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HOlmes Osborne

    Small Can Be Better!

  We recently purchased a series of bonds that yield 3.5% and mature in a few years. Not bad considering comparable certificates of deposit yield about 1%.

The bonds were issued by Kansas City Southern Railways, one of the largest railroads in the country. The bonds were associated with KC Southern’s Mexican division, though normal in almost every way except for one—the bonds are not rated by a major rating agency like Standard & Poors or Moodys. Therefore, many financial advisors have their hands tied and cannot buy these bonds for clients.

Imagine that! Internal rules from investment companies that preclude advisors from using common sense. The odds that these bonds won’t get paid 100% are extremely low.

Ironically, the rating agencies are not always accurate. Think back ten years about all of the AAA rated (strongest rating) bonds of investments that went belly up. Through our analysis and our opinion, we feel that the rating agencies are right about 70% of the time. The rest of the time is open to interpretation.

   Unfunded Pensions

So many pensions are stating that the returns will be 8% for the next 30 years, yet have 30% to 40% in fixed income yielding a little over 2%. This would mean the growth portion of the investments would have to return close to 10%. Warren Buffett recently stated that the Dow would reach one million in one hundred years. That’s not much of a prediction as the annual rate of return would be close to 4%.

The people who manage these pensions need to state realistic investment returns.
 Third Quarter Activity

In August, we purchased stock in the erstwhile newspaper giant Gannett. Gannett publishes USA Today, Detroit Free Press, Indy Star, and several other newspapers. The stock has been down but appears to have bottomed out. We like it because it yields over 7% in dividends. Our theory is that some people have to read a local newspaper and you can’t get all of your news on the internet.

We sold our position in Belgian holding company Grope Bruxelle Lambert. We made about 12.5% in four months. Not a bad return. The best part was that the stock paid a 3.5% in dividends right after we bought it.

We sold the Learning Tree after nine months for a profit of about 7%. The Learning Tree is an online education company.

We sold our position in Pearson and lost about 16%. Pearson is the publisher of Penguin Books and also publishes student text books. In the past, it owned a majority of The Economist and The Financial Times.

Pearson is trying to transition from publishing into education. It’s probably a good idea but we’re not going to stick around to see how things work out.

The major problem was that when we bought the stock, management was touting its dividend. Subsequently, management cut the dividend. Why tout something if you know you might eliminate it? To us, it seemed disingenuous. We don’t trust Pearson’s management team.

We finally sold our position in Hong Kong Shanghai Land after three years and three months. We made about a 21% profit.

The company owns what is arguably the most luxurious hotel chain in the world—the Peninsula Hotels. At the flagship hotel in Hong Kong, drivers will pick you up at the airport in a Bentley.

The reason that we bought the stock is that the underlying land was worth about double what the stock was trading for. Unfortunately, the stock took us on a rollercoaster ride. Finally, a big investor recognized what we saw and started buying up shares, driving up the price. We were happy to sell our shares and move on.

Towards the end of the quarter, we bought an energy fund named Energy Select SPRD EFT (XLE). The fund holds all of the major oil companies including—Exxon, Chevron, Occidental, Conoco, Phillips 66, etc. The fund yields an impressive 2.67%.

We bought the fund because oil has been down and out. With the invention of hydraulic fracturing, new oil discoveries are being made everyday. Having stated this, the fund had bounced off its bottom and we bought on the rebound. We’ll hold for a little while and hope to make a nice little profit.

Just for fun, we shorted a tiny bit of stock in Adidas. Adidas got itself in trouble when one of its executives got caught bribing several college basketball coaches. You’d think the stock would immediately drop but it did not. Very strange.

We don’t normally short stocks as it is a little risky but we did this time for entertainment. Ironically, we got to know adidas because it is a holding of the aforementioned Groupe Bruxelle Lambert.

 Everyone Rushing into the Same Thing at the Same Time

We have written on this subject before but it’s worth revisiting. So much of the industry is investing in index funds and stock mutual funds that all look about the same. It’s the usual suspects: Apple, General Electric, Disney, etc.

The theory behind index funds is pretty simple—the fees are low and it’s challenging for fund managers to outperform the averages. The problem is that everyone is doing the same thing at the same time.

Brokerage firm A looks like brokerage firm B. Financial planners and insurance people all look the same. Prestigious trust companies and private wealth managers all resemble one another.

What happens when the market makes its periodic 40% pullback? Is everyone going to run for the doors at the same time? People in index funds think they’re invested in something safe. They have also been conditioned to think that the market (American) always recovers. Nowhere in the U.S. Constitution or the Bible does it state that the stock market must bounce right back. Though it has recovered fairly quickly for each occurrence in the last four decades, this has not always been the case.

What will happen when index fund investors find that their accounts have been underwater for five years? Will they remain patient or lose hope and do something else? Or will they leave Brokerage Firm A and go right back into the same thing at Brokerage Firm B?

We don’t know. We just don’t want to be there when everyone hits the doors at the same time. We hope that we are out of the building.

When this firm was founded in 2004, we thought the real estate market was going to crash that year. It took another four years for that prediction to come ture. Nothing really bad has to occur for the stock market to “correct” 40%. It happened in 1974/1975, 1987, 2001, and 2008/2009. Each time, the markets came roaring back.

It used to be that financial advisors got to pick investments for clients and use their own judgment. Now, a new generation of advisors is in business. This generation has never picked a stock, never gone to an annual shareholders’ meeting, never read an annual report. They merely gather assets and can tell you the difference between a Roth IRA and a traditional IRA.

Truthfully, you can do all of this on your own through Vanguard or one of the many other financial companies that offers low fee index funds. You can Google “difference between Roth IRA and IRA” and find an abundance of information.

When we have ten years of no growth, people are going to be looking around for some place to make higher rates of return. We hope that we can be that place.

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