy. The health of a company, as evidenced by its balance sheet, is often overlooked.
At Barnett & Company we believe the health of a firm is a very important factor in determining the risk associated with an investment. Even if a company has strong earnings prospects, it may not have the strength to survive if it fails to realize those prospects in a timely fashion. Healthier companies are more likely to have the staying power needed to correct problems when they occur and to take advantage of opportunities that may not exist at the time their future earnings are forecast.
Through a process of screening large numbers of stocks using public information and proprietary databases available by subscription, Barnett & Company looks for companies with both positive prospects and low current valuation relative to those prospects. We then evaluate the financial health of the company offering the stock, using a number of additional screening tools. Finally, we perform qualitative analysis by perusing the companys SEC documents and testing for attributes that would have an adverse effect on stock ownership. For appreciation-oriented accounts, the end result of these efforts is a collection of stocks that we believe merit investment consideration. When several stocks in a given industry make the list, we narrow them down to the one or two companies in the group that we feel are the best prospects for appreciation.
The bottom-line goal when buying a stock for appreciation is for it to double its value in three to five years. Even if this objective is not realized, the goal itself tends to focus thinking on long-term potential rather than on short-term trading. Such focus is especially helpful in situations where long-term capital gains taxes are desired.
In investing for both current income and appreciation, Barnett & Company deploys a more modest goal for price changes, since a material portion of return comes from cash flow. We use the same balance sheet analysis in bond investing that we use in stock screening, although the criteria are different since bondholders do not usually participate in a firms earnings appreciation as stockholders do. In bond investing, our analysis centers around the issuers ability to meet its coupon payments, repay its principal and, should the bond become impaired, return its investment in reorganization.
The types of bonds we use again depend on our clients needs: income desired, risk tolerance, and the amount of funds available for investment. We recommend bonds of medium grade for the client who needs relatively high amounts of income from his or her investments, if the investor is willing to accept the associated risk of default that comes with such investments. Clients who need lower amounts of income or who have a lower tolerance for risk are directed to investment-grade or government bonds.