529 Plans: Are they the best way to finance a college education?

The 529 is the most popular “college savings” program today, and has the greatest tax advantages.

However, it comes at a cost in that it is irrevocable, expensive to operate, inflexible in investment options, and although the “beneficiary” can be changed within a family (even a cousin), the funds are only “tax advantaged” if they are specifically used for education.  If they are used for anything else, then they become taxable and there is a 10% penalty.

ROTH IRAs can be used for college savings and are completely tax free.  There is no requirement that the funds be used for education.  However, it is probably more advantageous (if you are planning on giving the money in a Roth to a child) that the account be kept intact as long as possible because it is tax free for the owners life, and even possibly the heir’s life.  The longer it can grow the better, and since college happens relatively soon in a child’s life it would be better to finance college from another source and let the Roth grow as long as possible, maybe even into the child’s retirement!

It is our view that parents ought to begin saving BEFORE children arrive, and we don’t prefer the “silos” like 529s since they limit the use of the funds.  We would prefer the parent maintain control of the assets for any purpose, invest in growing companies and real estate over long periods of time (creating long term gains, many of which will be unrealized) and then “use” those assets by prudently borrowing against them in order to pay for college, or any necessary expense.  If they have saved 15% of gross income (our preferred rule of thumb for saving), outside of retirement plans, since before they had children, then they should have no problem accumulating the assets to then borrow against for whatever purpose that arises.

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Finding Gems in the "Start-up Nation"

by Amy Parvaneh, 02/23/2015

Efforts to identify sound technology investments have led Taylor Frigon Capital Management LLC to Israel.

Investing in Israeli businesses is “part of a globally diversified approach,” says Gerry Frigon, president and chief investment officer of the California-based investment management firm. The firm isn’t necessarily trying to invest in every corner of the world, Frigon says, but is simply looking for investments that make sense and following them.

“And it so happens that it’s Israel,” he says. “We don’t care where in the world, as long as it’s great technology and fits in our portfolio. Our focus on Israel is a component of a broader strategy, and it happens to be an important component, because we think this is where we’ll see some of our most significant returns.”

Taylor Frigon currently has seven investments in Israel. The roster has public and private companies, including ASOCS Limited, a developer of virtual base stations that aims to reduce the cost for carriers to run cell towers. Taylor Frigon is the largest private investor in ASOCS. It also owns shares of EZchip Semiconductor Ltd., which is traded on both the NASDAQ and the Tel Aviv Stock Exchange. EZchip, a $629 million market capitalization provider of Ethernet network processes, is the largest holding in Taylor Frigon’s public Core Growth portfolio.

Israel might sound remote, but investing in Israeli tech-oriented companies “isn’t anything new,” according to Frigon. “There has been a longstanding, mutually beneficial relationship between Israel and the U.S., especially taking Silicon Valley into account.”

Investor, technologist and best-selling author, George Gilder, noted the growing significance of Israel’s impact to the U.S. and other countries in his 2009 book The Israel Test. “[B]eyond doubt is the increasing role of Israel as a prime source of innovations vital to the United States and to the world,” the book says. “As it approached the end of the first decade of the new century, Israel was a global center of microchip, telecom, optics, software, biotech, and medical-devices research, the country’s development and entrepreneurship rivaled only by its partners in Silicon Valley.”

Frigon pointed to Intel Corp. as an example of high-tech and high-profile companies being closely connected to Israel.

“During the early years, especially, Intel’s research and development efforts were largely driven in Israel,” he says. “If you go back to some of the early days of Silicon Valley and tech, some would argue that Israel was right there along with Silicon Valley, for example, in the early stages of semiconductors.”

A book called Start-up Nation: The Story of Israel’s Economic Miracle, published in 2009, observes Israel’s potential for entrepreneurs and opportunities for business creativity. As told by the book, written by Dan Senor and Saul Singer, Israel has continued to prove that its culture and infrastructure are conducive to starting businesses. For instance, data from PricewaterhouseCoopers LLP showed Israel had a sum of 70 exits and initial public offerings worth about $15 billion last year, coming off another big year with the sale of mobile mapping application Waze to Google for nearly $1 billion. Furthermore, Israeli companies were acquired “within an average of 3.95 years,” a “faster pace than ever,” according to data from Dow Jones VentureSource. A 2014 Deloitte survey on venture-capital confidence levels showed that global investor confidence for Israel has increased and ranked second only to the U.S.

