ROGER PALLEY : A Taste for ‘Plain Vanilla’ : Investment Manager Prefers the Safe, Steady Approach

The economy is slumping, the stock market is anemic, real estate is losing value and the days of high-yield bank and savings and loan deposits are gone. So what’s left on the investment front?

Roger Palley thinks there still are opportunities out there. It is not the best of times, says the founding partner of Palley-Needleman Asset Management, but neither is it the worst.

The Newport Beach investment firm, one of a handful of independent money managers in the county, was founded in 1985, just after the last recession, and since has weathered record ups and downs on Wall Street and other investment channels.

A self-described “plain vanilla” investment manager, Palley-Needleman has grown in just five years into a significant regional presence, handling a portfolio of $693 million for hundreds of individual, corporate and institutional clients, including the Orange County Performing Arts Center, Girl Scouts of Orange County, Chrysler Corp. and the Louisiana Teachers Retirement System.

Palley, 48, started the firm after 23 years as an investment manager and analyst with companies like Title Insurance and Trust and Oppenheimer & Co.

A transplanted New Yorker, he picked Orange County for his headquarters because “people here don’t understand what we do. Orange County has only about five bona fide, good quality firms that do what we do. But if you go to L.A., there are 25 or 30, and if you go to New York, there are hundreds. So what a golden opportunity to be in this business in a county with all of this money.”

In a recent interview with staff writer John O’Dell, Palley shared his thoughts on investing, the economy and Orange County’s reputation as a hot spot of investment fraud.

Q. An investment counselor operates within a certain base philosophy. What’s yours?

A. To manage assets in a conservative fashion, to have our clients stay ahead of inflation and taxes, and to do it with quality securities. The majority of our clients already have their money, so they’re not asking us to make them rich. They just want to preserve what they have. We aim for a reasonable rate of return on investments. We don’t buy stock in new companies or in volatile technology companies, we don’t trade in commodities or on margin or do option trading or currency hedging.

Q. You said that people don’t understand what you do. Here’s your chance to explain.

A. Well, first of all, we are independent investment advisers, we’re not brokers. We do not make any money on transactions. We charge a fee just like an attorney or an accountant. We bill quarterly. There’s no contract and we don’t make any money when we buy and sell something for you. Our fee is a function of the value of your portfolio. We want to see the value go up because then our fee will become a little bit greater.

Q. And what does a firm like yours charge?

A. It’s only 1% a year. So if you had a million dollar account, you’d pay us $10,000 a year, or $2,500 a quarter.

Q. The economy is lousy these days, but good or bad, where are you putting clients’ money?

A. There are only three broad classes of assets when you invest the way we do: cash equivalents, fixed income and equities.

Q. How about some plain vanilla definitions.

A. Cash equivalents would be money market funds, usually investments in government securities maturing in one year or less, or in direct purchase of treasury bills that mature in a year or less. For clients with taxable accounts, however, we buy short-term California tax-exempt funds so the clients don’t pay any tax on that part of their portfolio earnings. Then in the fixed-income area, we buy bonds. They can either be municipal bonds or federal government bonds, which would also include agency bonds and government-backed mortgage bonds. On the equity side of the portfolio, we’re very well diversified by industries. Our tendency is to invest in industries that are somewhat more stable than the average, so historically our largest investments have been in food, tobacco, beverages, utilities, things of that nature that are less cyclical. We have very small exposure to technology. We don’t buy small companies and we don’t buy emerging growth companies. Our tendency is to buy stocks that have good dividends, excellent balance sheets and good long-term records.

Q. You mentioned tobacco companies as an investment. Do you invest with any sort of political or social ethic?

A. As a firm, our only philosophy is that we are capitalists first. No one in our office smokes and we don’t have an ashtray here. But we’ve made the decision that if tobacco companies are indeed good investments--and we think they are--we will invest in them. As far as being socially responsible goes, we let the client make that decision. We have some clients who are socially responsible and provide us with a list of restrictions that we abide by. For some clients, we cannot invest in liquor companies, nuclear utilities, defense companies, tobacco or firms dealing in South Africa. But that probably comprises less than 10% of our client base.

