Download The Details of our Investment Process

Pavlic Investment Advisors Inc.
integrity

prudence

performance
The Details
Philosophy
Business
We are fortunate to work in an industry in which we can reasonably align our success with
our clients’ success. We do this by providing a service that our clients find valuable. Primarily, we
generate wealth for them, but we also communicate readily and make ourselves available for
conferences on an ongoing basis. We willingly lend our expertise to planning their financial
futures and act as a resource for any investment or finance-related question they may have. We
maintain high ethical standards and earn our clients’ trust over time. If we execute these
responsibilities consistently well, our clients will be happy and, hopefully, wealthier than when we
first met--and so will we.
Asset Allocation
In the last few years, asset allocation has received an increasing amount of attention from
all major media outlets. Deciding what portion of your portfolio to invest in each major asset class
(stocks, bonds, and money markets) can be made incredibly complex if one keeps adding to the list
(foreign securities, commodities, options, etc.) or slices the current classes too finely (large,
midsize, small, growth, value). We think simpler is better.
Bonds generate income and mature on a date that is certain. Stocks are designed to
generate wealth and fight inflation but can be volatile. If your investment horizon is less than five
years or you need income from your portfolio, bond investments are appropriate. If your
investment horizon is longer and you have no immediate income requirements, history has shown
that stocks will maximize your wealth over time. In either case, you have to fight inflation. That’s
not too complicated. Most situations change as people age. Usually, younger investors invest
entirely in stocks and as they get older (and have more to lose), they “take a little bit off the table”
and add balance to their portfolios by investing in some bonds. This is a perfectly sensible,
prudent and straight-forward approach that is not complicated.
Stock Selection
Investments in stocks will generate more wealth over time (historically 9-12% per year)
than investments in either bonds or money market funds. The key to earning above-average
returns is discipline and consistency. There are many systems that work, but most break down
because investors, for a variety of reasons, override the system. Our strength is in our disciplined
approach to stock selection.
To be properly diversified, we think a portfolio should hold 30-50 stocks. This minimizes
its exposure to a catastrophe should one or a few holdings decline. It should also be widely
diversified across industries and sectors. We don’t believe in “loading up” on a particular type of
stock, like technology or banks. The reason is because, in all the journals we have reviewed, we
have never seen one study that describes a systematic, disciplined way to earn above-average
returns from such a strategy. Another strategy which we have never seen perform well is market
timing, i.e., moving in and out of the market based on whether one thinks it will go up or down in
the short term. As a result, there is usually very little excess cash in our portfolios. We prefer to
have funds invested in higher-yielding, better-performing securities like bonds and stocks.
Bond Investments
We believe that bonds have two purposes: to generate income and to add stability. As a
result, we don’t think an investor should take much risk in this portion of one’s portfolio. The
bonds we purchase for our clients are very high in quality, e.g., U.S. treasury bonds, highly-rated
corporate bonds, and insured or highly-rated tax-free municipal bonds. Also, we don’t adjust the
portfolio based on an interest rate outlook because the accuracy and timeliness of nearly all interest
rate forecasts are notoriously like weather forecasts---sometimes right but often very wrong. To
smooth out the risk associated with changes in interest rates, we try to invest in bonds that pay an
interest rate that will increase when inflation does. Secondly, we try to invest an equal portion of
the portfolio in bonds that mature each year over a five to ten year period. This is called
“laddering” and it is a reasonable method of generating income and maintaining stability.
Equity Purchasing
Summary
1.
2.
3.
4.
We buy growth stocks we believe are undervalued
Across all industry sectors of the market
Utilizing a very systematic, disciplined process
That focuses on large and mid-sized companies.
Details
Over the past twenty years, researchers have repeatedly found that stocks with certain
characteristics (like low price-earnings ratios or high earnings growth rates) appreciate faster than
stocks without these characteristics. Our proprietary research process utilizes a ranking system to
evaluate more than 3,000 stocks on the basis of fourteen of these characteristics. Stocks that rank
attractively are candidates for purchase.
We group these fourteen characteristics into three categories: Value, Expectations and Growth,
and each stock receives a score (1-10) for each category. Here is a sample of our scoring system:
Company Name
Lennar Corp.
Cisco Systems Inc.
Seagate Technology Inc.
Ford Motor Co.
McDonald's Corp.
Royal Caribbean Ltd.
Sony Corp.
Reliant Energy Inc.
Value
Score
Expectations
Score
Growth
Score
Market
Cap.
