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    Guest Interview:

   Scotia Partners, LLC

    436 Ridge Road
    Spring City,PA 19475

    Telephone: (484)932-8560
    Fax: (888)694-7260


    Interview Quarter: 3Q2013

 Clifford J. Montgomery, CFA

 Founder and CEO

  Cliff, you argue that a huge percentage of investors are making a deadly mistake in their portfolios, despite ample warning. What is that mistake?  
  Well, Peter, thanks for inviting us to talk with you. We’ve talked with literally hundreds of investors, and we find that most investors are committing similar “deadly sins” in their investment approach. Perhaps the most common mistake that we find investors making is lack of diversification.  
  Really, I find that very interesting! If we were to ask investors how they manage their risk, most of them would probably say, “I’m diversified.” So, how is it that you arrive at the conclusion that this isn’t exactly the case?  
  Well, you’re right, I’d agree with you that most investors are aware of the NEED to be diversified. And, they are exactly right, they need to be diversified if they hope to manage risk. And, here’s the good news…the math behind diversification works. If you put together several investments that remain unrelated to each other in different markets, you have the raw materials for diversification.  
  OK, you mentioned the good news, Cliff; Is there also some bad news?  
  Cliff: Sadly, yes, there is. While the math of diversification is sound (ie. if you put a bunch of non-correlated investments in your portfolio, then you will be better diversified), the types of investments that most investors are trusting to diversify them are actually not doing much for them in that respect.

We find this again and again to be the case when we do diagnostics on investors’ portfolios, and how they performed through the 2007/2008 credit crisis.

Here’s an example of what I mean - A buddy of mine from years back recently asked me to take a look at what he’s holding in his 401k, and to give him my two cents on how he was invested.

So, we took the statements from his 401k and plugged his funds into our analytical software, and can you guess what we found?

Of the 12 funds he held in his 401k, 10 of them basically moved in lock step with one another – and the funds were split between small caps, mid caps, international, etc. So, my friend figured he was diversified.

Then 2008 came along, and I’m sure you can guess what my friend experienced – everything went down together, and it all went down together hard.
When I pointed this out to my friend, he just nodded his head saying, “Oh, yeah, you don’t have to remind me what happened in 2008!”

I suspect that many of your readers can sympathize, and what they need to know is that they aren’t alone.
  Can you expand a little on what this looks like in the typical investor’s portfolio?  
  Cliff: Absolutely. For starters, take the average 401k plan. In most plans, investors are given a limited menu of mutual funds that they can invest in, and they are generally placed along a spectrum from growth to value, large cap to small cap, and they are also split into stock funds and bond funds.

We’re also noticing that a lot of investors are keen on hard commodities, due to the widely anticipated impact of the Fed’s QE campaign on the dollar.

So, here’s your average investor, holding mainly stocks, split between large caps, small caps, maybe some international stock funds, with a smaller percentage in bonds, and then maybe even a bit in a precious metals fund, or something like that.

Well, do you know what happened in the most recent market crash?

Except for bonds, they all went down together, and even some types of bonds, like high yield, dropped during the crash! In other words, if you were counting on international stocks to cushion you from the impact of a decline in your US equity portfolio, you got a nasty surprise!

But, Peter, the bad news is even worse than that.

Not only did the diversifiers not really diversify you very well… when things got really nasty, several of those asset classes actually began to ADD risk to your portfolio, while you were expecting them to do the opposite.
  The data shows that this goes beyond 401k plans, Peter.

Did you know that according to the Bureau of Economic Research, of the accounts they surveyed, 25% were only holding one stock? 50% were holding just one or two stocks. Three quarters of investors, holding, at most, two stocks in their portfolios! Of the remaining 25%, based on our anecdotal experience, most are invested in things that have a demonstrated track record of INCREASING, not decreasing, market risk in a portfolio during downturns.

So, while we totally support the idea that one of the most effective tools for managing portfolio risk is diversification, we are trying to ring a bell in investors’ minds by asking them to reflect on the fact that there is a strong likelihood that they aren’t as diversified as they think they are.
  OK, Cliff, what do you suggest people do to address this shortcoming?  
  What investors really need is a winning team of investments working for them. Think of it like a baseball team. A World Series winning team isn’t just made up of a bunch of phenomenal pitchers – even if you have a great left hander, a stellar right hander, and the guy with the best curveball in the league. They’re still all pitchers.

It isn’t even made up of a group of phenomenal infielders and outfielders. If you had a team consisting of players who could field a ball well but couldn’t hit, you wouldn’t get very far. Instead, you need an assortment of players each carefully chosen to fit a particular position and role, and each with a particular skill set.

You see, a lot investors we speak with assume that they’re well diversified by holding different types of stocks (large cap, mid cap, etc.). But when the market goes down, these stocks tend to all tend to go down together – it’s like playing with a team made up entirely of pitchers. They may be good at getting that ball across home plate, but what happens when they’re up to bat?