Frigon noted that there are risks in investing in Israeli companies, but they’re no greater than investing in any other company.

“The geopolitical side of it” doesn’t worry him much, as it’s “a risk no matter where in the world you are investing,” he says. “That being the case, we’re appropriately concerned about business risk. We conduct due diligence for Israeli companies the same way as we would any other investment.”

It helps that Israel practices similar accounting and other legal or regulatory systems as the U.S., Frigon says.

“The system of accounting, the systems of even basic things like property rights—it’s so similar. Whether we’re investing in public companies or approaching a business through our venture arm, our legal system and theirs are so closely intertwined. Also, often times the Israeli companies are traded on American stock exchanges, like the New York Stock Exchange. And often times you have active operations here, and the executives are always here, too. Israel is such a small country, but companies there are extremely world savvy. Almost all of their business is done outside of Israel.”

Taylor Frigon has recently tapped Jonathan Wornick to help lead the Israel-oriented investments. Wornick, who oversees client relationships in Northern California for the firm, also serves as the regional campaign chair of the American Israel Public Affairs Committee.

“He is one of the most Middle East-savvy individuals we know,” Frigon says. “There’s a personal relationship that we’ve developed over the years. Having Jonathan on board gives us more macro knowledge.”

Taylor Frigon, with the recent boost in the talent base and network reach, is looking to keep close watch on potential investment targets in Israel. Companies sometimes come up in the firm’s screening methods, but opportunities arise mostly through active involvement.

“It’s really about putting your ear to the ground,” Frigon says. “There’s really no magic to it. It’s about the years of experience and putting in the practical efforts, like going to the conferences, knowing who the people are, knowing the experts, and staying connected to them. That’s what’s done it for us.”

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Don’t confuse a bull market for brains

by Amy Parvaneh, 01/20/2015

“Don’t confuse a bull market for brains.” - Humphrey B. Neill

Because it’s easy to do so—especially when a general lack of transparency in the investment industry renders it difficult for investors to determine exactly from where their returns are coming.

Integrity and trust have always been key principles in the investment industry, but they’ve become even more poignant issues following the financial crisis as investor confidence largely gave way. Along the same line, the need for investment managers to apply consistent return calculations and provide accurate performance information has also become increasingly crucial.

Questions remain regarding the degree to which investment firms are making efforts to calculate their returns and publicly report their numbers. Certain legal regulations exist, but how widely and sincerely is self-reporting practiced and appreciated in the industry today?

Taylor Frigon Capital Management LLC tells of its commitment to being transparent with its investing strategy and performance results. The boutique wealth manager based in San Luis Obispo, Calif. serves private clients and institutions throughout the U.S. It claims compliance with the Global Investment Performance Standards and is independently verified by Ashland Partners & Co. for GIPS compliance reporting.

“We’ve been doing this compliance from the get go,” said President and Chief Investment Officer Gerry Frigon, who founded the firm in 2007 after more than 20 years of investment strategy, planning and management for private and institutional clients.

“GIPS reporting is a lot of extra work, it’s expensive, and we’ve gone back and forth at times about our decision to report and be verified,” he said. “But transparency is the point we want to drive home. We have taken the initiative to show our performance. We’re not going to run from our performance no matter what it is. We’ve been through some periods of really good outperformance and sometimes underperformance. But over time, if you have a disciplined strategy, we know that it will work.”

Frigon spoke of what he has observed during the three decades of his investment management experience.

“I grew up in a world over the last 30 years where, frankly, the typical investment adviser wants to run away from performance, not embrace it,” he said. “I think we knew that was a problem in the industry. But somehow, the industry has succeeded in pulling the wool over the eyes of the investor. You’re fighting a battle of firms that have gotten used to saying, ‘Performance doesn’t matter; all clients care about is service.’”

There is no official set of data to tell exactly how many investment firms pursue transparency at what levels. But the Global Investment Performance Standards, created by CFA Institute, is becoming more and more widely accepted as a universal language for presentation of investment performance.

“The GIPS standards represent an important part of our effort to restore public trust in our industry,” wrote Annie Lo, director of GIPS Asia Pacific at CFA Institute and Trevor Persaud, managing director for ASEAN and Taiwan at Russell Investments, in a 2013 issueof the CFA Institute Magazine.

