Market Update Call Audio Transcript July 24, 2013

Transcription

1 Market Update Call Audio Transcript July 24, 2013 Speakers John M. De Clue, CFA Chief Investment Officer Edgar W. Cowling, Jr., CCIM Director of Specialty Assets Opening: This is a recording of the Market Update Call held on July 24, The discussion featured perspectives on current global economic and market conditions. Comments were also shared about the capabilities available through the Specialty Asset Management Group which is part of U.S. Bank s Wealth Management Group. Welcome to today's Market Update discussion. I'm John De Clue, chief investment officer for the Private Client Reserve of U.S. Bank. With me on the call is Ed Cowling. Ed is senior vice president and director of Specialty Assets for U.S. Bank Wealth Management. Ed is here to share his insights and expertise with respect to this important asset class. I want to thank you, Ed, for joining me today. Happy to be here, John. Before I turn to Ed and our discussion of specialty assets, let me briefly discuss the state of economies around the globe and specifically what we think are very important developments regarding actions taken by world central banks. I'll also take a minute at the end of the call to give you our outlook for the capital markets. When I think of developments in the investment markets I've always tended to think in terms of phases rather than years. Many on this call might remember the fight against inflation spearheaded by Chairman of the Federal Reserve, Paul Volker first under President Jimmy Carter and then under President Important disclosures provided on pages

2 Ronald Reagan. You may remember we had Reaganomics which extended throughout most of the 1980s, followed by the formation of the Internet bubble unfortunately in the 1990s, and then just recently the collapse in the housing market and the resulting financial crisis in Since then, I think it's safe to say that the single most important influence on the investment markets, not just here in the United States but around the world, has been what we've witnessed in terms of central bank interventions which have occurred on a scale that's previously just unimaginable. From the Federal Reserve's quantitative easing programs here in the United States to the announcement last year by the European Central Bank that it would execute outright purchases of government bonds to recent actions by the Bank of Japan to flood the Japanese economy with liquidity, both the number and the magnitude of these central bank actions around the world has just been astonishing. So I think it's fair to say that if we think in terms of phases instead of years, the phase we've been in for the last few years is characterized as one dominated and driven by this phenomenon of central bank intervention. So the question is, is this phase about to end? And I guess I'm going to duck this and say the answer kind of depends on your time horizon and your country of reference. So, the answer could be either yes or no. Here in the United States, the answer is probably yes. As most on this call probably know, Chairman Ben Bernanke of the Federal Reserve unintentionally rocked the markets a few weeks ago by indicating that at some point, quantitative easing in the United States would end through a process of tapering. And the result was, in part, the creation of a humorous line by market participants calling it a taper-tantrum. But in any event, thanks to further clarification from Fed officials, as well as reflection on the part of market participants, the markets did regain some sense of calm. But it does seem that here in the United States there's certainly a feeling that we've entered a new era or phase. Now we can't say the same of Europe which remains mired in recession with a very accommodative European Central Bank. And you can't say that for Japan either with the Bank of Japan providing enormous amounts of stimulus to turn the Japanese economy around and break what's been a decades-long pattern of deflation. But for the first time now in several years, we see the very interesting and meaningful development of a divergence in central bank actions and the investment markets have begun to respond accordingly with what has been uncomfortably-high correlations between asset classes in markets now beginning to diminish. And should this continue, it may represent a very positive development for investors interested in diversifying their holdings based, in part, on owning assets that don't tend to move in Important disclosures provided on pages

