July/August 2008, Wealth Manager
For one wealth manager, bonds are the only game in town.
By James Picerno
Asset allocation? Don’t even think about it, says
Stan Richelson of the Scarsdale Investment
Group, Ltd., a Blue Bell, Pa. wealth management
shop that he runs with his wife, Hildy. The only
sensible strategy, he insists, is all bonds, all the
time, for all clients.
Richelson is an affable fellow who just happens to have
an extreme perspective on investment strategy—at least
relative to most of his contemporaries in finance. Then
again, he’s only too happy to explain his reasoning: “I have
a very dark view of the world,” he admits.
The idea of building multi-asset-class portfolios for
clients may be widely hailed as judicious, but the received
wisdom draws a Bronx cheer from this fee-only wealth
manager. His reasoning is equally curt. “It’s all about wealth
preservation,” says Richelson, a tax lawyer by training who
switched to dispensing financial advice full-time in 1991.
Richelson concedes that a bonds-only strategy invites a
fair amount of inflation risk over time. His solution? Save
more, spend less.
As for looking to some mix of stocks, REITs, commodities,
and other asset classes for complementing
bonds, the idea strikes Richelson as unduly risky. “I like
individual bonds,” he counters. “Why? Because they
come due. Once you buy a bond fund, whether it’s an
ETF or an open-end or closed-end fund, you’ve moved
into a quasi equity.” Meanwhile, if a client is sufficiently
wealthy to live off the income stream generated by
bonds, there’s not much point in seeking out higher
risk, he reasons.
When Richelson speaks of bonds he’s talking about
Treasuries and U.S. agency securities, such as Ginnie Maes.
He’s also a fan of munis and, at times, high-grade corporates
and even TIPS, but he avoids high-yield and foreign
bonds. His preference for a particular type of debt depends
partly on the particulars of his clients—who include both
high-net-worth investors and those of more moderate means.
But his controlling philosophy is always the same: Avoid risk
by favoring high-grade domestic bonds, a strategy Richelson
details in Bonds: The Unbeaten Path to Secure Investment Growth
(Bloomberg, 2007), which he co-authored with Hildy.
For some perspective on his wary way of thinking, he cites
the so-called “Black Swan” risk, a reference to two books by
Nassim Taleb—Fooled By Randomness and The Black Swan—that
explore the causes and consequences of unpredictable events
and how they can wreak havoc on the best laid plans of mice,
men and naive investors.
In a recent interview with Wealth Manager, Richelson elaborated
on his bond-besotted investment philosophy, poking his
finger at a few sacred cows along the way. “You’ve never heard
this point of view spoken so forthrightly and with such passion,”
Richelson’s approach to investing may be atypical, but that
alone doesn’t make it right, or wrong. It does, however, make it
interesting, all the more so when you consider that Richelson
has been around the career block a few times. Having worked
for a large Wall Street law firm as well as several large corporations,
this tax lawyer is well acquainted with the finer points
of high finance. Perhaps he favors bonds because of his experience
in the financial industry—-or in spite of it?
Q: In your book, you effectively dismiss asset allocation by advocating
an all-bonds strategy. Isn’t that a touch radical?
A: Let’s first talk about the book’s intended audience, which is
the individual investor. We’re talking to the man-in-the-street
who’s being seriously beat up by the financial services industry,
and he has limited options. He can’t do all the things that
the Harvard Endowment can do [i.e., invest in conventional
and alternative asset classes such as venture capital]. What
can an individual do? He can invest in stocks, he can invest
in bonds, he can make believe he’s investing in real estate by
buying REITs—which aren’t real estate. He could go into exotic
stuff and pay enormous fees that he doesn’t see or know
about. He can speculate in gold and other commodities, and of
course he’ll get his timing wrong.
Q: What about mutual funds?
A: Yes, of course, but depending on which ones he’s in, he might
pay loads. And if he’s buying small or foreign stock funds, he’s
going to pay fees that, according to [Vanguard’s] Jack Bogle,
are somewhere between 2 percent and 8 percent every year in
addition, probably, to a front-end load. And an advisor may be
laying another 1 percent on top of that.
Q: Eight percent? Presumably you’re referring to charges over
and above the stated expense ratios?
A: Yes. Consider a small-cap foreign equity fund. Some of the fees
are disclosed—management fees and expenses. But what you’re
not seeing are things like the trading spreads and the brokerage
commissions. Add taxes and bad timing to the expenses,
and the investor’s cooked. He’s never going to make any
money in equities. He doesn’t know what he’s doing when he’s
buying real estate. What is he left with? I think he’s left with
bonds, and I’m talking about individual bonds.
We’re in Pennsylvania, so if you buy a 10-year Pennsylvania
muni at new issue, and you sit with it for 10 years, there are no
taxes and there’s no bad timing.