“By choosing to comply with the Standards, investment management firms assure prospective clients that the historical ‘track record’ they report is both complete and fairly presented,” the article said. “GIPS compliance allows firms to expand their business territories and to participate in competitive bids against other compliant firms globally.”

Institutional investment data research firm eVestment recently published its 2014 study of the value of GIPS compliance. Analysis was based on survey responses of 101 participants and on the firm’s internal database of individual managers. The survey primarily included advisers managing institutional funds and likely does not represent the trend among advisers who oversee portfolios of individual investors.

Data showed that about 74% of the eVestment database population claims compliance with GIPS, and 82% of those that are in compliance receive verification of their reporting.

About 65% of consultants and investors exclude managers from consideration “some or all the time” if they do not claim compliance with GIPS.

Qualitative survey responses about GIPS included thoughts that compliance is “demanded by international markets,” and that the standards serve as “a scorecard” and “a tool” to evaluate managers. Some said that although the standards “aren’t perfect,” they do provide a certain guideline.

Frigon pointed to the general lack of understanding in the investment industry, even among portfolio managers, regarding their performance.

“The typical adviser has no idea why his or her portfolio has been performing OK,” he said. “If the average investor were to ask his or her manager, ‘What are the business reasons that this or that has happened in my portfolio?’ the manager doesn’t know. It’s possible that the manager is in such a broad index strategy that the performance is kind of accidental. Don’t confuse a bull market for brains.”

He added that there’s been a gradual but clear change in the investment industry over the past few decades.

“It used to be that a stock broker would actually get to know the companies first, and then they would go out to sell the stock to their clients,” he said. “That’s the traditional stockbroker. Some of the best money managers ever were the ‘old’ kind of stockbrokers. They understood how to analyze the company. But we’ve gotten so far from that. That art has been completely thrown out the window for the most part. The money manager types now are in mutual funds, and it’s become a quarter-to-quarter numbers game instead of understanding the companies within them.”

Frigon said Taylor Frigon as a firm hopes to see a shift in the lack of adviser knowledge and value.

“Our clients know that we are ridiculously transparent and that we adhere to a strict set of standards,” he said. “And we tell our clients that there may be periods where the performance might not make sense immediately. That’s because we’re not making our investment decisions based on the whims of the market. We’re doing so based on the businesses we’re buying and based on the things happening inside the businesses. Those things don’t necessarily happen in line with the market.”

“Overall, the issue becomes one of investor trust and manager integrity, and GIPS could be a useful tool to bring about a restoration of those principles in the investment industry,” Frigon said.

“I think being GIPS-compliant is like the cherry on top at this point,” he said. “Most advisers are not even reporting any kind of performance. They are dancing around it, and that’s what I think is shocking. That’s what I think needs to be exposed. Our clients are used to getting those performance reports. It’s standard for them.”

Jonathan Boersma, head of professional standards at CFA Institute, said that he thinks the “biggest challenge [that asset managers face today] is the lack of integrity in the industry that has led to investors’ lack of trust and a collapse in investor confidence.”

Even as the details of the GIPS standards have and will continue to evolve to fit the complex needs of the financial industry, the core objectives of the GIPS standards “remain unchanged [which is] to support fair competition and to promote comparability through consistent calculation and presentation of investment performance information,” he said. “The GIPS standards address some of [today’s challenges] because they are ethical standards that focus on fairness and improving transparency, which can help restore trust.”

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Investment Climate, January 2015

Here is our latest quarterly investment climate report: "An Energized West." Follow the link to access the full commentary, as well as links to previous investment climate commentaries.

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The gut check

image: Wikimedia commons.

The term "gut check" usually refers to the idea of testing resolve, assessing the level of conviction to press on to the goal even in the face of increasingly difficult conditions. 

Militaries around the world have devised various ways of creating "gut check" scenarios: one such "gut check" that we remember hearing about, which was used in the training of candidates for a certain special operations unit, involved a long and difficult road march carrying heavy gear towards a designated point, where participants were told that trucks would be waiting to take them to the next objective. 

When the hopeful candidates, after several hours of walking, arrived at the designated location, the trucks that they found there suddenly started up their engines and drove away, just before anyone could climb on board. The instructor then informed the candidates that they had to move on foot several more miles to meet up with the trucks. 

