2012 is a year for which Oak Wealth Advisors will always be particularly proud. Almost all of our clients enjoyed portfolio performance that exceeded their custom benchmarks on an after-expense basis. While our clients have outperformed in the past, 2012 provides a great opportunity to explain how our process and experience comes together to generate great results.

2012 was a year that was filled with negative economic stories and political uncertainty both domestically and globally. The major issues were known prior to the start of the year. The presidential election in November, the debt ceiling, the fiscal cliff, and the sovereign debt crises in Europe were all issues that investors knew would impact the financial markets in 2012. In anticipation of these financial market headwinds, Oak Wealth Advisors adjusted client portfolios in 2011 and 2012 to reduce some of the stock market exposure (market risk) subject to each individual client’s investment policy. In addition, we actively sought new ideas and added small positions in complimentary strategies in many client portfolios to reduce portfolio volatility. Our focus was on decreasing the market risk in client portfolios.

In addition to the negative outlook for stocks, there were warnings about how inflation and rising interest rates were going to decimate bond investments. Interest rates at the start of 2012 were at historic lows, inflation had been running well below the historical average, and the U.S. government had printed so much new cash that the pundits were convinced that higher interest rates and inflation would soon follow. In this environment, the risk is that bond prices will fall and all bond investments will suffer. We did not share the widely held view that inflation and interest rates were going to rise in the near-term, but we nonetheless made some portfolio adjustments in case we were wrong. In all client accounts we sought to add new bond funds with very different characteristics than the traditional bond funds we have been holding for years. Our focus was on finding funds that would either be hurt less or possibly even benefit from a rising rate and rising inflation environment. Again, we targeted the reduction of risks in the investment portfolios.

Against this backdrop of overwhelmingly negative economic news and dire forecasts in the media and throughout the financial services industry, the stock markets delivered double digit returns both domestically and in many other countries. The bond markets delivered positive returns although they were far lower than their long-term average returns. Given that the stock markets delivered far better re turns than expected, and we decreased market risk in client portfolios, it would have been reasonable for our client portfolios to underperform their custom benchmarks for the year, but they did not.

There were a number of things that Oak Wealth Advisors did right in 2012 that generated the positive performance. The first of the items that worked in our favor was overweighting stock mutual funds that have a “value” style. Over short periods of time, stocks with value characteristics outperform or underperform those with a growth style. Over long periods of time, value style stocks hold a slight performance advantage over growth stocks. Since value stocks had been underperforming growth stocks for well over a year as of the beginning of 2012, we tilted our exposure even more heavily in the direction of the value stocks in 2012. For the year, large company value stocks outperformed large company growth stocks by 2.25% (17.51% vs. 15.26%). Small company value stocks outperformed small company growth stocks by an even wider margin (18.05% vs. 14.59%).

valuesto…gro…large companysmall company14.515.516.517.518.5Value vs. Growth Stocks by Percentage


Value vs. Growth Stocks by Percentage value stocks growth stocks
large company 17.51 15.26
small company 18.05 14.59

Within the bond portion of clientportfolios, we trimmed our exposure to bond funds that replicate the broad bond indexes in  favor of funds that had one or more of the following characteristics: shorter maturities (the bonds come due sooner and can be reinvested in new bonds at higher interest rates assuming rates have risen), lower credit quality (higher interest rates are paid by firms with lower credit ratings), and new categories of bonds like floating rate bonds where the interest rates reset at higher levels as market interest rates rise. These bond fund adjustments were made with the expectations that rates will eventually rise and the economy may be sluggish for the next year or two but is unlikely to experience another broad recession like the one we experienced from 2007-2009.

The addition to the complimentary strategies in client portfolios was done both as way to minimize market risk with additional diversification and to take advantage of some new strategies that had not previously been available as mutual funds. Trusting our research and experience, we implemented new positions for most clients in two complimentary strategy funds. Fortunately, both of these funds contributed diversification and better than expected returns.

The final positive action we took was the overall reduction of risk and volatility in client portfolios. If the investment markets had risen consistently every month, our risk reductions would have had a negative impact. However, markets almost never climb in a steady fashion and in 2012 there were a number of months during which the returns were negative. By reducing the volatility of the returns, we limited exposure to the losses allowing the portfolios to grow more rapidly.

While we do not look to public ratings of mutual funds to determine which funds to include in client portfolios for reasons we have written about on several prior occasions, we were pleased to see that the fund families that we use most frequently scored at the top of the Barron’s / Lipper lists of top fund families for 2012. For U.S. stock funds, Dimensional Funds was rated as the top mutual fund family in the world. Vanguard came in a respectable fifteenth. On the bond side, PIMCO was rated as the third best bond fund family and Lord Abbett, who manages some of our newer strategies in bonds, was rated the second best bond family in the world. We fully acknowledge that there is a degree of subjectivity in how the numbers are crunched and the rankings are determined. However, it is reassuring that others have reached the same conclusions that we have about which funds are worthy to be in our client portfolios.

Oak Wealth Advisors got a number of things right in 2012 related to our clients’ investment portfolios, but not everything. One of the smaller implementations that we did was with a complimentary strategy fund managed by AQR Funds. It wasn’t appropriate for all client accounts, but in a handful of portfolios with large IRA accounts we implemented the AQR Diversified Arbitrage Fund. It had a relatively high expense ratio which we generally try to avoid, but the strategy had the potential to add incremental returns and provide additional diversification benefits. Unfortunately, the fund did not deliver the returns we had expected when it was implemented, and we exited the positions in all client accounts by the end of the year. Thankfully, they were smaller positions, so they had minimal impacts on client returns.

Looking ahead to 2013, many of the economic concerns are still in place that we were facing at the start of 2012. Higher income tax rates and decreased government spending will add to the list of challenges.

The inability for investors to earn any return on their money in bank savings accounts, money market accounts, and short-term certificates of deposits is driving them to find other places to put their money. We have witnessed positive flows of cash into stock mutual funds during the first couple of months of 2013 reversing a multi-year trend during which investors were pulling money from stock funds. Cash flows into bond funds have decreased but are stillpositive. These flows suggest that investors have gotten frustrated not earning a return on their money and stocks may be the beneficiaries in 2013 of the very low interest rate environment.

In 2013, Oak Wealth Advisors will focus much of our portfolio modification work on the bond investments in client portfolios. We believe that traditional high quality bond funds are going to deliver unsatisfactory results for the next few years. Anecdotally, the Lehman Aggregate Bond index, the most widely followed bond index, is down one half of one percent through the first seven weeks of 2013 in contrast to the S&P 500 stock index which is up over six and a half percent over the same period.

We will continue to keep our focus on the markets and will m ake investment decisions in client portfolios based on what we know and not what we think. Well diversified portfolios delivered great investment results in 2012 and we expect that trend to continue.

This update is intended for the use of Oak Wealth Advisors LLC clients. This update should not be viewed as personalized investment or financial planning advice from Oak Wealth Advisors LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult Oak Wealth Advisors LLC. Past performance does not guarantee future results and all investments should be scrutinized before being implemented in a portfolio.