Sunday, February 8, 2015

Focus for Investment Victory


Often the most focused player wins the competition. (This is why years ago, I gave up golf, despite the occasional good shot, I couldn’t stay focused shot after shot and hole after hole.) I do try to be a keen observer of the investment game. Few, if any investors with a public record can stay intensely focused on all three parts of the game, I know I don’t. The three parts are: (1) Recency (a new word for many of us about the current picture), (2) avoiding mistakes, and (3) anticipation.


The media and therefore most individuals including many in professional roles spend their time on the headlines of the day. Far too often they make transactions going within the flow of the so-called news. This is somewhat understandable as they believe as most traders believe, that a security is exactly worth its current price; to which they add their impressions of the impact of the latest news element be it economic, political, corporate, governmental, or in some cases important sports results. While there are some skilled in the art of the trader, far too many go with the direction of market prices. I find that this is often a mistake as the market has already discounted the so called “new” development. Further, normal to enlarged rates of volatility cause quick reversal of recent transactions. As one goes with the crowd, bid and asked spreads widen plus commissions add to the cost of unwinding a trade. Our fund data does not directly capture these actual costs. However, with mutual funds and other professional funds, transaction turnover rate data is available. As I have previously mentioned there are a few rare individuals who manage money for others and have continuing trading skills. All other things being reasonably equal,  I tend to avoid high turnover rate funds. As each market segment and type of security is different, one should determine high turnover compared with a fairly wide sample of peers.

In our construct of four generalized time-span oriented portfolios, the Operational (1-2 year time span) and the Replenishment (2-5 year) Portfolios need to pay attention to current prices and near-term trends thus could tolerate some high turnover rate fund selections. There is no need for this type of talent in the Endowment Portfolio (5-15 year) and Legacy Portfolio (beyond 15 year to multi-generations). In a recent post  I suggested that a long-term oriented portfolio should increase its combined energy commitment from 7 to 10%. At today’s oil prices many of the energy related stocks have gained off of a recent bottom and some are mirroring the 20% rise in the price of oil. If this was a shorter portfolio I might start to be prepared to capture the gain off the bottom. But since, in my mind, this is a long-term portfolio in which I was prepared for a 20% further loss, I would continue to hold on to these cyclical positions for a number of years into the future.

Avoiding mistakes

This is the investment equivalent of the medical Hippocratic Oath of doing no harm. Today the investment application of this crowd-following doctrine is indexing or at a slightly higher fee level, closet indexing. Similar to the Prudent Man Rule proclaimed in the 1830 case that Harvard College lost; one should do what others are doing to avoid criticism and surcharge. This precept is based on the belief that the crowd is right, as demonstrated in securities indices. The weight of wisdom is now placed on the shoulders of the publishers of securities indices to make the right selections with the right mathematical formulas and updating mechanisms. I was able to build a reasonably successful business comparing funds utilizing Judge Putnam’s rule for my clients’ investments and more drawn to an earlier natural law first put forth some 41 years earlier. Benjamin Franklin in a letter written in French to a French scientist said in 1789,  “Nothing is certain except death and taxes.” Thus, I have difficulty locking my clients into a mechanistic formula.

Since we are looking at investing through historical lenses, allow me to bring up a major change to the way the investment community has changed over the last 40 years. On April 1st, 1975 the final element of the SEC-mandated end to fixed brokerage commissions came into force. The first element came into operation on December 5th, 1968. A little background is useful in understanding the regulation which produced the opposite result than what was intended and has materially changed how the stock markets work around the world.

The official reason to introduce brokerage commission competition into the market, (neglecting that there already was vigorous service and capital competition) was to lower the cost for the retail public. A number of the traditional financial institutions like trust banks and insurance companies wanted to cut into the profits of brokerage firms who were attracting some of their best investment people to join  “The Street” at higher compensation than they were being paid. I will be happy to discuss with our subscribers how things evolved, but the key to this item is the twin recognitions that, excluding retirement accounts, there is very little retail listed equity agency business being done today. The traditional institutions have lost share of market to brokerage firms' wealth and asset management arms and to  the phenomenal growth in hedge and private equity funds. These newer players, through the use of technology, exchange traded funds, and borrowed capital, have introduced a much higher level of volatility and share price competition at the same time as the retail investor’s total investment costs have gone up. In the next major market decline the all-invested market indices are likely to have a fate similar to large war time bulk shipping at the introduction of faster, more accurate torpedoes.

Anticipatory investor

Perhaps it was my scanning the morning workouts at the local race tracks and the past performance records or some things that my brother told me about the Marine Reconnaissance training and battles; whatever the reasons I feel a need to look for what others are not seeing.  (USMC reconnaissance troops are now part of the US’s growing Special Operations forces.) One of the lessons that I learned was an understanding that in the Mexican-American War Robert E. Lee found a sunken (hidden) road by personal recon which let him to move his troops much closer to the fortified Mexicans than they were expecting and win an important battle. 

With these elements in my mix, I keep looking for what others are not seeing. Steve Jobs and other entrepreneurs do this regularly. While I do not believe anyone can accurately predict the future, I do believe that if one focuses on some of the elements that could change and locates some of the change elements, it will be the equivalent of finding that sunken road.

This anticipatory gene should play out on the Legacy Portfolio to produce a stream of income of multiple generations for the institutions and families (including my own) that I am involved with. To capture these results one must be patient. However, I am very conscious that to many there is no difference between being too premature and being wrong. That is why the great artistic masterpieces take a long time to develop.

Question of the week: Please share privately how much of your risk capital are you willing to invest in anticipation of change.
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