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Wednesday, January 02, 2008

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"HOW TO" Be a good client and prosper 01/02/08

There are plenty of books and articles written over the years on what criteria investors should use when choosing a money manager. Analyzing the various money management styles and how they match up to the client’s objectives as well as personality have all been discussed in depth. However, we cannot recall ever reading a “how to” book on what it takes to be a good client once a money manager has been selected. Believe it or not, the responsibility for failed relationships between the money manager and the clients is shared by both parties. This is especially true for clients that retain a money manager in a Separate Account Management structure. Why Separate Account Management? The answer is that this particular style offers the unique advantage of full transparency and full access to the money management team for the client. Therefore, the lines of communication are open creating the ideal situation for a true team approach between the client and the money manager.

The client shares in the responsibility for the short, intermediate, and long-term success of the investment program. Clients that simply delegate their funds to a chosen money manager without understanding their responsibilities in the process usually bail at the first sign of underperformance. Unfortunately, their timing is usually horrendous, and they are notorious for being contrarian indicators. Furthermore, they usually add to their misery by “Performance Chasing” the next hot money manager of the quarter.

Your friendly neighborhood Kcap team has composed a list that all clients should abide by if they hope to have a prosperous long-term relationship after they “carefully” select a money management team:

· All clients need to be realistic regarding volatility. Living with and embracing short and intermediate term volatility is almost always a necessary component to achieve significant out performance over the long term. Clients who unrealistically demand low volatility yet expect high returns are sure to be disappointed and ultimately will switch to a new money manager, but will never be satisfied in their utopian quest. In other words, instead of abhorring volatility, clients should accept short-term fluctuations and even embrace them as opportunities for enhanced returns. Clients who are striving for significant out performance need to accept the fact that some of their statements will be on the dark side. Even the best money managers in the world have a cold spell. Clients need to consciously remember that the long-term trajectory of the account should far out-way the short-term gyrations.

· Clients that understand the long-term strategy that their money manager uses need to also be flexible when the manager deviates for short-term opportunities. We are not talking about style drift, but instead allowing the manager to operate in several time frames i.e. They can be long term bullish, yet remain short-term bearish. Good money management teams need the ability to carry significant cash or even short positions for an extended period of time while waiting for the proper setup to implement their longer term bullish strategy. Clients need to allow the money manager this flexibility with full understanding that the short-term plan may turn out to be incorrect.

· The media, clients, and virtually anyone who invest in the financial markets are obsessed with artificial dates used to measure the performance of investment portfolios. Quarterly ends, and especially the all mighty December 31st are used by clients like a gun to the head of each and every money manager. This has the undesirable effect of forcing money managers to either take outsized risks or avoid opportunistic risks when those critical dates are drawing near. For heaven’s sake, what difference does it make on what the value of your account is on exactly December 31st at 4 p.m. versus January 15th at 4 p.m.? Should you really be making decisions about your money manager based on one single mark in time? Unfortunately most people do, which has a huge negative effect on the performance that most money managers deliver to their clients. Ironically, money managers that do not live and die by theses artificial dates tend to deliver far superior long-term performance than their peers who are enslaved to this ridiculous phenomenon.

· Be a partner in the overall strategy with your money manager. This means that the client should take the opportunity to understand the short, intermediate, and long term views of the money manager. A good money manager can explain in uncomplicated terms the investment strategy for various time frames. The client will have ample information to assess the merits of the investment plan and will therefore be more comfortable with the outcome as long as the strategy is being properly adhered to (allowing for flexibility). Clients that do not want to know how the money manager will achieve great returns but only care about watching the performance will surely bail at the first sign of volatility. In other words, a client as a partner in the plan will have much better staying power as the money manager works the plan. Obviously the client has to believe that the money manager still possesses the intelligence and capability to deliver excellent long term results in the first place.

· One of the most powerful tools in investing is dollar cost averaging. Clients would benefit tremendously by providing their money manager a steady diet of fresh cash that can be utilized especially during volatile markets. There is nothing more beneficial to long-term performance then adding to quality existing positions when they are down. Ironically, clients too often withdraw some or all funds from their money manager at precisely the worst point in time which dramatically lowers long-term performance. In fact, some clients treat money managers as an ATM, which is a tremendous drain on the performance of an equity portfolio. Statistically, it has been proven that clients who add money to quality money managers during times of severe volatility dramatically outperform those that do either nothing or withdraw some of their funds.

· All money managers charge their clients fees based on numerous factors. When comparing the fee schedule between two different money managers, the client should consider factors such as risk management control, access to the money manager, lockup periods, termination charges, front end loads, level of transparency and target returns.. There are other more obvious considerations such as past performance but the above list is too often ignored.

· Clients should not compare money managers with different investment styles. All styles go in and out of favor, which will affect short to intermediate term performance. However, most quality money managers can offer solid long-term performance despite the temporary headwinds of their particular style. Clients that jump from style to style are likely to chase their own tails. Clients should also be aware not to get lured by the “next best thing”. Too often they think someone else has invented a better bread box when in fact staying with the tried and true methodology is the best way to achieve solid long term performance.