Many of them threw their rucksacks on the ground and declared that they were quitting right there. What they did not know was that the trucks had only driven a few hundred yards over a ridge and around a bend, and that if they had just pressed on for a little ways their long march would have been finished successfully.

There is an old saying in the investment world that "guts" are in some ways more important than "brains." Certainly, analysis and research are vitally important in finding good investment candidates, and in evaluating those investments and deciding whether or not to commit capital to those investments. But those who have been at this business for any significant length of time will know that the markets have a way of delivering "gut checks" that are every bit as mentally challenging as the truck scenario described above -- and if an investor does not have the "guts" to persevere through those periods of testing, no amount of "brains" will matter.

Investors in the systems which enable the interconnected, mobile networks of the modern world are presently experiencing a real gut check right now -- some might argue that they have been experiencing a gut check for the past few years.

Yesterday, for example, network processor company EZchip, which we have written about in the past, announced that their revenues for the current quarter would be about 10% lower than they had predicted -- an announcement which contributed to the overall negative sentiment in the sector of companies offering solutions to the carriers whose data centers and towers and nodes move the data and enable the mobile networked activity that consumers and businesses use every minute of the day.*

The selloff in EZchip was immediate and significant, with the stock dropping about 10% in one day. It was, in an sense, a "gut check" for investors who thought that "the trucks would be here by now," so to speak -- and many investors (including some who may have invested in EZchip for many years) threw their rucks on the ground and said they were done with it. In other words, they sold their shares.

We bought more.

The reason we bought more in this case is that, while we don't know exactly how much further we will have to go before the situation suddenly gets better, in this situation we are absolutely convicted that the situation will in fact get dramatically better. 

The conditions that investors and industry participants have been talking about for years have not changed: the demand for more and more data, delivered more and more rapidly, and at higher and higher levels of sound and visual quality and resolution is growing exponentially, and the infrastructure to deliver all of that data at higher speeds and higher levels of quality has not been keeping up, and will necessarily have to be upgraded. 

This fact is no secret in the industry: it is the focus of nearly every company involved in the networking world. The carriers are facing billions of dollars in spending (actually, tens of billions of dollars in spending) and we believe that they have been evaluating their options and weighing their deployment of so much business capital very carefully over the past several years. 

At the same time, many new transformative approaches to the underlying problem have been developed, including the industry-changing approach known as NFV, or "network function virtualization," which has radical implications for the makers and buyers of network equipment and for the designers and architects of data centers and data networks. In light of this fact, it is to us no surprise that the carriers want to thoroughly evaluate the situation and look at all of their options prior to committing to courses of action which will involve billions and even tens of billions of dollars.

We believe that this process has been going on for some time now, and that it is still going on -- but we also believe that it may be nearing an end and that the move may begin to take place very soon. We don't know exactly when the evidence of this move will begin to be evident, but we are fairly certain that it will in fact happen. 

Obviously, this move will involve industry dynamics which are bigger than any single company or any single investment name, including EZchip -- we just use EZchip as a timely example in this discussion. We invest in other businesses which we believe are positioned to benefit from this same dynamic, not just EZchip, and we would advise other investors who want to benefit from these types of major industry paradigm shifts to follow a similar course. 

The bigger point is the concept of the "gut check." Many market participants are very short-term oriented in their focus, for various reasons (sometimes for very good reasons). For whatever reason, they simply cannot continue to march after the trucks, even if those trucks have only gone over the next ridge and around the next bend. When investors with a longer focus see others around them "throwing down their rucksacks," so to speak, and declaring that they are done with this road march, it can be very disconcerting -- and some investors may be tempted to do the same thing just because everyone else is doing it.

Please note that we are not advocating that investors never sell an investment, or that selling an investment when new information requires a re-assessment indicates some kind of failing: if the new information changes the investment thesis to the point that the original assessment is deemed to be no longer valid, then selling the investment may in fact be the right thing to do, and failing to sell it at that point would be the real failure!

But if, on the other hand, the original investment thesis is still valid, and it is the market which is being short-sighted and throwing a tantrum when the trucks drive on a few more hundred yards out of sight, the right thing to do may well be to press on. 

We believe that this may well be the actual situation right now in the networking solutions space, but we also believe that this valuable and important principle of the "gut check" is one that is broadly applicable in the business of investing -- and in life.

* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by EZchip Semiconductor (EZCH).

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