Instead, investors need to “draft,” if you will, a team of investments that span not just different “asset classes”, but also different types of investment strategies, so that they’re prepared for the different challenges the market will throw at them. You can’t depend on one player (or a team full of players who are limited to just one skill set) and hope to succeed over the long term.
  How does an individual investor draft a winning team of investments?  
  Great question! With all of the options and information available to investors, it’s harder than ever to decide what to buy, sell, or hold, much less do that for an entire team of investments.

For managing our clients’ portfolios, we have a system of clearly defined rules that guide us on what to buy, sell, or hold, and our goal is to come at the problem that we all have to confront – risk management – through the lens of recognizing that diversification in today’s market requires far more than just a passive portfolio of stocks, bonds, and cash.

So, in building their portfolios, investors need to first be willing to think “outside the box” of just stocks and bonds, and secondly, they need a well defined process for making decisions about where the best opportunities are likely to be at a given time.

Notice how I said “at a given time”. Markets change, so we need to adapt. We make changes up to several times per month in our clients’ portfolios.
  Why trade so often?  
  Our investment approach is based on the premise that there are times when it makes sense to expose our clients’ portfolios to market risk, and there are times where it makes sense to lower their exposure to market risk.

You know, Peter, it’s easy to ignore the fact that the stock market has spent more time in bear markets (where the market has gone basically nowhere, but with a lot of ups and downs on its way there) than it has in bull markets.

That’s astounding, isn’t it? Because we all have that picture in our mind’s eye of a chart of the Dow that has basically gone up over the last hundred years or more. And, it has. But, the fact is that when you parse that history for secular market trends, you will find that for almost 2/3 of that time span, the market has chopped up and down to go basically nowhere.

In other words, the gains have come in relatively condensed periods of time.

So, you see, without a solution to address that reality, most investors find it simplest to leave their portfolios at the mercy of Mr. Market, let it ride, and hope it turns out okay by the time they need their money.

Let’s face it, for most of us that isn’t 100 years from now. It’s more like 20 or 30 years from when we really hit our peak investing years after the kids are out of college, married off, and out of the house.

Our premise is that this leaves far too much to “chance” as to when you are getting into and out of the game. Instead, investors need an investment strategy that can adapt to the market’s behavior so that they’re not stuck at the mercy of the market.
  OK, Cliff, so can you give my readers some idea for how Scotia Partners goes about being adaptive?  
  Sure. First of all, with all of our investment strategies, we have the potential for moving 100% to cash, as a way of putting our defense on the field. We use investments that allow us to move in and out without penalty.

Second, while cash is a “safe” place to be during bear markets, there are also times when it’s most beneficial to invest in an inverse fund in order to take advantage of a down market. With some of our strategies, we have the ability to take both long and inverse positions relative to the market. We get this exposure through using long and inverse mutual funds, which means that this strategy offers investors a totally liquid, transparent way of investing even their IRA in a strategy that looks for times to get short exposure to the market.

Third, rather than guessing what to buy, sell, or hold, we objectively measure which industry sectors, which international markets, and which asset classes are showing the strongest (and the weakest) momentum, and we adjust our clients’ portfolios based on our rules for interpreting price movement in each of those different areas.

So, while we would agree that it’s very difficult to consistently manage risk as a way of reaching our goals as investors, and that it takes a lot of diligence and discipline to do so, market history tells us that there are periods of time, long periods of time, when the markets face major headwinds.

Wisdom dictates that we use different strategies in those time periods than we do in the bull markets. However, we’re the first to acknowledge that simply having a tactical, or adaptive, strategy isn’t going to get an investor the results they’re hoping for.
  What do you mean? What else does an investor need if he or she has already implemented a successful investment strategy?  
  Simply having the right strategy isn’t enough. Any strategy or process must be inseparably joined to a fanatical willingness and ability to follow that process. Just as sticking with a diet and exercise regime produces healthy results, sticking to the rules of an investment strategy is key to your success as an investor. And just like cheating on your diet sets you back, so does ignoring your investment rules. I’m saying that it’s not even okay for you to say, “Well, I’ll have my process, and every now and then when my strategy doesn’t seem to fit the latest market headline, I’ll let my own gut instinct find its way into my process.” You and I are always most prone to allow that type of thinking into our decisions at just the time when we are least well served to do so.

What I’m saying here, Peter, is that discipline is the simplest ingredient to grasp conceptually, but the most difficult to master in practice. It’s what makes us human, for crying out loud, but the markets don’t care how you and I “feel” about a decision.

reserves, you can quit worrying about inflation until you have a tight labor market.
  So, what you’re saying is that it’s critically important than an investor have rules to follow as they make their investments?  
  That’s right, Peter, but I’m going a step further than that. I’m not only saying that investors need a process that’s guided by rules, they need to a) trust those rules, and b) follow those rules. If you don’t trust them, believe me, you won’t follow them. And rules are meaningless unless there is a will to follow them.