· Clients should expect hot and cold streaks from their money manager even when their style is in favor. The best money manager will eventually have a cold hand or fall into a hole that they will need to dig out from. Unfortunately, clients want to only be with managers that have a “hot hand”. This is another large mistake which causes them to chase their tail as they rotate from money manager to money manager.

· Clients should show a sense of loyalty and offer encouragement to their money manager. The money management business can be very cold. Clients that show loyalty, long term commitment and encouragement during those stressful times help the money manager to remain confident and clearheaded. This will help the money manager to avoid taking unnecessary risks but rather provide the confidence to take well calculated risks. In other words, a book of clients that know how to act maturely during stressful times is extremely important to the money manager to deliver successful performance. Experienced money managers should cut lose high maintenance clients that provide negative energy during times of underperformance. In other words, everyone benefits when the whiners and complainers are eliminated (good bye and good riddance).

· Clients need to fully understand the differences between momentum and contrarian investing. Furthermore, clients need to commit to the pros and cons inherent in whatever particular style is being used. For example; there are specific negatives inherent to contrarian investing such as enduring short-intermediate term underperformance. Tremendous patience is a must. On the other hand there are significant negatives to momentum investing as well; such as the potential for sharp volatility in the value of the portfolio. Clients that understand the downside to the style that is being utilized will be much more at ease through the long term investment plan.

· Clients would be far better off concentrating solely on absolute performance as opposed to relative performance verses an arbitrary index such as the S&P 500. Trying to always stay close to the relative performance of an index is an excellent recipe for mediocrity. Most of the time, superior long-term results are delivered by ignoring the averages. Short or even intermediate term underperformance is usually a necessary evil in the quest for superior long term performance as has been mentioned earlier. This is especially true with contrarian style investing.

· Clients should not pay any attention to the media cheer leaders or dooms dyers. Those entities always live in the short-term, and only know how to extrapolate current market conditions into the long term. They are only after ratings and do an excellent job of proving to be contrarian indicators for savvy money managers. DO NOT GET SWAYED BY THEIR AUTHORITATIVE EXUBERANCE!

· Clients need to understand the strengths and weaknesses of Wall Street analysts. Simply put, most if not all are nothing more than glorified accountants that are completely useless with their stock recommendations. They have virtually no feel for the psychology of the market which is 90% of the game. Timing is everything with stock selection and they have NONE! However, they do provide some research for smart money managers to use in making their OWN decisions about IF and WHEN a stock should be bought or sold.

· Clients should never micromanage their money managers. Active money management entails buying and selling many stocks often resulting in losses. A client that sees many losing transactions should not be concerned as this is often a case of good risk management techniques being deployed by the money manager such as tight stops, etc. Money managers often deliver strong overall performance despite taking many realized losses in the account. Realized losses also help with tax planning.

· Clients need to stop having aversions to large quantities of cash that the money manager might be carrying for extended periods of time. The money manager is responsible for long-term performance, and if he feels carrying significant cash is the appropriate thing to do than the client needs to respect that decision. Fees should be unaffected by the amount and length of time that high cash levels remain in the portfolio.

The above list is not comprehensive, but covers many of the pet-peeves that your friendly neighborhood Kcap team has endured and learned from over the years. For this reason, we are very selective with who we take on as a fee paying client.

Many readers of the Kcap trading blog whom are not fee paying clients have asked us to publish our returns. We are happy to report that the range for our client base in 2007 was up approx: 50% - 75% while the S&P 500 was only up approx: 3%....oops there’s that relative performance thingy.

Predictably, a few immature clients decided to pull out some money early in the year before our awesome returns really kicked in. Our bearish posture in the first half of 2007 had us slightly underperforming the S&P 500 at that time. Those clients that pulled some money away (others were asked to leave) were the type that failed most of the criteria that we outlined above. They missed out, and as Mr. T would say, “We pity the fools”. Happily, most of our clients remained fully engaged and are loving life with Kcap.

If You Held A Taser To Our Head:
Your friendly neighborhood Kcap team will continue to be uninterested in mediocrity. We will continue to implement the strategy of accepting and even embracing short-intermediate term volatility which we believe is a necessary component that through trading produces excellent long-term results. In addition, momentum and contrarian investing will both be deployed in our client’s portfolios which are guaranteed to produce volatility and at times underperformance (respectively) in the values of their accounts. This is our style and we remain excited and confident that significant long-term outperformance can be achieved. We encourage our existing clients to adhere to all the guidelines listed above. We are straight forward in our dialog to our clients and always look for willingness for them to follow these guidelines. Those that will not should leave.

This will be the last post of the Kcap Trading Blog for a long while. We are just too busy navigating the financial markets to maintain a regular posting schedule. The huge gaps between posts are unfair to the readership and we have decided to postpone this blog indefinitely. We will consider restarting the Kcap Trading Blog under a subscription service in the future as we add more resources. However, you may catch us posting to the free blog once in a blue moon just to say hi and share some thoughts.

If you want to start a fee-based money management relationship with Kcap, and have ($1.5 Million dollars net worth, including your home), call us to further explore at (732)617-9001. Oh,…and please call us only if you think you can meet the criteria that we have outlined throughout this final post.

Until next time, whenever that may be; Thank You Very Much for reading the Kcap Trading Blog – Hope it was informative, fun, and profitable.
All the Best,
Mitch and The Kcap Team

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