Unfortunately, some people have the habit of remembering what I say even if I don’t. In order to protect me, I am trying to write down what I think I say in various conversations. This week I had four discussions that separately focused on what investors and managers should be doing. In thinking about these communications, my point of view was they should be doing something now, to make money in the future.
The two portfolio approach
In a discussion with an organized group of sophisticated investors who travel behind a cloak entitled OFIC, much of the conversation was about the various concerns that were preventing them from investing. In reaction, in part due to my reading about naval warfare, I suggested that they immediately do something. In a naval battle, a ship that is not moving is a much better target for the enemy than one that is in motion, particularly if the motion leads to rapid changes of direction and speed. For my National Football League-oriented friends, this is advocating the use of broken field plays to keep the defense off guard. My suggestion was that each investor create, at least in his or her mind, if not in fact, two portfolios. The first portfolio is to hold the investor’s maximum need for liquidity. The first would have not cash (yielding nothing) but mostly munis and other income producing paper. With the need for liquidity addressed, the second portfolio could be aggressively invested. The aggressive portfolio should be focused on the reasonable extremes of the myriad of opportunities that are available today. We should keep in mind that even during the Depression there were some fantastic up-market moves.
There are two keys to this strategy, the first is get out of the middle where everyone else is, and the second, like a broken field runner, be prepared to change courses rapidly.
Essential elements of information
I spend a lot of time with analysts and portfolio managers trying to understand how they make investment decisions. I get worried when they express their decisions based on the complete confidence that they have all the information on a company, stock, or market. This confidence belies what I learned in the US Marine Corps as well as my own analytical endeavors on individual stocks. In the military intelligence world (perhaps it’s an oxymoronic statement), one needs to identify what are the critical facts needed to make a decision. These facts are called the essential elements of information. Further, each element was graded on the likely accuracy and the quality of the source of the information. In the heat of battle, did the Marines, and I suspect other forces, have complete knowledge of the situation that faced them? As an analyst, I used to lay out what I wanted to know about a company and a stock. (They are very different for the long-term.) In both cases, in the military and on the analyst desk, did we ever have 100% of the essential information? Due to time pressure, we frequently had to make decisions having only 60% of the needed elements. Rarely did we get to 75%. When the battle is on (or when the stock is recommended or bought), some of the missing elements become known, plus new unanticipated factors surface. When properly processed and communicated, the additional information can cause changes in direction. With this as a background, I am less likely to buy a fund where the manager and/or responsible analyst feel that they know everything. A level of doubt is an important additional attribute that is a positive for me.
Precision vs. accuracy
Recently I was in communication with a very bright law school student who was entering his last semester with a very good record. I suggested that it is possible that at the end of his last term some professor could ask a question whose answer was not in his books but in his evolving understanding of the practice of law. I used as an example that, I believe 50% of my last Asset Accounting exam was to answer the question as to what was wrong with accounting. What the professor was asking was, in essence, what value was all this work? (The same question could and perhaps should be asked at the final term of all professional schools.)
There is a significant difference between accurate bookkeeping and accounting. Bookkeeping requires the capture of all the financial information and displaying it in an acceptable format. Good accounting takes the product of bookkeeping and colors it for other factors based on experience, regulation, and tax management. A bookkeeper can capture the cost of an asset and assign it to an expense or asset account. The bookkeeper can charge against the asset an agreed depreciation, so that the balance sheet reflects how much of the asset has been paid for through the income statement. The accountant needs to determine whether the asset is overstated or the property is materially not worth its carrying cost. While the bookkeeping is precise, the accounting is making a judgment as to the accuracy of the numbers. As a portfolio manager and investor in financial services securities, I am offended by the argument in the press and by some managers and analysts that many banks and other financial companies are holding large amounts of assets, particularly loans, that are selling at ridiculous low valuations. They scream that these stocks are selling at prices that approximate book value. These same stocks are not only not going up, they are going down. They have mathematical precision to buttress their argument. The market is not buying it. The imprecise market is looking for accuracy. Accuracy as to what the assets are really worth. One could take the attitude that instead of being cheaply valued, that these securities are in fact, expensively priced. The assets could, for example, be worth 50% of their carrying value and thus these stocks are selling at 2X their realistic book value. On this basis, I am suspicious of many so-called value managers who assert that their portfolios are statistically cheap based on published book values. There are, undoubtedly, a number of stocks that are selling at substantially below what a knowledgeable buyer would pay for the company. When we see a pickup in M&A deals for already public companies, there will be more verification of values in the market.
Hire a good pro
One of the observations that I make in interviewing CEOs of private investment management organizations is to see whether they hiring people. During most periods one of the constraints on future growth of a business is the lack of good people to hire at reasonable wages. I believe that eventually we will see high stock market levels and that there are an inordinate number of good investment people that are either out of work or for the first time in their careers, would be willing to jump to a better opportunity. Thus, I think this is a good time to hire. As a matter of fact, if any member of this blog community knows of an experienced analyst of US mutual funds who is looking for an investment employment opportunity, there is a good chance we should talk directly (not through any intermediary).
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