Sunday, August 31, 2014

Labor Activity Needs Protection


The nature of humans is to labor to make better and safer lives for themselves and their families. The unfortunate image coming out of today’s school systems and many of its union-dominated teachers is that manual labor and skilled labor by employees is to be celebrated only on Labor Day in the US and similar holidays elsewhere.

I see labor all around. Certainly the homemaker producing meals, keeping house, and often serving as the household purchasing agent is laboring. Laboring also are the portfolio managers who are acting, along with others, as stewards for the retirement funding of employees. Many of these put in more hours than some that are punching a time clock or equivalent.

On Labor Day 2014, I think we should be thinking about how to make all that labor a better value. At the first level we should see how to improve unemployment and under-employment. At the next level we should be paying attention to retirement funding. Finally, almost all laborers desire to take care of beneficiaries after they are gone. This post will share some of my own thoughts on each of these topics.

Mismatched openings and job seekers

As someone who speaks with various employers and particularly entrepreneurs about their future progress, I often learn about the need to fill particular positions within their organizations. Often they cannot fill existing (or more importantly new positions) not because applicants don’t have the required skills. If the employment decision was left to a computer match procedure, it is estimated that all or almost all the roughly four million job openings would be filled very quickly. But that is not the case when are faced with hiring fellow humans.

I don’t know where so many of these applicants get their work-related attitudes; whether from their families, friends, or their teachers. The first hurdle is that the world or others owe them a job. The second is that they have pre-conceived notions as to the conditions of employment which they think they should dictate. In many cases they do not grasp how a commercial organization functions to provide what the clients expect and need. Too often they anticipate that their co-workers will make room for them and coach them on the first day as to how the work and social elements really work.

I believe that everyone within an organization is a salesperson meant to convince every contact that his or her firm is absolutely the best organization to meet people’s needs. We are all involved with sales and service. People who want to join a firm need to feel loyalty to the firm, its customers, managers, and fellow employees. The sad truth is that there is not enough of these people, thus a number of the openings will not be filled.

The cost of vacant jobs

The economic and financial impacts of not filling the vacancies are significant. As long as people are unemployed the cost to the society will be high in terms of taxes paid and more significantly a shortfall in consumer purchases. There are also, at this time, important investment implications to the unfilled openings. Organizations will not be operating at optimum productivity levels. Profit margins will be less than what they could have been. Today there is concern that profit margins, not profits, have reached record levels. If these slip, even with higher sales generated profits, the valuation afforded these stocks will decline, as they will be viewed as more cyclical and thus could lose their place in some portfolios.

Profit margins are under pressure in numerous employers and particularly in health and financially oriented concerns today. Due to increases in compliance and supervisory responsibilities, companies are being forced to hire good but unproductive people in terms of bringing in more sales. This is hurting existing margins. When we combine these pressures with much more restrictive activities mandated for the financial community the results are significant layoffs at numerous banks and other financial firms. Major clients are already seeing a decline in the levels of service and supervision. I suspect that this trend will continue unless there are major changes in regulation.

Retirement funding awareness

One of the potentially major upticks for labor in the US is the ability to influence its own retirement funding. The switch to Defined Contribution plans from Defined Benefit plans can produce a retirement account that more closely represents what the specific employee wants from the available alternative options rather than being bundled with all other employees. The various 401(K), 403b and 457 plans leave the responsibility of choice to the individual. These plans need to be carefully constructed in terms of levels of contributions, matches, vesting, fees and expenses.

I am pleased that according to BrightScope, the Number One plan based on these characteristics in 2013 was the Second Career Savings Plan for the National Football League and the NFL Players Association that I have advised as to the construction of nine specific fund accounts.

The reason for the nine accounts was to allow the Players to decide how they wanted their money to be invested, in a collection of mutual funds or separately managed accounts that generally clone their advisor’s funds. Other retirement accounts that we manage are customized to the needs of the employee base. However, all investors including retirement plans are exposed to both stock and bond markets. With that thought in mind, we all should ask whether there are parallels between Labor Day 2014 and Labor Day 1929.

As was noted in The Wall Street Journal, both days had just past the 2000th day of a bull market. In the case of the earlier market it continued to rise in September and started its cataclysmic decline in October 1929 to recover in December but the damage had been done to the confidence in the market and eventually the economy.