Q. Back to the economy. Where is it going?

A. The economy for the last several months has been in a slow-growth mode. Some industries are doing OK, some are doing poorly. When you look at the aggregate national account numbers, it’s about flat. It’s likely that later this year and into next year, we’ll start seeing some negative readings, especially on industrial production. Unemployment is likely to rise somewhat and inflation will probably go higher for a while but is likely to flatten out if not go down next year. So, our outlook right now is for a slow economy.

Q. And how do you invest clients’ money in a slow economy?

A. We still think that a good mix of cash, bonds and stock is the best way to go for the individual investor who needs a reasonable rate of return above inflation and taxes. The exact mix will depend on the particular client. In the cash area, we have money in government money market funds for safety, liquidity and income. In the bond area, we have U.S. government bonds or good quality municipal bonds, with short-term maturity, to take some of the risk out of inflation. If inflation were to rise a lot, the bonds would be protected on price. In stock, we are in quality income-type stocks. In the technology area we’ve been very light, although we still think larger companies like IBM will do well and have good growth rates. The last segment is foreign stocks, where we have some investments. They are listed on the New York Stock Exchange, however, in the form of an ADR, or American Depository Receipt.

Q. The benefit of foreign stocks?

A. Foreign stocks are a play on currency if the dollar continues weak, and a play on the diversification taking place in different countries and businesses because of what’s going to happen in Europe with economic unification in 1992. And also the changes in Eastern Europe.

Q. You say the mix varies, but what would be typical in a climate like we are in now?

A. In most cases, it’s a balanced portfolio. We might have 50% to 55% in stock, 30 to 35% in intermediate government bonds and the balance in money market funds. If interest rates were to drop significantly, and if we felt the economy was going to improve, then somewhere down the line we would increase our equity exposure by 10% or 15% to take advantage of a rising economic environment, good corporate profits, rising dividends and probably a rising market. Conversely, when things go the other way, we’re going to reduce our equities, but never to the point where we’re totally out. We don’t feel we’re that smart. More important than how much you have in stocks is the kinds of stocks that you own.

Q. The Orange County economy has tended to be affected less than other regions by national recessions. Has there been any change in the economy here that could change that?

A. No. I don’t think so. If anything, the economy here has probably tended to be more diversified in the last five years. We continue to have more upscale people moving to this area. So we continue to have fairly good income levels. The only area that would concern me, and I think the jury’s still out, is the number of people involved directly or indirectly in residential construction, mortgage-related and real estate development businesses.

Q. That’s a lot of people in Orange County.

A. And there are many people I’ve talked to who are no longer employed by those companies. There have been some very quiet layoffs. All the way from home builders to major commercial developers to interior design firms. Many have laid off anywhere from 10 to 20% of their staff because of the slowdown. And it’s not that people aren’t buying because interest rates are high. It’s because home prices got too high and people couldn’t afford it.

Q. How long do you see that lasting?

A. One could make the case that housing, for the next five years, may not be a very good investment. In fact, some people have suggested that you’re better off renting now, letting the landlord worry about all the expenses like insurance and taxes, and taking the savings and investing your money elsewhere.

Q. Let’s take some people whom you probably don’t deal with, members of the middle class who might have an extra $5,000 or $10,000 at the end of the year to do something with. What should they be doing?

A. Let’s just put that in perspective. Our minimum-size individual account is $500,000. Somebody with $5,000 or $10,000 or $15,000 doesn’t need an investment counselor. What they should be doing is sitting down and making a financial plan with a financial planner or their own accountant. In that plan, they would decide what to do with the liquid portion of their asset base. Assuming they have their house, some insurance and a car, then they may want to diversify the rest of their assets. The most inexpensive way to do it, and the most diversified way to do it, I think, would be to buy some good no-load mutual funds. But there are a lot of factors to consider, including the person’s age, marital status, whether there are children . . .