Not only do we do extensive research to arrive at the rules that guide our investment process; we never, and I mean NEVER, dishonor those rules. This is the linchpin to any sound investment process. Without it, let’s face it, there is no process.
  Can we look for a moment at your individual investment strategies? One of your strategies, your Growth S&P Plus strategy, looks like it performed very well in the 2007-2009 crisis, yet it’s underperformed the market since then. Would you call this a bear market strategy?  
  That’s a great question, Peter, and it’s one that we get often. This is the really the primary strategy we offer that has the option of buying inverse funds. The short answer is, no, we would not consider it a bear market strategy.

However, history demonstrates that this strategy has typically performed best when there is a lot of market volatility. And that tends to be the case during bear markets.

But, we’d point your readers to periods of time like 2005, or even the first quarters of 2012 and 2013, to highlight that there are times of market strength where this strategy has also performed well.

This strategy is truly a non-correlated strategy. More importantly, its correlation to the market dropped during the bear market. This is what investors should hope to have, in at least SOME of their investments.
  What would your recommendation be to an investor who wanted to include this strategy in their portfolio?  
  Well, every investor’s situation is slightly different from that of his or her fellow investors, but in terms of broad guidelines, we typically recommend this for 5-15% of an investor’s portfolio. It’s an aggressive strategy, and its real value comes from the fact that it’s non-correlated rather than from its excellent performance during the bear market. But, I stress that this is a decision that has to be made in consultation with an advisor.  
  Okay, if this is only appropriate for a relatively small portion of an investor’s portfolio, how do you generally handle the rest of your clients’ investments?  
  Again, this depends entirely on each client’s investment objectives and their specific situation, but we generally blend our Growth S&P Plus strategy with one or more of our long only strategies.

Our Keystone Portfolio is a blend of 5 separate investment strategies, including sector rotation, style rotation, commodities, international, and high yield bonds.

Our Dynamic Momentum strategy trades 7 industry sector funds and 2 market index funds tactically, based on short term momentum.

And, our Focused Equity portfolio is comprised of a sector rotation strategy and a style rotation strategy.

All are tactically managed, and with each strategy we are seeking to manage risk in such a way that we are taking market risk off the table in those markets where investors need less of it.
  Cliff, where are your firm’s offices?  
  We are in the rolling countryside of northern Chester County, Pennsylvania, just outside of a little town called Spring City.

Our office is on a piece of property that four generations of Montgomerys share, and that has been in our family for 55 years.
  That sounds like a great place to live, but do you see it as a disadvantage to be so far from Wall Street?  
  It’s funny that you’d ask that question. We’d actually take the opposite view, believe it or not. Our goal in business is to work closely with people who we can truly help, and to offer them a high level of service while doing it. We also believe that in order to help our clients be successful with managing their investments, we need to be able to think, and act, independently.

Both our physical setting, and our business model, testify to the values that define our lives both inside and outside the walls of our office – strong relationships, boldly independent thinking, and hard work.

But, in spite of our distance from Wall Street, make no mistake about it, the ratio of computing horsepower to human horsepower is high, which allows us to stay on top of the markets by the second.
  What does your average client look like? What kinds of investors are best suited to your “non-Wall Street” approach?  
  What we’ve found over the years, Peter, is that we tend to attract individuals and families who have built and owned businesses. Some of our clients are currently running a business. Others have built and sold a business or two. About 7 out of 10 of our clients right now would fall within this category.

We also work with a couple of institutional clients. In those cases, we subadvise both separately managed accounts and 1940 Act mutual funds.
  Why do you think this business owners are attracted to you? Do you ONLY work with these types of individuals?  
  We’ve asked ourselves, and our clients, this question, and here’s what we’ve come up with:

  • 1) To have built a business requires a certain level of independent thinking. You have to either have an idea to do something that no one else is doing, or to do it in such a way that you are meeting a need in a way that your competition isn’t. We think this personality type is naturally wired to appreciate and understand our independently minded approach to managing wealth.
  • 2) To have built a business also requires that a person have some understanding of the nature of risk, and the fact that opportunities can’t be separated from the risk that accompanies those opportunities. Our investment process is driven by this understanding.
  • 3) At the risk of stating the obvious, business owners tend to be busy with running their businesses!

Their investments are very important to them, but they realize that their time and energy are better spent doing what they know best.

Now, having said all of this, of course, none of these qualities are exclusive to business owners, or entrepreneurs, but we find that for even those clients who are not business owners, they tend to look at the world as I’ve described above.
  How can someone go about opening a conversation with Scotia Partners?  
  Well, Peter, the simplest way would be to pick up the phone and give us a call at (484)932-8560. It will most likely be Katie, in our office, who answers your call, and you and she will have a brief conversation about your goals and your investing experience, and she’ll work with you to schedule a conversation with one of our advisors.

Or drop Katie an email at to schedule a conversation. We’d also point your readers to our website,, which is a welcome page we’ve prepared specifically for your readers.
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