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Tom Herrick Featured in The Wall Street Transcript Interview: Participating in Market Upside While Limiting Downside Risk

February 23, 2024

Cary Street Partners’ Chief Market Strategist, Tom Herrick, was recently featured in The Wall Street Transcript, which focuses on in-depth interviews for investors. “Sleep at night strategies, consistent returns, limited drawdown, trying to add diversity to client portfolios. It’s what we’re trying to do here.”

The full interview follows, and you can also download a pdf copy here.

SECTOR — GENERAL INVESTING

TWST: Could you tell me about the firm?

Mr. Herrick: Cary Street is a registered investment adviser with a little over $8 billion in assets. Last I saw a few days ago, it was $8.2 billion. We’re headquartered in Richmond, VA. We have at this point roughly 75 financial advisers, 155 employees, many of which support those advisers within the branch system.

We have locations primarily in the mid-Atlantic. We’re all over Virginia. We do have an office in the tristate New York area, in Morristown, New Jersey, a whole laundry list in Virginia. And once you get outside of Virginia, we have offices in Charlotte, North Carolina, Greenville, South Carolina, two in Texas, one in Austin and one in San Antonio, as well.

We’re primarily a wealth management firm. But we do have an asset management division as well, of which I’m the Chief Investment Officer. That constitutes about $1.5 billion out of the $8 billion.

TWST: And is there an overall investment philosophy at the firm?

Mr. Herrick: Yes. As Chief Market Strategist, I’m responsible for setting the firm’s viewpoints. Obviously, everybody will say they’re client-centric, as we are. We definitely are. Our clientele, for better or worse, is what I would call mass affluent. We have 5,000 households, 15,000 accounts. So that client composition drives part of the answer; our average account size is several hundred thousand dollars.

So we’re very focused not only on stock and bond portfolios and funds, but also we have a liquid hedging strategy. That’s primarily what makes up that $1.5 billion of models that are in the asset management group. But all liquid.

We are a relatively small player on the private side, but we are expanding. We have a lot of capabilities there, but that’s not a huge portion of our book today.

The discipline that we operate under is high-level macro inputs coupled with technical research. Those viewpoints are distributed, published on a high level. And then as they get disseminated through the branches and accounts, and as you work your way down the food chain, as you get closer to ground level, the solutions take a lot of different forms, because you’re dealing with all kinds of tax ramifications and individual needs.

I’ve been doing this for 40 years and I’ve yet to see a client come in with a check. They all come in with existing stuff. So there’s a lot of workarounds or work-throughs that our advisers have to do.

TWST: I understand you work on the Fairlead Tactical Sector ETF?

Mr. Herrick: That’s correct. So, the ETF is our Street-facing business and we’re going to add more. But that’s our first Street-facing business. Cary Street is the adviser on that, then Fairlead Strategies, which is embodied by Katie Stockton. She’s a technical analyst. Fairlead traditionally has been a research house, selling research to the Street. This is their first effort at becoming a portfolio manager.

We launched that on March 23, 2022. So, we’re the adviser. Fairlead is the sub-adviser. We’ve branded it as Fairlead, candidly, because she’s done such a tremendous job on Wall Street for two decades building a brand around her name. She’s a CNBC contributor. She’s in the press all over the place. And that’s a few hundred million. It’s about two hundred and a quarter at this point since we launched that. And that’s a tactical sector fund.

Again, we hope to expand that brand. Our role in that is compliance, oversight, trading, all the business side. And I work with Katie as we do presentations for potential capital providers. You could call that marketing.

TWST: I see it’s in a few different sectors — communication services, technology, consumer discretionary, industrial, financial. Is
there an overall reasoning behind that?

Mr. Herrick: It’s a model-driven multi assist approach. Our investment universe is 14 different buckets, 11 of which are the S&P equity sectors. And then we have three, what we’ll call, risk-off buckets, which is gold, long Treasuries, and short Treasuries.

And all of these are embodied as SPDR sectors. That’s how we execute. That’s how we express what we’re doing in these portfolios.

When the model is risk-on, we may be in as many as eight equity sectors. During its history, the markets have done since March of 2022 — we had a long stretch there where we were predominantly riskoff. The only sector we were in in 2022 for any period of time was energy. Last year, pretty much the entire year, we were in technology, communications, and consumer discretionary. But the rest of the fund was allocated to those three risk-off buckets.

Recently, the equity exposures increased, adding the additional equity securities. But we’re still not fully in the equity market yet. And
what’s driving that are long-term technical signals, long-term momentum, long-term overbought, oversold, relative strength signals. It’s a 20-year model, even though we’ve only been actively managing it — it’s only been live since that March 2022 date.

