1. Applying physics discipline to investment careers
2.
Policy makers not thinking
Applying physics discipline to investment careers
I have just returned from the
quarterly meeting of the Caltech Board of Trustees. At the meeting we discussed
the appropriate preparation of the graduates for their entry into the business
world. A survey of the students felt very comfortable in entering the academic
world on the basis of their superb education from Caltech. However they did not
feel as prepared to enter the business world and particularly the financial
world of Wall Street.
As one of a very small number of
voting trustees with current investment activities, I pondered how I could
help. It occurred to me that the very education that graduates from Caltech
achieved actually could be somewhat counter-productive to their early success
in investing. This is particularly true for those who go to Goldman Sachs*
and elsewhere as “rocket scientists.”
In their scientific courses,
particularly Physics, they look for natural laws. These require exactly the
same results to be achieved under all conditions of their experimental work. To
the extent that they take Classical Economics they will learn from the works of
Adam Smith about comparative advantage where one nation can produce something
cheaper than another serving the same marketplace.
The differences in my world are
that known conditions are never totally identical and definitely some critical
elements of information are not known (the unknown unknowns). For example, some
of my fellow aging portfolio managers and analysts are suggesting that the
current stock market price structures are similar to the markets that fell
dramatically in 1987 and 2007. I recognize the incomplete parallels, but I
suffer from Physics Envy in that I cannot completely accept the inevitability
of a meaningful decline. That is why we have been cutting back on our equity
exposure rather than complete elimination.
To me a general balanced account
with a spending time horizon of up to five years should never have less
than 50% in stock or stock alternatives.
There are other differences between
their academic exposure and the world of Wall Street. As investors we are not
interested in comparative advantage, but competitive advantage. We need to find
ways to bring to our clients and seniors better risk/reward ratios. I suggest the
graduates pay particular attention to the risk part of the equation. In the
laboratory it does not matter how many experiments you conduct. In the
financial world each experiment has some costs in terms of money or more
importantly, time. This is definitely not to say that you should only make an investment when you are absolutely sure.
The late and great Ace Greenberg, the last great chairman of Bear Stearns, built
a very profitable and effective trading desk by urging his traders to take
quick losses. When I was involved with a trading desk I tried to always remember that the first loss was often the best loss.
Another useful attribute for the
graduates is to learn how to read the news. They need to look for the
non-headlined stories. (By the way, most headlines are fully discounted in a short time after they appear.) Very few of the “talking heads” with their 20
second sound bites will spend much time dissecting the following facts:
In discussing mutual fund net flows
they do not make the distinction between the net flows of the
traditional mutual fund buyer and the hedge fund and other
institutionally-oriented players. For example, two weeks ago the headline was that
mutual funds were net redeemers of equity funds to the tune of $7.6 Billion. Few
people noted that the net result was the combination of the traditional mutual
funds having net purchases of approximately $379 million and the Exchange Traded
Funds (ETF) redeeming $7.97 Billion in equities. Even those that noted the
difference chalked it up to different levels of
speculation.
While I am not positive of this, I
suspect that a number of macro oriented funds were unwinding their
Quarter-end statements which showed a reasonable equity
commitment rather than a significant under-investment in stocks. We use
to call this approach “window dressing.”
Other potential straws in the wind
from the Financial Times include:
1. John
Dizard’s opinion piece stating that there is “…greater systemic risk in fixed
income as it easier to leverage.”
2. John
Authers is worried about prime and sub auto loans in his article, “Bubbles are
Forming in the Credit Market.”
3. The
three highest dollar volume securities traded on the NYSE last week were ETFs. One of the
reasons that I focus on ETFs is that according to the CEO of
BlackRock which manages iShares, some hedge funds which are its clients
have been using ETFs rather than futures to
adjust their portfolios.
These items suggest that the market
structure has changed and therefore sole reliance on back data can be
misleading. Investors and traders today need to understand the changing
structure. The old needs are still there, but they are being expressed in
different ways.
Policy
makers not thinking
All too often various politicians
react strongly to pressure “to do something” about their political base’s
current problem. An old example was the reaction to Walmart when it wanted to
open stores in strong union towns. The
local politicians colluded and made it difficult for Walmart to open in their
communities. The politicians and their supporters did not pay attention to the
fact that many from the poorer communities lined up to get job applications.
Further, there is some good analysis that demonstrates that Walmart itself has
lowered food price inflation by at least 1% point.
The latest element of
short-sightedness by politicians is the attack on the
traitors to the US that practice
the art of inversion; i.e. moving their tax domicile offshore. To the best of
my knowledge none of my individual company investments have inverted. (I can not attest to
all of the companies owned by the funds that we own for ourselves or clients.)
On Friday of this past week I
listened in on the quarterly earnings call for Moody’s*. While there
was no discussion about the company shifting its tax domicile, I started to
think about the implications if Moody’s or other companies moved overseas.
Under the law, the management is
elected by and responsible to its shareowners. In the case of Moody’s and most
“American” companies the vast majority of their direct and indirect holders are
Americans. Either they own shares directly or they are part of some collective; a mutual fund, 401(k),
defined benefit plan, non-profit endowment, etc. Each would benefit if his or her
investment paid lower taxes which should translate into higher earnings and
dividends and in turn should increase the investor’s wealth and ability to
spend money largely in the US. Thus the economy would benefit.
* Stock owned by me personally and/or by the private financial services
fund I manage.
There is another class of company
that is growing faster outside the US than within perhaps due to both
taxes and regulations. Moody’s is one of these. The needs for its services
continues to grow faster outside. In order to serve those needs, they employ
people overseas.
Years ago when I was the owner of
Lipper Analytical Services two of our five offices were overseas. We had these
offices to service our American Mutual Fund clients. We like many others were
in effect, following the flag as carried by major financial institutions. This
in turn led to discussions with a foreign buyer who recognized from its own global perspective the value of global suppliers
to the global investment management business. While I did not directly create
an inversion, by selling to a foreign owner some of our taxable earnings went
offshore. If the politicians attempt to stop US companies from reducing the
potential returns to their US shareholders, these shareholders will be replaced
in part by non-US holders and our tax take will be reduced.
For
us to fully understand how our system works in reality,
all of us need to follow the money throughout the cycle from initial investment all the way through the spending
cycles.
Question of the Week:
In the long run how do taxes matter to you?
_______________
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Copyright © 2008 - 2014
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.
All Rights Reserved.
Contact author for limited redistribution permission.
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