Should employees and other investors totally jump out of the market with the belief that they will jump back in at materially lower prices?

The great portfolio manager, Peter Lynch, who built such a great record at Fidelity, is quoted as saying that more has been lost by investors trying to execute such a maneuver than the size of the losses at the bottom. In addition, I would be particularly careful investing substantially in high quality bonds now. Instead of celebrating that the purchasing power of bonds is now stable to perhaps rising which will help the long punished retirees, the central banks such as the Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan are very much interested in raising the rate of inflation to spur more risky investment as a way to create jobs. If they are successful, the purchasing power of bond principal and interest will decline. Based on their past record they may not be successful.

Helping beneficiaries

All of us who are looking to the future for the benefit of families and others such as universities, hospitals, and other non-profit groups need to invest over multiple time spans. In prior posts I have discussed our Lipper Time Span Fund Portfolios which are designed to meet the different needs of beneficiaries. With the measurable possibility of a significant market decline sometime in the next five years we have created a Replenishment Fund Portfolio concept (REPPORT) to replenish the capital that will be spent over the next two years to meet operating needs by the Operations Fund (OPPORT).

The Replenishment Portfolio probably has a mixture of equities and fixed income funds or securities with a maturity of five or fewer years. With the recognized risk of a significant decline and Peter Lynch’s warning, a conservative approach is warranted. At this point I would select funds that invest in companies that have relatively little debt but compared to others have high returns on assets, equity, and invested capital.

At the other extreme in terms of time spans, the Legacy Fund Portfolio should be looking into funds that invest in companies that are spending wisely in research and development plus intelligent brand building. If these companies do spend wisely they will be creating the kind of unassailable position often called the protective moat. At that point they should be producing substantial excess capital, fulfilling Warren Buffett’s favorite structure of a company that has both a moat and a fortress. On the way their financial ratios are unlikely to match those found in the Replenishment Portfolio.

Question of the Week:
Where and how are you finding new good people to hire?
Did you miss my blog last week?  Click here to read.

Comment or email me a question to .

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A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Sunday, August 24, 2014

Melt Up-Expectation Risks


All movements are either trends or turning points of different lengths and importance. Most people and most pundits are firm believers in riding whatever the current trend is. Politicians call it the “Big Mo” or momentum as they desperately try to find a parade to get in front of. I maintain the job of professional analysts of all types is to anticipate turning points. At least that is the self-imposed task that I assign myself as both an analyst and a fiduciary. However, I do not claim any special expertise at predicting the timing of critical tipping points as one reader was hoping.

The trend in stock prices is up

I have been concerned for some time that prices have been rising in general, despite my announced concerns about a potential major decline. The media celebrates round numbers called handles. Thus there is excitement when Berkshire Hathaway “A” shares went over $200,000 and Apple rose to $100 and then passed its own enthusiasm high point. The odds favor some time soon there will be a celebration of the Standard & Poor’s 500 going over its 2 handle (2000). According to my old firm, now known as Lipper Inc., so-called smart money or professional investors are riding the momentum with net flows into ETF equity funds, for the week totaling an estimated $8.5 billion, approximately six and half times more than the $1.3 billion going into equity mutual funds. Total assets in mutual funds (our normal playground) are many times larger than the size of the ETF arena. (Interesting to note that of the $1.3 billion going into equity funds that 76% went into emerging market funds as many of these were the distinct leaders in July. Perhaps the larger, slower group of investors is expressing some doubts as to the primary trend of US stock prices.)

Another category seeing significant inflows are the High Yield Bond funds, which an old observer called “stocks with coupons rather than assured payment bonds.” On both sides of the Atlantic money is flowing into Asset Allocation funds which are meant to participate to some degree in the rising enthusiasm for speculative bonds, loans as well as stocks. The Dow Jones Industrial Average and the S&P 500 have made many new highs this year and the NASDAQ is at a 14 year high.

Turning points

While there are frequent, small changes in direction of a trend, there are only a few that break the momentum of the trend and start a meaningful reversal beforehand, or if you prefer “a priori” These are difficult if not impossible to predict; e.g., the murder of the Archduke Franz Ferdinand.

