Introduction
With the passing last week
of Andy Grove it seems appropriate for me
to consider the breadth of thinking in his book Only the Paranoid Survive. While some can be comfortable following Warren Buffett’s words
(not his actions) to buy and hold forever, along with most professional
investors, my insecurity does not permit me to buy and forget. We worry all the time
and particularly when trends turn and accelerate in our favor. This is one of
the reasons why I came up with the four increments in the Timespan L Portfolios®
. These require me to focus on both the short-term to make tactical decisions
and to learn what are critical lessons for successful long-term investing.
The Short-Term
Operational Portfolio Worries
The timespan model for
this portfolio was designed for an endowment that has to feed an operating
activity over a two
year duration, (in practice we will modify the timespans to meet client needs). While we think of this
as a short-term portfolio, a number of individuals and institutions perceive
their preferred measurement period for the entire portfolio is one year, thus
for some, this is a long-term portfolio.
As longer term readers
of these blogs have learned, I find a need for excessive enthusiasm to be in
place before I start to prepare for a major decline, possibly of 50%. I am beginning to see some growing enthusiasm.
After all of a five week improved US stock market, and rising Chinese stocks
and oil prices, I see shopping at the nearby high end mall getting crowded.
Parking spaces are hard to come by, shoppers (mostly women) are carrying three or
so shopping bags. Stores were reasonably crowded and both the Apple and the
Verizon Communications stores have customers waiting.
As an analyst I search
for negative indicators as much as positive ones. As long as there is
sufficient uncommitted money to equities I know that there is spare buying
power that can push prices higher. This is particularly true if the money is
being guided by so-called professional, conservative money managers. In a
recent asset allocation study of forty large wealth managers' recommendations, I
looked at the five most aggressive wealth managers who were recommending that
their clients put 60-70% in equities compared to the average of 51% for the
forty. Only one manager would put 10% in Emerging Market equities and another
sole manager would put 16% in High Yield debt. In both cases the average for the group was
about 4%. This was the same level of group aggressiveness in terms of private
equity where the five most aggressive had between 10-14%. The commitment to
hedge funds on average was 9% where the leaders had 18-25% in these vehicles.
Thus the wealth managers in general haven’t been swept up yet by enthusiasm.
Some of the money in
hedge funds and other trading vehicles is finding its way into ETFs either on
the long side or short side. For the week ending March 23rd there
was a net inflow into equity ETFs of $2.8 Billion which included $1.1 Billion
into Balanced ETFs. (It is important
to remember that the institutional community has learned that Index ETFs are a
cheaper entry vehicle than futures for their hedging and other trading
purposes. I will be discussing the impacts of ETFs on the structure of the
market places in early April at a meeting of the International Stock Exchange
Executives Emeriti.)
I would not pay a great
deal of attention to the net redemptions from conventional mutual funds in
terms of future direction of the market. In the latest recorded week $1.5
Billion were redeemed, all of it from Domestic funds, almost all that from Large Cap funds. It is my contention that the bulk of these redemptions are in effect
“completions” of long-term investment plans prior to funding other needs. This
is an old phenomenon which in the past
was offset by new purchases of funds that are not happening because it is more
profitable for the distribution systems, including registered investment
advisors to deal in other products including hedge funds, private equity funds,
and to some extent ETFs.
There are some signs of
significant enthusiasm which need to be tracked. In the last week $3 Billion
went into Emerging Market equities. Some could be short covering. In a recent
survey the second most crowded trade was being short Emerging Market stocks
which are less liquid than our domestic stocks.
Other examples of
rising enthusiasm are the quarterly hockey stick-like estimates of earnings for the S&P 500: 1St Quarter ‑6.9%, 2nd quarter ‑1.9%, 3rd
quarter +5.0%, and 4th quarter +10.6%%. Certainly part of the gains
is earnings from the Energy sector going from a ‑98.9% decline to a gain of
+10.6. While these estimates suggest a trailing price/earnings ratio of 17.2x
and a forward one of 17.0x, the real action is more towards the large and
midsize companies found in the Russell 2000 with a trailing p/e of 24.9x and a
forward p/e of 22.5x.
Bottom Line For Short
Term Portfolios
With the above list of
inputs, I still believe that the short-term portfolios should set up a price
grid to begin to reduce their risks as the market moves higher. For longer term
portfolios they should continue to invest for the long-term and occasionally
buy into some opportunities that the market will serve up, but not attempt to
market time.
Longer Term Lessons
As much as I question the perceived wisdom from academic sources, like many analysts
I am always a student of our
environment. As a practical matter it is more difficult to learn from successes
than mistakes. Almost every aspect of a success could be the critical element,
if you will, the secret sauce that made the success. Most mistakes come from slavishly following the perceived wisdom of
reported successes without looking deeper as to why they worked when they did.
Probably the toughest part to learn of the art of investing is timing. There is
nothing fundamentally wrong with balanced accounts, all equity accounts,
private equity funds, and hedge funds. The keys are when to use each of these,
in what mix, and what level of patience should be applied. Generally one should
use these tool sets when others are not. Most of the time it is a mistake to
follow the crowd.
This week I read about
an endowment that fired its poorer performing managers after the first seven
months of its fiscal year which occurred through the horrible January
performance. The group couldn’t take that it was down ‑8.5% and the S&P 500
was off ‑6.6%. The endowment fired their hedge funds and moved into private
equity funds. We don’t know what the future will bring but I have serious
reservations on the basis of the little bit that we do know. The endowment:
- Probably picked its managers largely on the basis of past performance
- Accepted a popular asset allocation
- Did not understand the cyclical nature of performance
- Did not have sufficient patience
- Elected to do a
dramatic change all at once
- Chose to go into the currently most popular asset class with the proceeds of transactions.
I will attempt to
follow the organization's future progress because I am always looking for decision makers
who have a high percentage of mistakes. These rare negative indicators
hopefully will help me and my accounts from making similar mistakes.
Secret Sauces
Far too many investors
follow successful other investors and try to mimic what “the experts” do. They
don’t focus on the tools the experts applied to their art. Classic examples are Warren Buffett and
Charlie Munger at Berkshire Hathaway, who we will visit this spring. In many
ways the tools, not the judgments that they bring to investing is in their
annual report. The report contains 67 pages of notes and supplements to their
financial statements. I do not claim to fully understand all the nuances that
could be found in these pages. To fully grasp the tools that they have used,
one would need individual courses in accounting, corporate finance, tax accounting/management,
insurance accounting, treaties, various state/federal/foreign legal codes, and
various forms of investing. Unless you have a firm understanding of these arts,
don’t attempt to play their game. I benefit from both their skills and tools as
a long-term share holder.
Other users of secret
sauces were the late Sir John Templeton ably assisted by the late Tom
Hansberger, both of who were my long-term data and consulting clients. In many
respects Sir John was the leading expert on tax code differentials which he
applied brilliantly to his personal and company benefit. Tom acted as symphony
conductor skillfully managing different personalities as portfolio managers and
analysts with global offices and people always on the move. Both understood the
sales process and more importantly the sales people as well as how to motivate and control
them.
Both of these pairs of
artists were much more than stock pickers. Each brought much more to the
process of building wealth for themselves and their companies.
Question
of the Week: What are the secret sauces that you
have seen?
________
________
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Copyright © 2008 - 2016
A.
Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.
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Contact author for limited redistribution permission.
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or email me a question to MikeLipper@Gmail.com.
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Copyright © 2008 - 2016
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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