TWST: Is it targeted to people who have a certain set of goals?

Mr. Herrick: This is where I come in a lot more, because Katie, she’s running the model. This is where my role heightens. I spend a lot of time talking to other RIAs, financial advisers at wirehouses as to where this fits in. That’s the short version of that question, I think. And it definitely fits into this, I hate the phrase, liquid alternatives, but any kind of hedging, liquid alternatives, portfolio, sleeve or mandate, because where this model adds a ton of alpha is on the downside.

Because we will go risk-off, feels like in 2022, very low beta, very low drawdown relative to the S&P. In more normal markets, we’ll be fully invested, and historically there has been some advantage to the sector selection as well. But, like I said, the real alpha generation, the real reason you want to own this is so you could sleep at night, frankly. That is a giant piece of the marketplace.

It’s predominantly retirees that have a lot of accounts in America. And these folks need a good sequence of returns, they need to participate, but they need a good sequence of returns and they can’t go backwards dramatically.

So that’s where it fits in. That risk averse mandate or budget is where we advise people to place it. It’s not designed to run hot versus the market, I guess, is what I’m trying to say.

TWST: Sure. And I see you have something called CSP Global portfolios.

Mr. Herrick: That’s the model program I alluded to earlier. CSP Global is an internal portion of our asset management. These are models that I have discretion on for the firm’s clients and there’s about 3,000 of them that have these accounts.

Primarily, it’s a series of model portfolios that we fully execute. These are verified compliant type portfolios. They’re tied to results. It’s a real asset manager, even though I reference them as models.

Most of the asset at base is in the hedging sleeves that we run there. Those sleeves are heavily dependent. They’re 90% derivatives-based strategies. I don’t run the derivatives. We have partners that do this and some of them are well known and widely available. And a couple of them are unique to our models, i.e., they’re managers that are managing a fund just for our clients.

And they fall into three basic buckets: call writing, put writing, and put spread strategies. And I lean one way or the other in terms of how much beta to have in portfolios, but they’re always hedged.

And this falls, again, into that liquid alternatives bucket, which is much more commonly found in the marketplace. It’s more of a spaghetti against a wall approach. It’s a little bit of commodities. It’s a little bit market neutral, long/short, a little bit of managed futures maybe. Option strategies, derivative strategies are in that same category if you look at the Wilshire Liquid Alternatives Index. It’s a piece of it.

We focus on that, because it’s so much more predictable than that laundry list I just gave you. I mean, managed futures are fine, but they’re going to save you once a decade, and in the meantime, you’re losing money. That’s a hard strategy to own in a retail world, and not particularly effective for consistency.

So we run these hedging sleeves, one, to generate some income as well, the other is a no income strategy, but again, to limit drawdown to at least a minimum. Maximum we want to draw down is 50% versus the market, and we’ve been running those things since beginning of 2015. So there’s a lot of analytics to support that kind of result.

Now, on the upside, we’ll capture market upside. We’ll capture a lot of market upside in an environment like the last three years. We’ve captured a lot of the equity upside over the last three years. But you have a bear market smack dab in the middle of those three years. If you look at a different three years, which is more of a typical bullish, bent market, we should capture 75% to 80% of the upside, a number like that.

Again, sleep at night strategies, consistent returns, limiting drawdown, trying to add diversity to client portfolios. It’s what we’re trying to do here.

I have a strong viewpoint that we had a long downtrend in yields and consequently kind of post GFC up until two years ago, the 60/40 was fine. There was very little volatility. The nadir of that was 2017, when markets had a VIX of around five.

As we’ve morphed here over the last year or two we’ve had an inflation spike that’s come back down. But you’re going to have a much more normal volatility and rate environment, and that 60/40 portfolio, which we like at times, I’ve published in the past recommending that. But it’ll be more intermittent in terms of performance, and those guys are going to be much more correlated — stocks and bonds I’m talking
about — more than they have been in the past.

So we’re looking for diversifiers and TACK is a version of that. This hedging strategy model portfolio program that we run is a different version of it, using derivatives.

TWST: You mentioned about people being able to sleep at night. What’s keeping a lot of investors awake and worried right now as you interact with them?

Mr. Herrick: I think the biggest thing is geopolitics, honestly. Certainly, people felt the effects of inflation. We’ve had a strong viewpoint both on the way up and the way down in terms of what’s driving the inflation. We see more disinflation trending. I think that’s waning. But geopolitics definitely is something that’s out there and that takes a lot of forms, both international and domestic.

I remember 1968 pretty well. I was alive then, and the polarization is much more dramatic. So I see folks with very dramatically different views of the world depending what side of the aisle they’re on these days. That combined with sort of the axis of evil running from Russia to Iran to maybe with a dotted line to China. There is a lot of turmoil in the world and that has influences.

