Lycos Asset Management: Managing Portfolios in Canada
To learn about portfolio management in Canada, Finance Monthly hears from Constantine Lycos, the Founder and CEO of Lycos Asset Management Inc., a Vancouver-based firm offering investment management services to business owners and professionals. Constantine has over 20 years of experience as an investment professional, holds the Chartered Financial Analyst designation, as well as a […]
To learn about portfolio management in Canada, Finance Monthly hears from Constantine Lycos, the Founder and CEO of Lycos Asset Management Inc., a Vancouver-based firm offering investment management services to business owners and professionals. Constantine has over 20 years of experience as an investment professional, holds the Chartered Financial Analyst designation, as well as a Master’s degree from Oxford University in Mathematical Finance.
In what ways does Lycos Asset Management do things differently than other investment management companies?
I believe several factors differentiate us from other firms:
- We are a boutique firm and we look after a relatively small number of families’ investment portfolios and our clients really matter, they are not rounding errors as they can be for large firms managing billions of dollars.
- Our vision, which is to manage clients’ ‘serious money’ as a marathon, using a proven and consistent approach to grow and preserve clients’ wealth with a long-term investment objective. We believe that the centerpiece for success is a long-term plan that outlines the investment polices to follow, so that clients can reach their unique goals. Our experience is that asset mix decisions have the greatest impact on portfolio returns as well as portfolio risk and we pay a lot of attention to getting that right for each and every client. The foundation of investing ‘serious money’ requires patience, discipline and objectivity.
- We are committed to the success of our clients and to fostering long-lasting relationships and we tend to have a very low client turnover rate.
- We are independent and ‘fee-only’, only compensated by our clients.
- Our advice is objective and unbiased.
- Our counsel is without conflicts of interest.
- Our integrity of counsel is uppermost.
- We are fiduciaries, i.e. we are obligated by law to put our clients’ interests first, ahead of ours and do what’s in their best interests. While this is true of all portfolio managers in Canada, portfolio managers currently make up a very small percent of the investment professionals helping families invest and manage their wealth, so we operate at the highest level.
- Client portfolios subject to a minimum asset size are fully customizable allowing for special circumstances to be taken into consideration and for better tax efficiency.
- We have a value investment philosophy. We look for good investments where there is good inherent value in the investment. If the market takes such investment down in price unless the fundamentals have changed, we feel good buying more of such investment. While this is true for all asset classes it is especially true for public traded equites where market prices may fluctuate a lot more than the inherent intrinsic values of the investments. This not only makes us more comfortable navigating volatile markets, it also provides us with opportunities at times when other investors are running scared, realising losses and taking permanent hits to their portfolios.
- The biggest problem investors face is in our opinion a behavioral bias, specifically recency bias. Investors tend to give more weight to recent performance than they probably should, feel good when markets are down and commit more capital at higher prices, feel bad when markets are up and either sell or do not commit new capital at lower prices. Our investment philosophy helps us fight this in clients’ portfolios, forcing us to buy when prices are generally low and sell when prices are generally high. We also help educate clients of the huge importance of the correct investment behavior and how it can determine their financial success more so than picking any individual investment.
- Our investment philosophy also helps us avoid ‘benchmarkitis’, a disease that has plagued the investment management community, where investment managers construct client portfolios in such as way is to be very similar to market benchmarks. This is done unintentionally by over-diversification or intentionally by trying to avoid the risk of under-performing a benchmark by a wide margin. This behavior is usually not in the best interest of clients and allows for a dumb investments, usually in highly overvalued stocks, that can have devastating effects when markets go down.
When is the best time for a family office or business owner to take on a portfolio manager?
Immediately! Business owners and professionals with a minimum of $500K of investable assets that do not work with a team of investment professionals that are fiduciaries do themselves a huge dis-service. I will emphasise the word fiduciary again, as our industry has been very good at making things look very complicated when they don’t have to be. Fiduciaries have to do what’s in the clients’ best interest. Portfolio managers licensed to operate in Canada, in order to earn the right to be able to invest client money on a discretionary basis (i.e. the portfolio manager decides what investments make up the investment portfolio), have achieved the highest level of professional qualifications, experience and integrity and are obligated by law to act in the best interests of clients. Hiring a portfolio manager when a family’s nest egg has reached 500K is a no brainer, even if they are already working with a financial adviser, typically at a bank. Our fees are usually lower than the banks’, and perhaps more importantly – the opportunities for improvements in the family’s investment portfolio and tax efficiency are huge. If they are not working with an investment professional already, the opportunities are even bigger. Research has shown that investors working with an adviser have vastly outperformed, on average, investors investing on their own. A 2016 study by Dalbar concluded that the average investor grew 100K to 305K over the previous 30 years when over the same period, the stock market would have grown 100K to 2.3 million! Working with an investment professional, especially one that subscribes to a value investment philosophy, would likely have produced at least similar results to that of the stock market. My US stock picks over the last 17 years have outperformed the market by roughly 3.5% per year, with the market returning 202% total return and my picks returning (net of fees) 425%.
What can you advise for strengthening an investment strategy?
Typically, if there is room for improvement in an investment strategy, it comes from the risk management side, for example incorporating low cost hedging. Hedging is hopefully a drag in investment performance because it means that the main investment strategy is performing well, but is there just in case the strategy does not work.
For what reasons might a client’s portfolio need to be customised?
