Investment Philosophy

Our investment philosophy centers on our belief that the markets are not always efficient and, as a result, there are periods of over valuations and under valuations as well as periods of low risk and high risk. We further believe that anticipating short term directions in the markets is futile and that successful investing requires a long term time horizon.

Our duty as investment advisors:

1) Determine relative valuations of the major investment sectors.
2) Assess the relative risks associated with the major investment sectors.
3) Balance the elements of Risk verses Return by constructing portfolios in a manner that seeks to minimize perceived risks while concurrently attempting to maximize expected returns.

Five key elements to our approach:

1) Managing risk is equally important to seeking returns. It has been well documented that higher returns generally require taking higher levels of risk. Risk has been defined in many ways, but we define risk as the permanent loss of capital. If a portfolio loses 1/3 of its value, it takes a 50% return to get back to even. A loss of this magnitude can be devastating to an investor nearing retirement. That’s why we focus heavily on managing risk. Diversification is the most common approach used to manage risk, but we go far beyond common diversification. We believe that valuations are a critical measure of risk. Owning assets that are cheap is much less risky that owning assets that are overpriced. Unfortunately, many investors follow the crowd which inevitably does the opposite, buying when assets are expensive and fleeing when assets are cheap. This ultimately leads to unsatisfactory results.

2) Investment Markets are not completely efficient. Academics may take issue with this idea, but the fact that we have had three major bear markets in the past 40 years indicates that markets are not completely efficient. Over longer periods of time, markets tend to go to valuation extremes, overvalued in good times (Bull markets) and undervalued in bad times (Bear markets). Markets are an aggregation of human behavior. They reflect the competing emotions of fear and greed. Over the long term it should be possible to profit from the inefficiency of markets, as Warren Buffet has said, by being greedy when others are fearful and fearful when others are greedy.

3) We are strong believers in regression to the mean. Financial variables like earnings, profit margins, and valuations are highly volatile. They tend to fluctuate greatly over short periods of time. Over longer periods of time, however, they tend to oscillate around their long-term average or “norm”. The further away from normal they get, the stronger the tendency to regress to the mean. This is clearly illustrated in the chart below which shows the Price/Earnings multiple on the U.S. stock market since 1881. Note how the valuations have moved above and below the solid green line which is the long term average or mean. Generally speaking, the higher the valuation, the greater the risk. The lower the valuation, the greater the opportunity.

4) Astute Investment Management requires utilization of ALL the major investment sectors. Many investment managers view cash, bonds and stocks as their investment universe. It has been well documented that the vast majority of the gains and losses in the stock and bond markets are attributable to the overall direction of the markets. A minority of the gains and losses are attributable to superior stock or bond selection. The term “a rising tide lifts all boats” best sums up this phenomenon. The majority of investment managers utilize a “long only” approach to managing their client’s assets. We believe that a “long only” approach subjects client’s assets to the whims of the markets and results in a higher level of risk than most clients’ desire. Sterling Investment Management utilizes Alternative Investments including Hedge Funds, Commodities, Real Estate, and other alternative strategies that seek to reduce portfolio volatility while maintaining the possibility of positive returns even during hostile market environments.

5) We serve as a “Manager of Managers” and act as your personal CFO. There are many asset classes, styles of investment management and investment techniques. Managers who have achieved long term success have typically done so by focusing on one investment style and developing their skills in that one specific area. Our role as investment advisors is to find the best managers in each of the classes, styles, and segments. We conduct extensive research to determine the relative valuation of the various asset classes and segments. We then assess the relative risk associated with each asset class and segment. Finally, we identify the best-in-class investment managers to gain the desired exposure to the various asset classes and segments. Using these best-in-class managers, we construct custom portfolios specifically designed to meet the unique needs of each of our clients.