So, rightly or wrongly, I’m an optimist. I’m not one that thinks there’s a nuclear war imminent or a civil war or things like that. I think we get through this. But that is definitely the thing I sense as sort of the man on the street’s biggest concern.

TWST: When it comes to an investment approach, some people might not have the same confidence in the future.

Mr. Herrick: Exactly. They lack the confidence that they might normally have. And part of it, I can understand, because we’ve gone through a lot of turmoil recently and some of this is related to the pandemic too, but just a tremendous amount of turmoil, misinformation, international angst, hijinks from Russia.

The confidence is what’s shaken there. So you get folks that literally don’t want to invest because they’re just scared of the future versus the past. So our challenge is to get them in the markets and get them invested, because, again, we don’t have this negative outlook. But we have to navigate that challenge.

We navigate it by trying to offer them diversifiers and ways to limit risk. And, again, I already alluded to this, when you look at who has got the money in America, most of them have to be sort of risk averse, because they’re not 25-year-olds. They can’t drop 50% if you have a market like that. I don’t foresee something like that anytime soon, but I didn’t really foresee that in 2008 either.

You have to plan for it, I guess, is what I’m saying. If you’re in a position where you can’t ruin somebody’s life by riding a market down that dramatically.

TWST: Looking at the year that’s just started, in terms of both stocks and bonds from what you’re telling me, those are some of the strategies that some investors might want to consider for their portfolio?

Mr. Herrick: Yes. We have five takeaways on the market, and we are constructive on equities.

It’s particularly important to own the growth side of equities. This is a repeat from last year. Those are long-duration securities that will act well as rates come down, just like they acted terribly when they went up in 2022. That’s sort of a simple, number one, takeaway that we have.

Number two, there’s a lot of opportunity in the smaller capitalization stocks, and we’re starting to see some early signs of life there, breakouts of the Russell 2000, and things like that.

Longer term, there’s a giant dispersion there that you had in performance relative to large caps. And our regression analysis would lead you to a conclusion that over the next decade or so, you ought to double your return in small caps versus large caps. There ought to be a very wide gap in performance.

Now, that won’t be linear. A lot of that could happen in three years, and then it’s over with. Or it might be a drip, drip, drip. It’s hard to say. It’s not hard to say, it’s impossible to say. So, that’s our second takeaway.

Our third takeaway is in fixed income. We’re at the end of a rate cycle, so we want people to lean into duration a little bit, because it’s a good time to lock in yields. That’s helpful. Again, if you’re risk averse, do that with Treasuries. You could do it with Treasury ETFs.

Number four is also within fixed income. Mortgage backs have become very attractive. And normally there’s a big gap between mortgage back yields and risk-free yields. Normally, it’s way closer.

And normally you have some prepayment risk at this point in a mortgage cycle, but this is a weird mortgage market. Ninety-seven percent of America is locked into sub-4% mortgages and a lot of them are 3% and under. They’re not going to give those things up. It’s going to take a lot of pressure from their spouse to move, so they’re not going to want to give up 3% paper easily. So that normal prepayment risk isn’t as apparent as it normally is. So, we do like mortgages.

Then the fifth recommendation or takeaway that we have already alluded to is a normalized volatility and rate environment, where stocks and bonds will be locked at the hip a lot more. And while we’re positive on those things right now, it’ll be a little more intermittent.

And these diversifiers are important, i.e., hedging strategies, the TACK portfolio. We do like private credit quite a bit in here as well. There’s some reasons to like that as well. That’s an additional diversifier. So, there’s a laundry list of takeaways.

TWST: And this sounds like it may not be a time like in the past where some investors have looked at seven technology stocks and put all their money in there.

Mr. Herrick: Yes. My publications and in fact my monthly notes that I’ll be publishing in a week or two will be along these lines. We had a very strong finish to the year. A very powerful month of small cap outperformance versus large cap. I think, the Russell was up 12% and change, and the S&P was up 4% in December. So, you’re getting a little bit of just sort of natural reset to that right now. Minor pullback type activity, I would call it, or consolidation.

The S&P is still a little bit below its all time high, but as that consolidation or all that overbought stuff works off, which a lot of it has, we see equities again. We’re more constructive when we see rebound.

All that’s leading to a very simple conclusion on my part, which is if you’re doing dip buying, if you’re buying the dip, we would definitely focus in the small-cap area, because you already said it, America has a lot of exposure already to these large cap growth companies, and I’m not negative on those necessarily, but there’s better opportunity in the small-cap. So if you’re adding exposure, add it there.