However we can identify vulnerabilities or underlying deterioration. As of this writing, the following fears should be considered. 

1.   Some good market analysts are expecting the current bull market to conclude soon.

2.   Even this weekend there was another multi-billion dollar pharmaceutical acquisition. Both as an investor and as an entrepreneur I have participated in mergers and acquisitions. Any detailed study of past such activities indicates that the sellers are smarter than the buyers. The ones that have worked are when the buyer recognized not just a product line extension but a critical group of management professionals that can play an important role in the combined operation. The classic case is when the strong JP Morgan Chase acquired Bank One Corp. and Jamie Dimon soon thereafter became the leader of JP Morgan. The ones to watch out for are those where the acquirers believe they know how to manage better and can raise the acquirers’ profit margins. Warren Buffett is famous for buying good to great companies at a currently fair price. In today’s market an over priced or poorly thought-out acquisition has an impact on all other similarly viewed companies (which sends their prices higher).      

3.   In the last quarter stock prices have moved up more because of raised valuations than sales and earnings gains. We may be moving from a fairly priced region to a more fully priced one. Fully priced securities have difficulty absorbing negative news or even well constructed rumors.

4.   There is increasingly great reliance on government agencies to be able to prevent future market problems rather than being a major contributor; e.g., FNMA and Freddie Mac with housing and going off the gold standard with Richard Nixon in terms of inflation (“We are all Keynesian Now”). The past couple of US administrations have practiced bailouts to protect jobs that were in many ways capped and eventually lost. The SEC is attempting to finish the bailout process with new rules on redemptions on Institutional Prime Money Market funds. Already there are people within the Federal Reserve who question whether the new rules will actually accelerate “runs” on the fund in anticipation of gates to prevent withdrawals and/or penalty fees. The Commission believes that this won’t happen because the institutional shareholders will know more and can protect themselves. I don’t think that under current disclosure procedures this will work. I am pleased that some of the members of the New York Society of Securities Analysts, of which I am a long-time member and former President, are forming a committee to get more transparent information as to derivatives. Almost all high quality instruments in money market funds are to some degree buttressed by someone owning derivatives. If there is even a rumor as to problems in terms of significant issues, issuer, or dealer there will be a measurable impact on many fund money market instrument holdings.

5.   There is an even more serious potential problem caused by the SEC’s money market actions. By focusing only on the Institutional Prime Money Market funds, they are implying that all other money market funds are safe. Remember the movie “Jaws” when it was declared that it was safe to re-enter the water and then the sharks returned? As we use all sorts of funds, including money market funds, we attempt to understand how these funds invest. Some use a very restricted list of high quality brand names, others have seasoned staffs which look at their portfolios. The latter are preferable as long as they are fully staffed which was not true temporarily a number of years ago. Nevertheless, my attitude is that nothing is absolutely safe and that is why we attempt to intelligently diversify.

6.   While history can be instructive, it is very important to update the views of important leaders. In the Sunday newspaper there were two articles that caught my eye which illustrate this point. The first was an obituary on John Akers who was the sixth CEO of IBM. Though he was a trustee of Caltech, I didn’t know him. He led IBM from being primarily a manufacturer of computers, particularly large ones, into a focus on the development and sales of software and services. Without these changes IBM would have been part of the group of large computer producers. (Tracking this kind of major change in direction is not part of the selection process for ETFs, which is a disadvantage).

The second article which is entitled “Large Dams Just Aren’t Worth the Cost” is about a 180 degree turn by a emeritus anthropology professor at Caltech, Thayer Scudder. Until very recently he had been an impassioned advocate of building large dams in developing countries. He now believes that these multi-billion dollar projects don’t pay off as expected in a financial sense and more importantly do not bring to the displaced farmers better farming and living conditions. This change of mind by a single person, albeit a renowned expert could change the value of numerous bonds around the world as well as having important political implications.

7.   The apparent enthusiasm for index funds either in mutual fund form or ETF is shifting immediate interest into judging investments by price movement rather than by specific corporate developments. This in turn means that there will be fewer buyers interested when some good companies stumble, as almost all will at some point. The lack of these singular buyers of distressed prices suggests to me that when prices decline they will do it more quickly and deeper than past history suggests. This will produce two elements. The first is that many active and passive portfolios will have worse than normal performance. The second element will be a good price opportunity for those of us that have both cash and faith in particular companies.

