Sunday, September 29, 2013

Are You In an Investment Bubble?


Sales people of all types are taught the doctrine of KISS, Keep It Simple Stupid. A more urban version of this is the “elevator speech” to be used meeting a client or prospect in an elevator and designed to be delivered quickly and simply in the time the  elevator takes to go from the lobby to the floor of the intended client’s interest. Both of these approaches prize getting an intended result rather than a transmission of understanding.  

William Shakespeare, market analyst

In his masterpiece of summing up trouble, Shakespeare has the three witches in Macbeth, Act IV, Scene I intone “Double, double toil and trouble; Fire burn and cauldron bubble.” This may be the first literary introduction to a market bubble. Notice the words “double, double.” In the investment marketplaces, a requirement for a “bubble” is a phenomenon of great popularly-driven walls of money flowing into dotcoms, housing, derivatives, treasuries, and high yields. Note there is nothing wrong with any of these investments in moderation, but when they enter into the phase of double, double, or much more there is danger of being in violation of the concept of prudence by not avoiding large losses. (In handing his ruling against Harvard College in 1830, Judge Putnam intoned the famous “Prudent Man Rule” which required a trustee or fiduciary to do those things that other men of intelligence and prudence did with their own money.”)  This ruling created a peer-related legal concept of prudence. By definition, if there are large holdings in a security or sector, when they go down there is limited demand for the falling securities which will lead to even greater declines.

Camp followers or market followers

In many European wars the armies were closely followed by a bunch of women; some of these were the wives of the soldiers, others pursued a more professional type of transient relationship. The wives were interested in the long-term, the second group were more interested in the action of the moment. I see a parallel to the second group in some of the emerging trends today.

This week the MacArthur Foundation recognized Professor Colin Camerer from the California Institute of Technology for a genius award. I am a Caltech Trustee, thus my wife Ruth and I know and prize Professor Camerer for his leadership of a group of graduate and post-doctoral students who finished their work at other universities. Their combined study that linked blood flows in the brain to financial decisions showed that sophisticated risk-taking investors rather than neophytes were more likely to get caught up in playing bubbles. (Two well known brains who lost a great amount of their wealth in past bubbles were Sir Isaac Newton and Winston Churchill.) When I read about Colin’s success I wrote that the victims were in effect playing the old market ploy of the 'greater fool theory'. My good friend and regular Wall Street Journal columnist Jason Zweig had the same conclusion. The greater fool theory works on the basis of buying and holding an investment at a price that is disassociated from reasonable value on the basis that there will be a bigger fool who will pay an even higher price. Essentially these “fools” are letting the market make their decisions for them on the belief they can identify the ultimate fool. (Not themselves, of course.) It didn’t work with tulips or any of the other previous investment bubbles.

Where is this present bubble?

Over this past week and on a recent trip to London I was made aware of investment managers who on the basis of their back-tested data make the claim that they can produce better than market results due to their timing and selection of market sector skills through the use of Exchange Traded Funds (ETFs). As with other vehicles which can be driven too fast, ETFs are based on a safer, older model that had a more prosaic basis. Having given up on selection skills in picking managers or securities, many financial institutions are opting to closely match the market through low-cost index funds. (Unless the profits on securities loans or smart intraday trading are particularly adroit, the fees charged most of the time mean that the index vehicle comes close to matching the reported index return, but rarely produces the exact return of the index.) The merchandisers of securities recognized that using an index in a publicly traded security opened up opportunities for them to generate commissions, spreads, arbitrage opportunities and margin interest and thus became advocates of ETFs (Bubble, double bubble). Further, hedge funds found a safer vehicle to short against the risks in their long positions.

KISS and Elevator Speeches seem to be working. Each week I look at the net flows into ETFs and mutual funds as produced by my old firm now known as Lipper, Inc. In these reports the volatility of the dollar flows into and occasionally out of ETFs are larger than mutual funds even though the total size of the fast growing ETF business is considerably smaller than the mutual fund business. This is beginning to feel like the players of the day are increasingly playing the greater fool theory. I don’t know how long this phase of the game can last.