TWST: We were talking about people who may be in their retirement years. Any other advice for them? People are living longer.

Mr. Herrick: And that’s the challenge. That’s one of the reasons we’ve developed this hedging sleeve, because you’ve got to participate.

And, again, kind of turning the clock back, before we started this, we looked at sort of all these other alternatives. And if you look at the bucket of liquid alternatives, things that will limit volatility, for sure they are very low volatility instruments. They’re also extremely low return. You’ll see the Wilshire Alternatives, Liquid Alts Index is like 2% a year for five years, numbers like that.

I mean, that doesn’t solve the return part of the problem. It’s almost like saying, yeah, just put your money in cash, you won’t make anything, but you won’t lose anything either. Great. OK. That doesn’t really help me, because you said it, these folks are living longer, which is a good thing. They need to plan for longer periods.

Commonly, every firm like ours deals with a constant draw of spending, hopefully, within limits. So they need this strong sequence of returns. They have got to limit downside, while at the same time participating to some large degree. So that is super important.

And again, there’s various ways to handle this. When I’ve sat on panels, a lot of people are trying to handle it entirely with private funds. That doesn’t work with tons of clients, because they may not be qualified participants, they may not be $5 million net worth people.

So, in the liquid space, we definitely believe derivatives have a role to play there. And maybe a little more democratized diversifiers like private credit, that’s pretty easy to get into. That’s not something that takes a $5 million net worth to buy.

It’s a huge challenge. I’ve watched this real time with clients. I’ve been client-facing for 39 years. I’m still client-facing. And I have seen this happen where I saw it in 2000 to 2003, where people were drawing off their accounts, they were too aggressively invested. They didn’t want to change anything, because the 1990s were great and they were very complacent, I guess, is my point.

And then they dug a hole, because you had a bear market and it lasted three years while they were drawing money off of their account. That can dig an insurmountable hole. I don’t know that I had an insurmountable issue with any one client, but it could happen very easily. So that’s why limiting drawdown, yet still participating to the upside to some degree.

You need things that can demonstrate that. And, again, derivatives have a long history of doing that, those sorts of categories I was talking about earlier. So, it is important. I think it’s the number one challenge. It’s a combination of planning and investment strategy in understanding that.

And I’d go slightly further, and this will be my final point, that it’s also a challenge people have to address even before they retire, because you can be riding great markets, great investments for 30 or 40 years.

Let’s use that 2000 to 2003 example. Say you’ve been doing that for 30 years. You’ve built up this nice bucket of money that you can easily live off for another 30 years. Well, if you haven’t changed your thinking about how you’re going to invest that while you’re drawing on it, that sequence of returns matters a lot.

And let’s say you retired in 2003, and you had this big bucket of several million dollars in 2000, and then you get to 2003, all of a sudden, it’s a third less or 40% less. I mean, that sequence of returns as someone’s nearing retirement is very important as well. There’s no exact number there, but I would say three years. When you’re within three years of retirement, you have to think about managing risk, but participating at the same time.

TWST: And anything we haven’t talked about, you care to bring up?

Mr. Herrick: Like I said, I do feel this fear of geopolitics is rampant. I don’t factor that into my viewpoints in terms of outlooks and things like that, because the world does change and has a lot of self-correcting mechanisms in that regard. And it’s impossible to predict.

If you go back to 2016, on one side of the aisle, everybody was super-positive, and the other side was super negative. And in 2020, it was a flip flop. The reality is, in both cases, there was ample opportunity and ample ways to manage your way through these situations.

So, I guess, my main piece of advice to investors is don’t let the geopolitics sway you one way or the other. Look at stuff that’s a little more data driven and really going to solve your actual problems or needs. Maybe problems isn’t a good word, needs. And, again, there’s certainly ways to minimize risk, while at the same time participating in markets.

TWST: Thank you. (ES)

THOMAS O. HERRICK is Chief Market Strategist, Managing Director for Cary Street Partners and is a member of the firm’s Executive Committee. Mr. Herrick has spent over a decade with Cary Street Partners. He is responsible for oversight of the firm’s managed model account offering, manager research and due diligence, and growth initiatives. Mr. Herrick is accountable for firm viewpoints and produces thought leadership and investment commentary through various mediums, including podcasts, videos and written published content. Earlier, he was a member of the portfolio advisory group manager research team. Mr. Herrick joined the firm as a Financial Adviser in the Fredericksburg, Virginia, office. Before joining Cary Street Partners, Mr. Herrick was a Financial Adviser at Smith Barney and its predecessor firm Legg Mason Wood Walker. He started his career and spent more than a decade at Wheat First Securities. He received a degree in economics from the University of Richmond.

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