Question of the week:

At some time a major decline will occur, how will you handle it?  Please share with me confidentially. 
Did you miss my blog last week?  Click here to read.

Comment or email me a question to .

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Copyright © 2008 - 2014
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Sunday, August 17, 2014

Investing for Future Generations:
The 5 “D’s”


Institutions and families of wealth often think that one of their highest purposes is to invest to benefit future generations. I agree with this both professionally and personally in terms of several non-profit organizations that I serve and my own family.

As extenders of their ancestors, future generations are beneficiaries of the past’s assets and liabilities. However the greatest gifts that we can pass on are not money, but reputations of integrity, compassion, and good habits; particularly the willingness and ability to convert liabilities into assets. The last phrase reveals my financial training and the shorthand of reducing many problems to numbers. For me money is not an end in and of itself, but an acceptable means of buying time and efforts of others beyond what I can provide at the moment.

Portfolios for future generations

One of the most difficult tasks that I am faced with is the creation and management of investment portfolios for the benefit of future generations. These are portions of the portfolios of various tax-exempt institutions and various multi-generation trusts. With these responsibilities in mind I included “The Legacy Portfolio” in developing the Lipper Time Span Fund Portfolios.

The 5 “D's"

In addressing the questions of how to invest for future generations (as differentiated from investing for current needs), I am developing a thought pattern in looking for characteristics that will guide decision making. The future will be a continuation of the past assaulted by various forces of change. I start the exercise in thinking about where to invest. The characteristics that I have identified as probably useful can be summed up in the “Five Ds”- Determination, Demographics (and psychographics), Discipline, Debt, and Desperation.


Under the topic of determination I look for evidence that people want to materially change their lot in life as difficult as that task may be. They are willing to work hard and sacrifice for the future. My investment portfolio friends will recognize that this is like active rather than passive investing which is harder to do and will certainly be less productive during certain periods of time.

There are 168 hours in the week; the strivers should be spending about 120 of those hours improving what they do at work and in family/community development. We perceive some of this drive in almost every country, but much more pronounced in certain Asian and I am told selected African countries. Often a clue to this determination can be seen in business successes on the world stage.


Because of past wars, societal economic mistakes, and technological changes, we have a world that can be easily divided into two parts. The first is one which has an aging population that on average is not producing sufficient numbers of new entrants into the work force to replace those who are or should be retiring. Most of Western Europe fits into this category as does China due to its past one child policy. The US is close to slipping into this group, but immigration whether legal or not is still permitting the US to have a rising work force potential. India and Indonesia are examples of societies that are growing. (Whether they can find economically productive jobs for the new entrants remains largely unanswered.)

Consumer marketing successes are not solely based on demographics, but on psychographics which is a way of analyzing what elements of personality will motivate people to buy particular items and when they will do it. I include psychographics in my list of required characteristics to be evaluated.

Not enough young people are emigrating from regions with outsized aging populations, a situation compounded by growing unemployment.  This is largely true in Western Europe, but not in Eastern Europe. Countries that have seen some of their youth leave include Scotland, Ireland, Denmark, Sweden, Korea, Vietnam, Canada, Mexico and other Latin American countries. The willingness to move signals taking responsibility for one’s own future and not relying on the home country’s social fabric. This personal initiative is a positive sign for future investing in both the destination country and the traditional homeland.  


Regular readers of these posts have learned about my treasured experience in the US Marine Corps. I am not focusing on that level of discipline, as helpful as that was for me and a few others. I am spotlighting the necessity of self-discipline learned at an early age in the home environment.

Elements of this self discipline can be seen in appearance, punctuality, and work and study orientation. The single most important self-discipline signal is effective time management. If we were to capture all of the unproductive time wasted in the world, we could build better societies for all. One clue to the level of discipline in society is the average years of schooling, particularly if the time in school is broadening and not basically memorization.

When analyzing a country or community, two telling indicators for me are the cleanliness of the streets and homes plus the volunteer structure of their organizations and their military. Switzerland, Israel, and Singapore are leading examples of countries where discipline is considered to be important.