3 lockstep and may even move in opposite directions during certain periods of time. So, this is the trend, and by that I mean diminishing correlations between markets, that we're monitoring very, very closely. Speaking of the benefits that arise from relatively low correlations, let me shift gears and turn to what we call specialty assets, a term we use in U.S. Bank to identify a diversified group of assets that we can help clients manage within the context of their broader investment portfolio. And let me bring in my colleague, Ed Cowling, to help us better understand this important and interesting group of investments. As I mentioned, Ed is Director of Specialty Assets in the Wealth Management Group of U.S. Bank. So, Ed, perhaps you could explain to us just what do we mean by the term, "Specialty Assets," and why at U.S. Bank do we believe it's important to be actively involved in helping clients manage their holdings in this area? You bet, John. This is a term that describes what we also refer to as real assets or non-financial assets. These are tangible assets such as real estate, farms or minerals that are not readily marketable on public exchanges. They are distinct from stocks, bonds or cash instruments. And they are important investments for many of our clients. Under this broad heading there are several different categories of specialty assets that our professionals can provide specialized experience in to help clients in managing these assets within their overall portfolio. So with that said, let's dive deeper into it, Ed. Let's go through the different types of specialty assets where we provide guidance. Some of the examples include real estate, which can include both residential and commercial, farm and ranch land, timber properties, interest in minerals such as oil and gas and also closely held entities or private businesses. So in terms of magnitude of assets, how do specialty assets stack up against stocks and bonds and more traditional investments? Well, according to the information from the U.S. Census Bureau, a very large percentage of the wealth in America is held in non-financial assets. So, John, imagine the size of the wealth in all the real estate, farms, minerals and businesses in the country. This class of assets also makes up a substantial portion of our client's net worth. And we believe that these assets deserve the same kind of active management from experienced and capable professionals that investors have become accustomed to with more traditional vehicles like stocks, bonds and cash. Important disclosures provided on pages

4 We also believe that specialty assets are truly an important asset class. These are investments that can produce a valuable stream of income and also have the potential for price appreciation. Isn't it true, as is the case with stocks and bonds that these assets can fluctuate in value? Well that's absolutely true. Just as with other financial assets, past performance does not guarantee future results. Markets can go up and down and specialty assets may have other risks that need to be managed and mitigated. Give us an example of one of those risks. John, one of the biggest risks is risk of liquidity, because assets like real estate and farms are not traded on public exchanges there is generally a lack of liquidity. And economic influences, such as mortgage rates or commodity prices, can affect the value and marketability of these assets. Before clients invest in any of these specialty assets, they need to keep these facts in mind. And if they own them already, they will likely appreciate having experienced professionals help them manage these risks. Let's go through the different types of specialty assets you listed earlier, Ed. And why don't we begin with real estate? A great deal of the wealth is held in real estate. For some people, it may include their primary residence but it could also be a second home. Some clients own commercial property, as well as a source of income from a tenant's lease. So what would lead a client to approach us at U.S. Bank for help in managing real estate? There are a variety of reasons, but let me pick out just one. Real estate is often a more complex investment from an asset management standpoint. One of the keys to managing a commercial property and making money doing so is in tenant selection and tenant management. It takes significant time and expertise to help make sure the tenants and the property are potentially top performers. Real estate management includes everything from maintenance to leasing a property to acquiring and selling residential and commercial properties. Understanding how to capture the full spectrum from real estate holdings is critical to the overall return that this investment generates. You mentioned farm and ranch land. Talk to us a little bit about this class of assets. Important disclosures provided on pages

5 John, this encompasses productive agricultural land that's owned by clients who need the assistance of qualified and dedicated management. All across our country, many of our clients own or have interest in farm and ranch properties. We've been managing agricultural properties for a very long time. When you say managing properties, talk to us a little bit about that. Well one example is a case where an individual has been farming for years, but is reaching a point where he is ready to slow down or even retire. Maybe he's passed that on, but there's nobody in the family to take over. The children have moved away and their interests lie elsewhere. Yet maybe the farm is productive and can still generate a good return or may have special sentimental value to the family. We step into the farmer's boots in a management and oversight role. As such as we interview local farmers and select the best candidate to operate the land. And we keep an eye on the operating farm and production and continue that ongoing return. Our farm managers are all farm raised and each has an agricultural background with at least 20 years of ag management experience. They know how to raise and market crops and they are focused on being good land stewards and ensuring the tenant farmer has those same capabilities as well. And they are all located in key farm and ranch areas across the country. Sometimes these things are exactly what are needed for somebody with a farm or ranch property. Okay. Let's move on to timber, which is interesting to me because I have some experience with clients that have very substantial timber interests. Just talk to us a little bit about that if you could. Well these are situations where the client owns properties where forestry and the growing of trees and land management is important and is required. In some cases, timberland is held for recreational or hunting purposes, but of course, it also has value as well and can be a very good investment. Where do you see particularly value in timberland from your perspective? Well timberland is an investment that can provide a hedge against inflation. And it has numerous advantages as well including tax advantages. Prices for timber have historically tracked with the rate of inflation and trees generally grow and that growth, when harvested, can provide additional volume which increases the value of the portfolio. The timing of the harvest can be managed as well, so if we're in a period where timber prices are down or if the client needs to delay income to help manage taxes, we can just let the trees grow and delay the harvest and the sale of the assets. And, John, while we don't provide tax advice we'll work with the client's tax and legal professionals to help capture those potential tax benefits. Important disclosures provided on pages