The revenge for 2008

Diversification became the buzz word for safety in many financial institutions. The assumption is that if one is invested in a number of different asset classes and sectors one can’t lose it all at the same time. This belief was based on a mathematical model that showed traditionally different market sectors were not particularly well correlated. However in 2008 almost every stock and bond around the world went down, except for treasuries and some small markets not usually held by foreigners. The spread of correlations collapsed.  In reaction to this painful experience many chose to play the market in a risk on/risk off fashion. For a lot of these players the ideal vehicle was and is today, ETFs. (double, double bubble).   

A study of history may suggest that we are in the midst of a Hegelian Synthesis where one trend creates an opposite trend and prominence of one over the other reverses. We may be heading back into a market of security selection not index trends.

The lessons of George Washington

One of the lessons from this weekend for Ruth and I with some good friends came from the dedication of a national library for the study of the first President. In the dedication of the library at Mount Vernon, the well known author David McCullough said George Washington had no better than a sixth grade education, but his library and his letters showed that he learned a lot. His first military battles were defeats but he learned to be a brilliant tactician using maneuver and surprise that my Marine Corps text books value so highly. He was a great leader of men getting his troops to stay with his ragtag army when their enlistments were up and farming season was looming. He stopped a potential army take-over in its tracks by just addressing the troops. Of all his manifold skills the greatest of them all was his leadership.

Applying General Washington’s leadership to your portfolio

How do you avoid the group think that is surging through the use of ETFs and other index-hugging approaches? George Washington was not afraid to try different things. He found and led other generals who were more trained in the arts of war than he. He kept his eye on his strategic goals and did not focus only on tactical moves. He endured the loneliness of command well. In the context of today’s investing world this means picking securities and managers who are different and that are focused on the strategic goals of the account to deliver funding when needed.

Are you strong enough in your investment beliefs to escape indexing a major portion of your investment responsibilities? Share your views with me privately or publicly.
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Sunday, September 22, 2013

Investor Mindsets Mine Different Results


Is changing investment attitude all that is needed to change investment results? Is it as simple as flipping the coin to the other side? In my search for these and other problems I often take the contrary view or flip the coin to the other side. I do this frequently in my conversations with CEOs of investment firms, chief investment officers, portfolio managers, analysts and most importantly investors. I try to learn from all of them to help the accounts for which I am responsible.

Lessons from Budapest

My wife Ruth and I have just returned from a much too short visit to Budapest. We were part of a small group of senior and/or retired leaders of stock exchanges from around the world. On the last evening of the conference we separated ourselves from the group to meet to meet for dinner with nine locally based CFAs.

When we sat down around a large round table, I thought the analysts took random seats. However as the evening evolved what became clear was that those seated on the left favored intervention by “authorities” and those on the right were very much for markets to develop freely. This right vs. left discussion has caused me to think about a two-sided model of thinking in which the wise investor and his/her manager can periodically flip the coin over.

The two-sided model

The interventionists were blaming the market and the economy for misallocation of resources to the effect that the middle class was being squeezed. Their solution was to raise taxes on the wealthy and fund the government’s redistribution efforts. The free market types thought that restrictions on corporate activities should be lessened so that businesses could hire more through their expanded profits. (I suggested that the quickest way to accomplish this was to reduce or eliminate the taxes on dividends.) From my point of view, this discussion could be boiled down to a simple equation. The external “they” need to take command vs. “we” need to be freer to produce for all to benefit.

The juxtaposition of the dinner with the conference did create an interesting insight. The blamers were incensed about High Frequency Trading (HFT). Based on the discussion at the conference I indicated that there is little evidence that the individual investor is materially harmed by HFT. Further it was pointed out that due to its loss of profitability, one of the largest independent HFT shops has had to acquire another firm whose basic business was executing orders for correspondent firms. (In other words, market forces have reduced the attractiveness of HFT to the point that it is no longer attractive.)

The other dichotomy that hit me in retrospect is that blamers saw the markets and their economy to be hemmed in by walls. (Remember the dinner was held in Hungary.) I guess it is my training from the US Marine Corps: where others may see a wall I see a hurdle to either get over or around.