The basic economic model that runs the world is to produce, save any excess earnings and to invest wisely for future spending. Notice that debt is not fundamental to human economic progress. Yet it has become endemic to most societies. People, and therefore countries, rely on the use of debt to meet current gratification rather than waiting until savings can pay the bills. Originally the use of debt was as a stop-gap measure to fit a specific, largely unforeseen need. The four key elements of debt creation were: 

1.        The generation of cash earnings that could repay debt
2.        An interest rate high enough to induce lending rather than consumption or other investing
3.        A time-certain payment of interest and repayment of principal
4.        Sufficient collateral to reduce the risk of failure to pay timely debt service.

These principles are still the basis for undertaking private debt. What has evolved in terms of government debt is deficit spending not covered by tax revenues. The history of the world has shown that governments, no matter how they are created, are not good borrowers. Their history is either to directly default, or through the control of the central banks to inflate the value of their currencies so the lenders do not get full value of their capital, particularly after taxes are paid.

We all know that there are unexpected emergency needs that have to be funded. In our personal and corporate experience that is one of the reasons to have sufficient reserves to pay for the unexpected as well as the reasonably expected needs. One of the less obvious reserve elements for individuals and businesses is their unutilized borrowing capacity at reasonable interest rates.

Governments’ first source of additional funds is their unutilized taxing authority and the second source is what they can borrow, hopefully within their own currency. Countries with large outstanding debt do not have the same flexibility of those with ample unused tax authority and availability of credit. What makes matters worse is how governments generally invest. While some of their spending can only be met by the government, much of the other kind of largesse not so. All countries can use physical and intellectual infrastructure improvements. The problem is all too often these efforts are politically managed. In numerous cases many of these efforts would be much better managed and cheaper for the society if they were done by the private sector. (We are seeing just this sort of controversy within the spending priorities of the Port Authority of New York and New Jersey.)

If the government sector continues to grow faster than the private sector it will not be a favorable sign for investing. The current leadership in China understands this balancing issue. Hopefully the new government in India will also. The government debt overhang in Japan is troublesome.


Those of us who have played sports or are about to meet important people know that too much pressure can lead to unforced mistakes. Individuals or organizations that are desperate to succeed are not careful or thoughtful and can make mistakes. There is a point to growing too fast. Years ago, at a bank, I learned that in trying to assess the future terminal price of an investment not to use long-term growth rates above 25% in terms of earnings and revenues. (In a slowing global economy I wonder whether future long-term growth rates should be limited to a multiple of economic growth. For example in a 2% real economic growth environment, the maximum expected future corporate growth rate might be 10%; with 3% GDP growth a 12% maximum growth; and at 4% also 12%. This suggests that a rapidly growing economy is using up some potential future corporate growth.)

This concern for desperation does not rule out a “disruptive force” coming into play. Cell phone sales had an explosive growth rate for awhile, but as the marketplace fills the vacuum that cell phones’ disruption created, the law of large numbers will exert itself and growth of this sector will continue to be immense in actual number of dollars/users.  However the percentage growth rate won’t be very large.

Thus we need to be very careful of “desperate” people and organizations.

Ongoing applications

For the truly long-term investor it may be wise to focus on youth finding productive work with a Confucian orientation to savings, discipline and loyalty.

Start small investments in “disruptive efforts.”

Average up on purchase prices when corporate developments are achieved.

Cut losses on companies that do not seem to have business smarts, even with their technological successes.

Because I am in business to meet the long-term needs of investors and beneficiaries, I am looking for mutual funds that can do a good job of screening for the next generation’s winners.

Reader feedback

Feedback from readers is very important to me, I am fortunate to have a blog community with many thoughtful readers and correspondents. (I try to answer them all).

Thanks once again to Citywire Global readers who have made my blog the # 1 most read fund manager comments last week. The large number of managers in the City and elsewhere in London make it one of the world’s best centers of fund knowledge.    

Question of the Week

How do you invest for the portion of your portfolio that is furthest into the future? Please let me know.
Did you miss my blog last week?  Click here to read.

Comment or email me a question to .

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of 

Copyright © 2008 - 2014
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.