Price/
Earnings
Div
Yield
Grow
Rate
Estimate
Revisions
1
1
2
2
2
5
8
10
1
2
1
6
7
5
7
10
1
4
2
10
6
5
4
10
8.9
129.0
10.0
18.5
39.9
9.0
35.7
3.7
8.1
21.8
16.0
8.4
16.2
16.4
36.3
54.0
1.0
0.0
1.5
4.0
1.7
1.2
0.6
0.0
26.0
8.8
18.8
0.0
7.0
8.5
9.1
0.0
1.2
2.2
4.5
0.6
-0.7
-1.1
-10.6
-8.6
The Value Score is an overall ranking for nine of the characteristics mentioned above. It ranks
each stock’s valuation relative to:
1. Its own history.
a. Price-to-Earnings vs. 5 year avg.
b. Price-to-Book vs. 5 year avg.
c. Price-to-Sales vs. 5 year avg.
d. Price-to-Cash Flow vs. 5 year avg.
2. Its growth rate.
a. P/E to Growth using 5 year forecasted earnings growth rate.
b. P/E to Growth using normalized growth rate.
c. P/E to Growth using next twelve month forecasted growth rate.
3. Peers (other stocks in the same market sector).
a. Normalized Price-to-Earnings
b. Normalized P/E to Growth + Yield.
Our Expectations Score is developed in a similar way and includes ranks for four characteristics:
1. Earnings Surprise
2. Earnings Revisions
3. Revision Breadth
4. Deviation from Normalized Earnings
Our Growth Score is developed by ranking a weighted average growth rate for each company.
This growth rate is a combination of a five year expected growth rate and a normalized historical
growth rate. To develop the normalized historical growth rate, we calculate more than a dozen
historical growth rates, selecting the median.
Finally, we use Trend Analysis to help us time our purchases. Sometimes stocks that rank
attractively on our model remain in persistent downtrends and thus make poor investments. To
try to minimize the risk of owning these types of stocks, we try to look at a price chart before
buying. While we acknowledge that this is a subjective process, we are looking for evidence that a
stock is establishing the reversal of a downtrend or is in an uptrend. The chart below shows a
stock that looks like it has bottomed and is beginning to reverse direction.
Charts Help Us Determine When A Stock Has Bottomed
$30.00
$28.00
$26.00
$24.00
$22.00
$20.00
$18.00
$16.00
$14.00
Equity Selling
Summary
We consider selling stocks when:
1. they rank poorly in our scoring system, or
2. price has fallen 15% from purchase, or
3. price trends are reversing.
Details
Long-term investment results can be enhanced by selling effectively. Many investors become
attached to their stocks or confuse good investments with good companies. We utilize three
different techniques to help us remain disciplined, objective and detached in determining which
stocks to sell and when to sell them.
Stocks that rank poorly in our scoring system are considered candidates for sale. As a stock
appreciates, it moves from undervalued to fairly valued to overvalued. Similarly, as its growth
rate falls and expectations wane, it becomes less and less attractive. Our proprietary ranking
system accounts for these changes and, as a result, poor scores provide the most elementary
reasons for selling a stock, i.e., it fails to possess any of the characteristics that will lead to further
appreciation.
If a stock’s price has fallen 15% from purchase it is a sign that the stock is not performing well. At
this point, many managers will decide to hold or even add to the investment on the theory that “if
I liked it at higher prices, I must like it more at lower prices.” However, this approach fails to
recognize that the very best stock selection systems have “hit ratios” of only 60-70%. This means
that 30-40% of the stocks will be average (or worse) performers. When a stock is not performing
well, we think it is prudent to acknowledge the mistake and sell the stock.
Finally, when we see that price trends are reversing, it is a good sell signal. Information flows
unevenly and is only
gradually reflected in
Evidence That Price Trends Are Reversing
stock
prices.
By
$105.00
focusing
on
price
trends, we hope to gain
$100.00
an early advantage in
noticing that a reversal
$95.00
is occurring.
The
nearby chart provides
$90.00
an example of a stock
that is experiencing a
$85.00
price trend reversal.
$80.00
$75.00
$70.00
Bond Management
Summary
1.
2.
3.
4.
We attempt to minimize risk and volatility
By purchasing very high quality bonds
Which mature in equal amounts
Over 5 to 10 years.
Details
Bond investments serve two purposes: to generate income and add stability to a portfolio.
As a result, we think there is little reason to take a lot of risk in this portion of a portfolio. We
typically purchase only very high quality bonds: U.S. treasury bonds or corporate bonds with a
minimum rating of A, insured or highly rated municipal bonds.