Other two-sided models

To me the single most important determinant for investment policy is what time horizon will be used to judge success. Because of the frequency of publications, the media is interested in things that change rapidly. Note how much more coverage there is for short or sprint races than the longer cross-country events. The money that we are responsible for needs long-term success. Our clients want success for ten years or longer including multiple generations. I urge you not to fall into the trap of using three year data which can show performance going in a single direction and not the more characteristic up and down patterns of history.

Turnover rates

Allied with the need to set time horizons for accounts or even parts of an account, is the speed of required decision-making. Trading accounts could turn over their portfolios 100% every single month adding their managers' trading skills to the results earned in the underlying asset class. In contrast, successful equity managers investing for the longer-term have a complete turnover of their portfolios only every four to five years. Turnover, in my opinion, is not a cause of good or poor performance, but is a symptom of the speed of decision making and the time horizon focus.

Risk assumption

Many investors wish to avoid taking risks. (Risk is a loss that is so large as to put the long-term goal of the account in jeopardy. Risk is not volatility which may be uncomfortable, but does not threaten the accomplishment of the mission unless the discomfort forces the investor to jump out before the long-term time horizon is reached.) On the other side of the coin there are those that are risk seekers or at least risk tolerant as long as the risk is appropriately priced and diversified. The first group, (the risk avoiders) will occasionally be surprised to learn that ‘riskless’ is an incomplete title. Further, they may be out of position for recoveries and further expansionsBeing out of the market for as little as ten days can lead to poor multi year results.


Oscar Wilde said that a cynic knows the price of everything and the value of nothing. He could have applied that to those that can and do tell investors everything that is wrong with any investment under review. The cynic and the blamer have much in common. Both can have a great deal of facts to buttress their arguments, but both presume that they know all that there is to know. The believer understands bad things can and will happen but that there are some good things that will also happen. The long history of the human race is that the believers are more often correct than the blamers.

What to do now?

I can not predict the future, but falling back to my experience handicapping races I can identify both probabilities and possibilities. At the moment the short-term signals from the bond market in terms of driving the equity market turned favorable, with the Barron’s Confidence Index dropping 1.7 points to 74.2. Normally the weekly move is 1 point or less. As this is a contrary indicator when it declines it is projecting a good stock market. However, twelve months ago the indicator had a reading of 66.3 which did lead to a remarkable bull market over the last year (more than twice a perceived normal rate of improvement). Considering the remarkable rise we have enjoyed since the first quarter of 2009, I would not be committing sizeable new money into the markets just yet. Nevertheless, I have a positive long-term view and am willing to assume well-priced risk in the global market.

Where are you in your thinking?
Please let me know.
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Sunday, September 15, 2013

Roles in Life Rule Investment Decisions


In studying investment managers for more than fifty years, I have learned that the roles that they have played through their lives have had an enormous influence on how they invest. What is true for the professional managers is also true for individual investors. If that is my thesis, I should apply it to myself. Thus, the following will be a form of self-analysis. The purpose of this exercise is to suggest that others should examine what in their personal history influences them as investors. Our life roles and experiences go a long way in explaining our self-imposed constraints and proclivities.

Handicapping Thoroughbred Racing

I have probably learned more about analytical thinking and careful money management from my experience at the New York race tracks than from all the classes I took at Columbia or in earning a CFA designation.

The first thing I learned was the existence of "racing luck". Despite a great deal of time and energy spent on past performance data, unaccounted things can and do happen. Thus the weight of money odds always includes the betting market's views on uncertainty or racing luck. The second thing I observed was that the betting crowd can be wrong. The most popular bet wins less than half the time and in many cases more like a third of the time. Thus, I usually have an aversion to investing in the most popular stocks or funds. The third thing I learned was that there was a better way to handle my hard-earned money.

One aspect of the first lesson mentioned above is not to feel compelled to participate in every race and to pick my opportunities. As an investor this has probably led me to favor funds that have fewer rather than a larger number of stocks. The second part of my track-induced money management course was to look for opportunities where the probabilities based on my thinking were different than the odds offered. Often I would bet on my choice for second (Place) so if my horse did come in either first or second I could still cash a ticket. Often if the favorite did not make it up to the wire at the end, when my horse did, the payoff for Place was substantial. 

Investment Lesson: Bargains are hard to discover at the track and in the market but are worth the time and effort to find.