The two most common reasons are a family’s over exposure to specific stock or sector and tax efficiency. An Executive’s or Senior Manager’s stock options or holdings in a publicly traded stock can be dealt with by using a custom portfolio – part of which includes a hedge against that single stock risk and/or sector risk. Similarly, a business owner’s exposure to a particular sector or industry can be hedged or dealt with by using a custom portfolio approach. Additionally, every family’s tax situation is different – some carry unused capital losses for example and some don’t. Thus, different strategies can be employed depending on the circumstances of the individuals involved. Capital loss harvesting can be employed for some families but not necessarily for others. More flexibility allows for better efficiency.
What is your process for identifying the risks and opportunities?
We typically look after a family’s whole nest egg and the opportunities and risks can be on the investment side, the tax side, the estate side, etc. In order to help clients as best as we can, we need to (and do) get to know our clients very well. Then the risks and opportunities specific to them and their situation will reveal themselves.
On the investment side, the risks and opportunities are more investment specific rather than client specific. We typically find the best investment opportunities in equities. They typically carry with them the most risk. Our value investment philosophy of ‘buying good businesses at good prices’ helps both to identify good opportunities and mitigate risk through a margin of safety in our valuation process. Typically, we would prefer lower beta stocks to higher beta stocks (relative volatility to that of the market), if other stock attributes are similar. My best stock ideas are in the fund that I manage, the Lycos Value Fund.
We also find good investment opportunities in private equity, albeit with an even longer time horizon than publicly traded stocks. For private equity, we would rely on outside managers. The process here is more with identifying competent and honest outside managers that are also reasonable on fees, an approach every investor should be using in selecting investment managers.
Fixed income investments are challenging in this low-interest-rate environment and are going to be challenging for years to come as either rates stay low or go up, essentially devaluing the worth of longer dated debt. We are at this point underweighting high-grade corporate bonds as the additional yield these bonds offer over government bonds is not enough to compensate for the additional risk and reduced diversification benefits, due to the higher correlation to equities. At this point, we prefer shorter-term private debt financing growth companies in the US or commercial mortgages also in the US, as the yields are better and the US economy is doing well. We also obtain private debt exposure through outside managers, so the process here is similar. In addition to analysing the risks and opportunities inherent in the asset class, we try to identify competent, honest and low-fee outside managers to help us. We also use long dated US Treasuries and long dated provincial bonds that carry the so-called duration risk, i.e. that the value of our holdings will go down as yields go up, not because of the yield we are getting from there, but primarily because of their negative correlation to risky assets such as equities.
Finally, and most importantly of all – how do all the different pieces fit together? Getting the asset mix right is the most important decision for us. Our process there is that for any particular return target for a client portfolio – we optimise the allocation to the various asset classes so that the portfolio can have the highest expected Sharpe ratio, i.e. the highest expected return divided by the expected volatility of the portfolio. We have found that this method has worked quite well.
Of what importance are third-party custodians in the management process?
Having independent third-party custodians to hold client cash and securities is important to our clients. As managers, we make buy and sell decisions on clients’ behalf, but we do not have physical access to their money, cannot make withdrawals from their accounts and essentially, have trading authority only. This is a good standard, one that I believe should be a requirement for all investment funds and a standard that helps maintain a high integrity and trust in the markets. I believe that the Madoff scandal would have been avoided if this was a requirement then, as the custodian for Madoff’s funds was a related party, not an independent third party.
What are the signs of a good investment to buy into?
Equities tend to make the best investments over time so I’ll focus on this asset class. Shares of businesses (“stocks”) whether traded on a stock exchange or not, represent fractional ownership of the businesses. Investors sometimes lose track of that simple fact and think of stocks as things that go up and down based on random macro-economic events, geopolitical events, company news, investor phycology, etc. While all of these may be true at one time or another, they neglect the two most important factors: the quality of the underlying business and even more importantly the price/valuation of the business in question. A good way to bring these two important factors into focus would be to think that you owned the entire business, not just a fraction of it, and that you couldn’t sell for a very long time, if ever. With that in mind, good investments will tend to be shares of good businesses bought at a good price. What makes a business a good business? This is not a particularly hard question. Some signs are:
1. The business has a good track record of profitability, for example an average return on equity over the last 5 years of at least 10% per year;
2. Good future prospects: for example, analysts are expecting decent growth over the next 3%-5% years;
3. A strong balance sheet;
4. The business has some ability to control its own destiny, rather than rely on external
factors such as the price of commodities or energy; As far as price is concerned, traditional valuation metrics here work well: low price to book, low price to earnings, low price to sales, low price to cashflow. Additionally, else being equal, given two stocks with the same attributes, a stock with a lower price volatility would be preferable.Stocks that meet the above criteria tend to do really well over time and make great investments. I have made it my aim in my professional life to look for such investments! Examples of good investments like these today would be: Walgreens (WBA) with a 5 year average Return on Equity (ROE) of 16%, price to book (P/B) of 2.26 and price toearnings (P/E) of 10; Arrow Electronics (ARW), Toyota Motors (TM) and Goldman Sachs (GS) with similar attributes.
Is there anything else you would like to add?
I would like to reiterate the most important takeaways for investors: 1. Work with an investment advisor if you do not already have one, research has shown that investors working with an advisor vastly outperform those that do not. 2. Work with a fiduciary if you have enough money to invest such a portfolio manager. A fiduciary has to by law put your interests first ahead of their own or other clients’. 3. Do not let emotions dictate when you invest money, invest money consistently: do not sell after markets are down just because they are down and do not add to investments after they’ve gone up in value because you feel good about them. Using an investment manager with a “value” investment philosophy will go a long way in helping with that.