Historically, there has been little incentive to purchase bonds that mature more than ten
years into the future. The slight increase in yield does not adequately compensate for the increase
in price volatility. Therefore, we construct a “ladder” of bonds that mature in approximately equal
amounts over five to ten years. For example, in 2016, we might construct the following
hypothetical $100,000 bond portfolio:
$10,000 Bank of America variable rate: CPI x 1.25, due 6/27/2016
$10,000 GE Capital Corp variable rate: Libor+1.00%, due 9/23/2017
$15,000 EOP Oper LP, 4.82%, due 2/13/2020
$10,000 Bank of America, 4.35%, due 6/15/2020
$20,000 BA/Merrill Lynch variable: CPI x 1.5, due 11/3/2021
$15,000 Barclays Bank PLC variable rate: CPI+2.25%, due 4/28/2023
$10,000 Morgan Stanley 7.00%, 8.00% after ’13, 10% after ’16, 12% after ’19, due 7/30/2024
$10,000 Citigroup 8% if 3mo Tbill yield is < 7% and S&P 500 is > 875, due 12/23/2030
We monitor the bond markets looking for opportunities to swap into better yielding bonds.
However, if these investments do not present themselves, we are quite comfortable holding them
until they mature. At that point, we purchase new bonds as necessary to maintain the laddered
maturity.
Equity Investment Performance History
Value of $100 Invested December 31, 1999
Through December 31, 2015
Pavlic Equity Composite
S&P 500 Price Change
$150
$100
$50
12/31/99 12/31/01 12/31/03 12/31/05 12/31/07 12/31/09 12/31/11 12/31/13 12/31/15
Bond Investment Performance History
Value of $100 Invested December 31, 1999
Through December 31, 2015
$180
$140
Pavlic Taxable Bond Composite
$100
12/31/99 12/31/01 12/31/03 12/31/05 12/31/07 12/31/09 12/31/11 12/31/13 12/31/15
Quarterly Composite Investment Returns
TaxFree
Bond
TaxFree
Bond
Pavlic Investment Advisors, Inc.
commenced operations in December
1997 and maintains a total of two
1Q98
10.6%
-0.7%
1.3%
13.5%
1Q07
1.6%
1.2%
1.3%
0.2%
composites (three prior to 3Q11). In
2Q98
-1.9%
-0.2%
1.6%
2.9%
2Q07
5.5%
-0.2%
0.1%
5.8%
order to be included in a composite,
a
portfolio
must
be
fully
3Q98
22.2%
0.1%
3.1%
-10.3%
3Q07
1.4%
1.9%
1.9%
1.6%
discretionary, fee paying, have no
4Q98
13.2%
0.6%
0.6%
20.9%
4Q07
-4.5%
1.5%
1.7%
-3.8%
low cost holdings, no special needs,
1Q99
-4.7%
0.3%
-0.6%
4.7%
1Q08
-9.0%
0.3%
-0.1%
-9.9%
requirements or circumstances and
be invested in individual securities
2Q99
14.7%
-1.3%
-2.5%
6.7%
2Q08
-4.1%
-0.1%
-1.1%
-3.2%
that have been selected by us. New
3Q99
-9.0%
1.0%
1.5%
-6.6%
3Q08
-6.0%
-1.5%
-3.1%
-9.0%
accounts, upon meeting these
4Q99
3.7%
-0.4%
-0.2%
14.5%
4Q08
-20.8%
0.6%
-0.6%
-22.5%
requirements will be added to the
composite at the beginning of the
1Q00
6.4%
1.1%
1.2%
2.3%
1Q09
-9.6%
-0.4%
-1.0%
-11.7%
following quarter. Portfolios failing
2Q00
-1.7%
1.4%
0.8%
-3.3%
2Q09
13.6%
3.7%
5.5%
15.2%
to meet these requirements will be
3Q00
7.6%
2.0%
2.7%
-1.2%
3Q09
14.8%
1.8%
1.4%
15.0%
removed from the composite at the
4Q00
-4.6%
2.5%
3.3%
-8.1%
4Q09
4.5%
1.7%
1.9%
5.5%
beginning of the quarter in which
said failure occurs.
All figures
1Q01
-6.4%
2.6%
3.0%
-12.1%
1Q10
4.8%
1.5%
1.3%
4.9%
shown
are
as
of
12/31/2015.
Our
2Q01
13.9%
0.9%
1.2%
5.5%
2Q10
-11.0%
0.5%
0.4%
-11.9%
All Equity Composite consists of 69
3Q01
16.4%
2.8%
3.8%
-15.0%
3Q10
8.0%
1.3%
0.9%
10.7%
discretionary
equity
accounts
having an aggregate value of $26.8
4Q01
10.8%
-0.9%
0.5%
10.3%
4Q10
9.8%
-0.5%
-0.3%
10.2%
million and representing 61% of the
1Q02
2.0%
0.5%
-0.7%
-0.1%
1Q11
4.5%
1.3%
1.4%
5.4%
value of the equity assets managed
2Q02
-9.8%
2.3%
2.4%
-13.7%
2Q11
-0.5%
1.6%
1.5%
-.4%
by the firm and 38% of the value of
all the assets managed by the firm.