Collegiate Fencer

As a five foot nine inch champion team member I was assigned to fencing épée. The bulk of my opponents were considerably larger than me, well into the six foot level.

Investment Lesson: I learned not to be overly concerned about being small. 

The bigger the foes, the harder they fall.

An Officer in the US Marine Corps

Here there are three lessons I learned from the USMC:

1.    Tight discipline produces first-rate results.

2.    The best defense is a good offense.

3.    Taking care of your troops and listening carefully to their reports often leads to them having the answers to difficult problems because their practical experience is far superior to field manuals of instructions.

Investment Lesson: A disciplined approach to investing is vital.

Simply avoiding large losses is not enough; one needs to make money to deliver against the needs of the account. Be aware one does not have to have all the answers. Many smart moves come from those with less theoretical, but more practical experience. However, one needs to take command of difficult situations even when you lack enough information.

Securities Analyst

A single financial statement in and of itself is relatively useless. Early in the game of analysis we learned to compare one company against the other, usually by numerical comparisons. The next step was to compare to price. On a statistical basis one security is cheaper than the other. This is unfortunately where a lot of analysts and investors stop. Cheaper does not always equal better. Often there are other factors including qualitative items that the market values higher than a pure statistical measure. At times a premium price is warranted.

Investment Lesson:  While numbers are very important, they are not everything.


I believe I have a tremendous advantage over many other CFAs and analysts. I started a business. At times I turned around failing products. I met a payroll and paid employees and suppliers as well as corporate taxes. Too many armchair analysts tell corporations what they should do while they themselves have never done it. Today most corporate managers do a pretty good job on what they believe to be the objective. In analyzing a company in addition to its sheer survival, one needs to understand what management believes is the objective. All too often history has shown that professional analysts make lousy business leaders. 

Investment Lesson: We should be respectful of the specific competence required in securities analysis, in business and in non-profit organization management.   

Business Consultant

Because my firm produced the most complete data on mutual funds, and to some degree on brokerage firms, I was frequently asked to consult with CEOs of various fund and other financial organizations. The real world problem was that the statistical or ‘school solution’ answer to the presenting question could not be executed for a host of reasons. The challenge just as in the Marine Corps was, “When blocked, how to go around the enemy and /or improvise with new and often on the spot solutions?” The more consulting jobs I completed, the more I came to the conclusion that the real problem was people and how they acted or will act under change of circumstances. Often the biggest problems were the CEOs who hired me; even when they recognized that they were part of the problem.

Investment Lesson: As investors: we are the biggest hurdle to better performance.  

Understanding and overcoming these limitations may be key to this exercise.  For example, I often harbor a reluctance to sell when short-term disappointment is likely. The short-term can turn into long-term, with the possible result a long period of under-performance.

Investment Manager

By the time one gets the responsibility of managing large amounts of other people's money, one should know exactly how to construct the portfolios for optimum results. Even with so-called discretionary accounts there are specified constraints and unspecified constraints. The latter is what I call the wrinkled nose syndrome. When discussing an investment or a strategy with a client or a high influencer, the nose or some other non-verbal feature indicates a weariness or disappointment.

Investment Lesson: At this point an alert manager should recognize the flashing caution light. The manager can proceed at his/her own risk, but if the particular investment strategy or single investment does not work, the manager has entered the regions of career risk.


For those of us who have been something of a success in the investment and other businesses and want to give back to a generous society more than just cash; donating time and effort come to mind. One is often asked to become a trustee of a non-profit organization. Thus, from time to time I find myself in the position of wrinkling my nose due to perceived incomplete research. With no ‘spare time’ to speak of, I usually must decline.

Investment LessonYou must be as careful investing your time as you are with your capital.  

At the same time I am empathetic with the managers and their staffs who are trying to deliver expected results while staying within the specified and unspecified guide lines.

In summation

I have performed all of these roles and they have significantly influenced my investment decisions. Through this exercise I am coming to a better understanding as to what makes me tick as an investor. Perhaps each of the readers of this blog could benefit from such an exercise. Let me know what you have revealed to yourself about the impact of the roles that you have played.
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Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
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Contact author for limited redistribution permission.