Introduction
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 expansions. Being out of the market for as little as ten
days can lead to poor multi year results.
Attitudes
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?
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