6 Interesting. So let's turn to oil and gas and talk about that a little bit. Sure. Individuals or Trusts may hold oil or gas or other mineral interests that can generate revenue. Maybe the minerals are part of a farm property or other real estate that they own. Or maybe they've inherited an interest in severed minerals. Demand for natural resources is strong and is, of course, reacting to an ever-expanding global marketplace. So my question is similar to the one I asked you about farmland. Give us a feel for your team and how you add value in the management of oil, gas and minerals. Okay. Some good examples of where our expertise comes into play would be lease negotiations and monitoring of those leases and dealing with environmental inspections. And, you know, John, with the discovery of new producing fields and with new technology, people who did not have mineral activity in the past may now be faced with some unique decisions that will impact them for a long time. The experience that we harness and provide may really help them out. Okay. Ed, you mentioned a category that seems to me to be a little bit different from what we've talked about thus far and that is closely held entities or private businesses. Talk to us a little bit about them and explain this type of asset. Well this certainly is different. Clients may be direct owners or heirs to a closely held business through corporations or partnerships, or they may hold a minority interest position in other types of closely held assets commonly referred to as non-marketable securities. An example would be a partnership interest in an operating company or holding in an investment vehicle. How does your group add value in this area? Well, through overseeing these assets, which is a real challenge and it takes a lot of time. Our professionals have meaningful business experience and can assume some of the routine tasks of owning these assets, such as voting proxies and processing distribution. We can also help with non-routine matters like the need to obtain independent appraisals to facilitate estate settlement or gifting strategies. Our team can play a modest role in helping consult on these assets or play a more direct role for the clients who would like to scale back their own involvement and simply hand it off to our team. So let's take another turn now and talk about the idea of what we call fiduciary relationships. Talk to us a little bit about what kind of clients you work with in that context and that might hold specialty assets. Important disclosures provided on pages

7 Well there are several fiduciary relationships that may hold specialty assets or that might potentially benefit from the investment attributes of these assets. Let me touch on a couple of them. Sometimes a person may inherit a nonfinancial asset, in addition to financial assets such as stocks and bonds. Without the experience or the ability to manage these types of assets, their first instinct might be to simply sell the asset. If they know more about the value of what they hold, they may not be as anxious to sell or they accept a price that is less than the asset is really worth. It's hard to manage some of these assets, like a farm, without some experience or if you're living 1,000 miles away from it and that happens quite often. We will work with clients in estate settlement situations and within revocable and irrevocable Trust structures to help manage these specialty assets. And we also have situations where we are agents for the client. Are most of these situations where the clients already own the assets or are there times when they're looking for help in obtaining a specialty asset for their portfolio? John, we deal with a mix of both of those circumstances. We help a lot of clients who already own the assets and perhaps they've inherited an asset where they have little experience or interest in managing it. There are also cases where clients have limited diversification in their portfolio and might benefit from having an ownership position in certain specialty assets. So, let me sort of bring this back home to where I was talking about correlations between asset classes and so forth and working with a diversified portfolio. My question would be, how do you incorporate the work your group does in Specialty Assets with other areas of U.S. Bank Wealth Management in terms of supporting the client? We work closely with all of our internal partners, such as the relationship manager and the portfolio manager who is overseeing the stock and bond portfolio. We also work closely with the client's other advisors, such as their attorney or CPA. We focus on incorporating the specialty asset into their overall portfolio and into the planning process. And, we all want to look at the client's unique objectives and if appropriate may suggest that they incorporate a farm or a commercial real estate property into their holdings if that helps them meet those objectives. Of course, these assets are not for everybody, but for some clients, real estate holdings or a farm property may be a proper investment consideration. That brings me to my last question, what's your view as to how specialty assets fit into an overall asset allocation model? Important disclosures provided on pages