The first chapter of our book lays out this argument, which
says that stocks have not outperformed bonds for the hypothetical
individual if you adjust for taxes, expenses and bad
timing. If you risk adjust for stocks and bonds, you see that
bonds are a much better deal.
Q: Just to be clear, you’re not saying that bond indices outperform
A: No, but I’m saying that the man-in-the-street can’t get those
[stock index] returns. No individual has ever gotten the Ibbotson
10 percent return on equities because investors pay taxes
and fees, even if they don’t suffer bad timing.
Q: On the other hand, what kind of return can investors expect
from a muni bond? Inflation adjusted, doesn’t the long-term
outlook for returns for munis look grim?
A: It is grim; that’s the whole point. Everyone wants to say that
you can average 10 percent after fees, taxes and so on [in
stocks]. The people of modest means are screwed. If bonds
are going to give them 4 percent to 4.5 percent tax free, how
is anyone going to retire on 4.5 percent tax free? But you’re
not going to do any better in the other asset classes. It’s all
razzle dazzle and smoke and mirrors. The
face of reality is this: If you can get 4 percent
after tax [with bonds], I don’t think
the man-in-the-street is going to do better
by going into 10 asset classes.
Q: Some might say that the grim outlook you just outlined by
way of munis strongly suggests that the solution is holding a
multi-asset-class portfolio comprised of, say, ETFs?
A: We’re going to see about ETFs. Wait ‘til another Black Swan of
1987 shows up, and then we’re going to see if ETFs work. So
far, they haven’t been stress-tested.
Q: Doesn’t the risk of a future Black Swan event strengthen the
case for broad diversification via multiple asset classes, as opposed
to just one, as you recommend?
A: And you think the man-in-the-street should educate himself
[on investing in multi-asset-class portfolios]?
Q: Let’s assume an investor is sufficiently educated, or hires
competent financial help. In that case, what do you think
about the concept of multi-asset portfolios?
A: I reject the concept. The whole idea of asset allocation is to
maximize return and reduce risk. I’m starting with the safest
investments, so I don’t need to reduce risk. All you can say is
that I’m missing out, possibly, on future returns, which may or
may not be there.
In fact, I have a different way of looking at bonds. We have
some very substantial clients, but we don’t “perform.” Nobody
asks us for performance figures. Nobody asks, “What’s your
performance over the last three, five or 10 years?” We don’t do
performance. What we do is cash flow. With cash flow, you
buy a 10-year bond yielding 4 percent and you know what the
cash flow will be. When the bond comes due, and you reinvest,
you’re going to get more or less cash flow [relative to the previous
bond’s cash flow].
The world we live in is different than any world you’ve ever
heard of. We say, “If you’re looking for performance, go find
someone who’ll trade.” On the other hand, we’re going to get
you the yield to maturity; we’ll get you the best price; and,
we’re going to charge you a very low fee.
That’s the world we live in. We don’t live in the world that you
write about and that everyone else lives in, with all the correlations
and bell curves. I reject all that. I don’t think the bell curve is worth
anything; I don’t think standard deviation tells you anything.
Q: What’s the basis for your investment philosophy?
A: Have you read The Black Swan? That’s what we believe. Taleb’s
Black Swan analysis underlies our entire way of investing and
presenting ourselves to the public. We believe that you should
be invested in the safest stuff because the rest of the stuff can’t
be trusted because of the Black Swan risk.
Taleb recommends in The Black Swan that you essentially put
85 percent [of assets] in Treasury bonds. With the remaining
15 percent, open yourself up to positive Black Swans—in other
words, the really risky stuff in the hopes of getting a positive
Black Swan, of getting a windfall. Essentially that’s what we
do, although I didn’t come to this view from reading his book.
Q: Isn’t focusing so heavily on bonds the equivalent of making
an active, highly concentrated bet?
A: Yes. We’re saying, “I don’t trust [other strategies] for my retirement.”
I’ve invested, aside from a little venture capital stuff,
all of our money in the same bonds that we recommend to clients.
I reject asset allocation and instead I’m investing in what
I perceive as the safest asset class. We’ve become financially
independent, without taking any risks.
Q: Doesn’t concentrating investments in the “safest” asset class
insure that you’ll do poorly over time because of inflation?
A: You’re right.
Q: What can you do to overcome that head wind?
A: I save more money. Inflation isn’t going to be kind to any
Q: What about gold or oil?
A: Do you recall gold doing nothing for 20 years?
Q: Wasn’t that a function of low inflation?
A: No, it’s supply and demand. For some reason, gold fell out of
favor. You could make a lot of technical reasons about why,
but I don’t believe in any of that. There were more sellers than
buyers; nobody was interested in the stuff. I was never interested
in gold; it doesn’t pay me a return.
So, to your question about whether inflation is going to
eat you up? Yes, inflation’s going to eat up everybody, which
means that you need to save more money.