3Q02
17.8%
2.5%
3.0%
-17.9%
3Q11
-15.2%
-0.4%
-2.9%
-14.3%
Our Tax-Free Bond Composite had
4Q02
4.4%
0.3%
1.1%
7.9%
4Q11
5.7%
-1.4%
11.2%
0 accounts.
Our Taxable Bond
1Q03
-5.3%
0.9%
1.2%
-3.6%
1Q12
9.3%
4.4%
12.0%
Composite consists of 46 accounts
2Q03
14.4%
1.2%
3.2%
14.9%
2Q12
-6.3%
0.4%
-3.3%
having an aggregate value of $19.9
million and represents 28% of the
3Q03
1.5%
0.5%
-0.2%
2.2%
3Q12
4.9%
3.2%
5.8%
assets managed by the firm. All
4Q03
14.2%
0.1%
0.2%
11.6%
4Q12
-0.1%
1.2%
-1.0%
figures are reported after deducting
1Q04
3.1%
1.0%
1.6%
1.3%
1Q13
8.5%
1.5%
10.0%
management fees and brokerage
commissions. The results have not
2Q04
1.1%
-1.9%
-2.4%
1.3%
2Q13
0.4%
-0.6%
0.4%
been audited. The composites are
3Q04
-1.9%
0.6%
0.5%
-2.3%
3Q13
8.0%
1.2%
4.7%
market value weighted and show
4Q04
8.0%
0.0%
0.3%
8.7%
4Q13
8.8%
0.7%
9.9%
total return (dividends + capital
1Q05
-3.4%
-0.1%
-0.2%
-2.6%
1Q14
0.0%
1.6%
1.3%
appreciation). Past performance is
not indicative of future results.
2Q05
2.4%
0.5%
0.8%
0.9%
2Q14
5.6%
2.0%
4.7%
Standard & Poors Corp. maintains
3Q05
2.5%
0.3%
0.5%
3.2%
3Q14
-1.6%
0.9%
0.6%
and manages the S&P 500 Index
4Q05
1.5%
0.4%
0.6%
1.6%
4Q14
5.6%
-0.4%
4.4%
which consists of the stocks of 500
generally large companies.
The
1Q06
6.0%
0.5%
0.7%
3.7%
1Q15
0.4%
-1.3%
0.4%
S&P 500 Index is unmanaged and
2Q06
-3.1%
0.5%
0.8%
-1.9%
2Q15
-0.9%
-0.3%
-0.2%
cannot be purchased.
No
management fee has been deducted
3Q06
5.2%
1.1%
1.4%
5.2%
3Q15
-8.0%
0.5%
-6.9%
from the Index. Factors such as the
4Q06
5.2%
0.4%
0.6%
6.2%
4Q15
6.3%
0.1%
6.5%
size and timing of investments,
client objectives and restrictions,
economic and market changes, tax
strategies, withdrawals and other
factors influence performance materially. Significant losses can occur by investing. The figures shown for this index
represent price change of the index for the period shown.
Period
Equity
Taxable
Bond
S&P
500
Period
Equity
Taxable
Bond
S&P 500
Fees & Custodians
We charge a fee based on the value of the portfolio we manage. Except for very large
portfolios, this fee is 1.00% annually. Usually, we collect it by charging your account 0.25% of its
market value each calendar quarter, in advance. So, for example, if your portfolio is worth
$500,000, the current quarterly fee is $1,250 (.25% x $500,000). Our minimum account size
requirement is $300,000.
Fee Schedule
Market Value
Of Portfolio
Up to $5,000,000
In excess of $5,000,000
Annual
Fee
1.00%
Negotiable
Our investment management agreement prohibits us from actually taking possession of
any of the securities or other assets in our clients’ portfolios. A new client would open an
investment management account at a custodian like a bank or brokerage firm. We would then
initiate transactions in that account. There are certain benefits to having most of our client’s
accounts with the same custodian. If you have no preference, we would be happy to recommend a
custodian with whom we have negotiated a very favorable custody fee schedule for many of our
existing clients. Please read our Form ADV for additional information. In certain limited
situations where the particular circumstances warrant, our firm may waive the minimum account
size and waive or discount the fees set forth in the above basic fee schedule.