Sunday, July 19, 2009

Learn from London and Paris
But Invest Creatively Elsewhere

Ruth and I have just returned from a trip to London and Paris. In addition to accompanying my wife on New Jersey Symphony Orchestra business, one of the reasons for the trip was to gain insights from various financial professionals. I spoke with the leaders of two publicly-traded companies, several portfolio managers, the strategic adviser to a large hedge fund, a successful currency trader and a data provider with an academic orientation. While all of these gentlemen were very intelligent, they did not share similar approaches or views of the future (I should note that I have visited many accomplished professional financial women in prior visits.)

I did notice that many of my discussions relatively quickly evolved into the use of complex derivatives, which represented 30-100% of the net equity of portfolios managed by these professionals. In almost all cases, the derivatives were used in various hedging strategies. While they expressed a generally positive long-term view, they were also using short positions through derivatives to hedge against a sudden, unexpected sharp decline. In almost all cases, the gentlemen relied heavily on their academic training and their experience of survival. To most, the future would be some pale extrapolation of the past. All feared changing regulation that will increase their operating costs, restrict their flexibility, and in the end, hurt the public’s ability to make money. They seem to have good reason not to try future-oriented strategies. Their instincts are similar to many analysts found on this side of the Atlantic. I have often said that if you scratch an analyst, a historian will bleed. There is comfort in knowing how the movie, play, or opera ends.

Investing in China, India, and selected other Asian countries was the source of good performance numbers for a number of the funds based in London and Paris. While some managers conduct research from London, others use Hong Kong and occasionally Singapore. If they do have Tokyo offices, it is to track Japanese, and possibly Korean securities. China is the biggest single bet or actually twin bets. The first investment bet is on product producers for the export markets (largely dollar earners). The second wager is on the growing home market for goods and services. The potential dynamite of rising expectations in a controlled environment is recognized as a difficult situation, and can go wildly wrong at times.

Currencies are viewed as trading vehicles rather than assets of long-term value certainty.

What does this all mean to those of us who manage money for retirement plans, non-profits and families of substantial means? I am still recovering from some jet-lag, thus my current thinking is evolving. First, most European analysts are much more financial statement-oriented than I am. They do not seem to want to understand how a company or a fund actually works. As statement-oriented analysts, they are much more likely to be enthusiastic about “value” than “growth.” They seem to see things in an orderly solar system and will use their intellectual skills to protect themselves against change. I tend to look forward to finding change, and discovering those investments that benefit from change. In America, we use far less leverage than they do in Europe. The fact that many European managers tended to invest in companies that used leverage is one of the reasons that financials often represented 50% of their portfolios. Even for someone who manages a financial services hedge fund, this commitment to financials seems a bit high to me.

The bottom line: While we can expect many new techniques will originate in London and Paris, it will be the United States’ distribution power that will generate the largest share of the profits. To use Peter Lynch’s term, we should be focusing on the creative skill sites of the world for our next “ten bagger.”

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