8 John, we often talk about the importance of an asset allocation and portfolio diversification. Owning real estate, farms or timber, as part of an overall portfolio may provide those diversification characteristics and enhance or benefit the client's portfolio. Non-financial assets generally are not highly correlated with other financial assets. What that means is they react and move differently from stocks and bonds through different market cycles. That kind of diversification can help limit the risk in a portfolio and in addition, commercial real estate, farms, even timber, may have certain income and appreciation characteristics that might be important to our clients. Ed, thank you, I appreciate you joining me today and going through specialty assets. It's a subject I know I hear more and more about from clients who either have exposure or an interest in that. Let me turn to the investment markets and our current recommendations regarding portfolio positioning. And as always, please keep in mind that not all investment solutions or strategies mentioned may be appropriate to all clients. Your U.S. Bank investment professional will be happy to discuss your particular situation in the context of our thoughts and advice. In a nutshell, economic data both here in the United State and around the world has recently been mixed. But, we remain fairly constructive as to the overall health of the economy on a global basis. In the United States, the Conference Board's Leading Economic Indicators Index has grown more than 2.8% over the past year and growth in employment has been reasonably good. Not as good perhaps as we would like, but reasonably good. And importantly, around the world, inflation seems very well contained. Europe does remain in recession, but there are some new signs of improvement there, and also definite signs of improvement in Japan where spirits of both consumers and businesses have been lifted by recent actions, as I mentioned earlier, on the part of the Bank of Japan. It could be argued that one cloud on the horizon is China where economic growth certainly has slowed. But remember, the GDP or gross domestic product growth in China is, frankly, still at a level that most other countries would love to have in their own economies so everything is somewhat relative. With all this in mind, we continue to believe that stocks are reasonably valued and may be positioned to do well for the remainder of the year. And we've also recently added to our overweight in equity-oriented hedge funds. We find equity valuations very attractive, in particular with respect to bonds. Despite disappointing performance year to date, we also remain overweight in emerging market equities due to attractive valuations, which I believe are at historically low levels in terms of that area of the world. Important disclosures provided on pages

9 As the fixed income or bond obligations, markets have begun to price in an end to the Federal Reserve's quantitative easing program through a steepening of the yield curve which we expect to continue. We, therefore, remain generally underweight fixed income or bonds due to the low level of interest rates on an absolute historic basis. I should say one exception to this, however, is that we're overweight, again, in hedged fixed income strategies where active managers can continue to add value through various tactics and strategies around that. As to commodities, our exposure is modest and we maintain a neutral stance primarily as a hedge against unforeseen price spikes in certain key commodities, such as oil. Ed touched on oil and gas and of course, it's still very much a two-pronged story, the development of resources here in the United States, but still geopolitical risk in the Middle East. On an overall basis though, our expectation for commodities going forward while somewhat positive given an improving global economic outlook, is fairly limited. And finally, we remain neutral with respect to REITs (or Real Estate Investment Trusts). And the reason for that is that valuations are still relatively high on an historic basis. Again, Ed, thank you for joining me on the call today. And to those of you on the call, thank you very much for your relationship with us and for taking time to attend the call. And please join us, of course, for future calls. Details on these future calls can always be obtained from your U.S. Bank advisor. Closing: Thank you for listening. We invite you to join us for future calls. Details can be obtained from your U.S. Bank Advisor. IMPORTANT DISCLOSURES This information represents the opinion of U.S. Bank and does not constitute investment advice and is issued without regard to specific investment objectives or the financial situation of any particular individual. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. These views were presented on July 24, 2013 and are subject to change at any time based upon market or other conditions. The information presented is for discussion purposes only and is not intended to serve as a recommendation or solicitation for the purchase or sale of any type of security. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to Important disclosures provided on pages

10 accuracy or completeness. Data and research information and statistics have been gathered from a variety of sources. U.S. Bank is not responsible for and does not guarantee the products, services or performance of its affiliates and third party providers. Any organizations mentioned are not affiliates or associated with U.S. Bank in any way. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes are unmanaged and are not available for investment. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investment in fixed income debt securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Investments in real estate securities, real estate and other non-financial assets can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate or asset values, changes in interest rates, and risks related to owning properties (such as rental defaults). Important disclosures provided on pages