Q. But in general, for a limited amount of money, you would not look first to the stock market?

A. It depends. If the person has emergency money put away, and everything else taken care of, then I think you have to look at extra money as investment money. And investment money to me means money you can buy real estate with, you can go into a limited partnership with, you can buy mutual funds with. Some people may want to invest their money in coins and stamps, which I don’t know anything about, or in artwork. But it’s very hard to do that with a limited amount of money and a limited amount of knowledge. So, giving your money to an investment firm makes the most sense.

Q. We always hear about the guy who bought yesterday and made a million today in the market.

A. He probably lost $2 million the day before yesterday. Our investment philosophy, and we try to educate our clients to this attitude, is that you have to be a long-term investor. And we like to think in terms of a three- to five-year outlook.

Q. You left out of your list of investment channels things like precious metals.

A. I mentioned earlier that we don’t invest in any of that. We don’t invest in any commodities. Nothing tangible, like real estate or diamonds or cemetery plots. It’s not our area of expertise. It’s too volatile, and we can’t be all things to all people. So we have limited ourselves to be, as I mentioned, plain vanilla investment counselors dealing in cash, bonds and stock. If people want to invest in those other things, they need to find an expert in that area, or try and do it themselves.

Q. Do you find with your individual clients that most are in real estate on their own?

A. I’d say, generally speaking, that people who live in Orange County who are in their 50s or 60s, probably own their own home, maybe two homes, and probably have made one or two or three real estate investments along the way. What we have seen the last several years is people selling their real estate, when they’ve been able to, and putting the money into more liquid assets and generating more income than they were getting before. We’ve seen a lot of money come out of real estate in recent years. We’ve also seen a lot of new money generated in the last several years by individuals selling their companies. There’s been a lot of that going on in Orange County.

Q. If people are selling real estate and businesses, then someone else must be buying them. Where is that money coming from?

A. In real estate you have a new element of buyers who are younger and willing to take the management time and effort to reconstruct a project or property. With companies, we’re seeing buyers doing leveraged purchases with the company’s assets pledged for bank loans. In the last year there have been a lot of local companies sold to other companies for strategic reasons. I think we will continue to see that--the strong strategic buyer, domestic or foreign, buying up good companies with good names and good operations here in the county.

Q. Orange County is known far and wide as the investment scam capital of the universe. Why do we seem to have so many gullible people in our community who are willing to throw money away at people who promise them the moon?

A. If you think about the communities that have this problem, they all have a couple of things in common. The other areas that are most known for scams are Ft. Lauderdale, Fla., and Phoenix and Scottsdale, Ariz. And what do they have in common? Retired people who are not highly educated, and people of all ages who want to live a certain lifestyle. They all go where the weather’s nice, and they typically have higher incomes. They’re more speculative; they’re more aggressive; they’re people who would take a flier on something--and they usually get burned. In Orange County, I think--and this is a pure conjecture on my part--there are many divorced women who have a lot of money from their settlements and feel that they need to make more money. So they’re willing to take more risk. I see it all the time. And so scam people set up shop here. They prey on people who are uneducated, greedy, who watch TV and think everybody should have all those things.

Q. Is there really that much wealth in the county?

A. There is a lot. But there is a lot of flash too. You see all the people on boats at Newport and don’t realize that a lot of those people have probably borrowed the boats. I used to say that we’d see the same fancy cars in Newport Beach all the time, but the people driving them would change frequently. I’ve met a lot of people who live well but have no money and are actually living from month to month.

Q. How do you protect yourself against scams?

A. I think you need to seek advice from people you trust. If you don’t have a CPA or a law firm or somebody you can go to for help in checking out an investment opportunity, then you need to either talk to other clients of the firm or ask for certified records and background information.

Q. Sounds like a lot of work, but I guess the bottom line is it’s your money, you worked hard to make it.

A. As they say, caveat emptor. You’ve got to do your homework because it’s “buyer beware.” These frauds are very frustrating to me personally. You read in the paper that $30 million was raised by some firm, some boiler room operation, and that they’ve run off with the money. Look what happened in Irvine recently with (FundAmerica). When they were active, investors couldn’t get in the door the lines were so long. They had these meetings every week and the place was packed. You just knew that was coming.