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