Roles in Life Rule Investment Decisions

Introduction

In studying investment managers for more than fifty years, I have learned that the roles that they have played through their lives have had an enormous influence on how they invest. What is true for the professional managers is also true for individual investors. If that is my thesis, I should apply it to myself. Thus, the following will be a form of self-analysis. The purpose of this exercise is to suggest that others should examine what in their personal history influences them as investors. Our life roles and experiences go a long way in explaining our self-imposed constraints and proclivities.

Handicapping Thoroughbred Racing


I have probably learned more about analytical thinking and careful money management from my experience at the New York race tracks than from all the classes I took at Columbia or in earning a CFA designation.

The first thing I learned was the existence of "racing luck". Despite a great deal of time and energy spent on past performance data, unaccounted things can and do happen. Thus the weight of money odds always includes the betting market's views on uncertainty or racing luck. The second thing I observed was that the betting crowd can be wrong. The most popular bet wins less than half the time and in many cases more like a third of the time. Thus, I usually have an aversion to investing in the most popular stocks or funds. The third thing I learned was that there was a better way to handle my hard-earned money.

One aspect of the first lesson mentioned above is not to feel compelled to participate in every race and to pick my opportunities. As an investor this has probably led me to favor funds that have fewer rather than a larger number of stocks. The second part of my track-induced money management course was to look for opportunities where the probabilities based on my thinking were different than the odds offered. Often I would bet on my choice for second (Place) so if my horse did come in either first or second I could still cash a ticket. Often if the favorite did not make it up to the wire at the end, when my horse did, the payoff for Place was substantial. 

Investment Lesson: Bargains are hard to discover at the track and in the market but are worth the time and effort to find.

Collegiate Fencer

As a five foot nine inch champion team member I was assigned to fencing épée. The bulk of my opponents were considerably larger than me, well into the six foot level.

Investment Lesson: I learned not to be overly concerned about being small. 

The bigger the foes, the harder they fall.

An Officer in the US Marine Corps

Here there are three lessons I learned from the USMC:

1.    Tight discipline produces first-rate results.

2.    The best defense is a good offense.

3.    Taking care of your troops and listening carefully to their reports often leads to them having the answers to difficult problems because their practical experience is far superior to field manuals of instructions.

Investment Lesson: A disciplined approach to investing is vital.
   

Simply avoiding large losses is not enough; one needs to make money to deliver against the needs of the account. Be aware one does not have to have all the answers. Many smart moves come from those with less theoretical, but more practical experience. However, one needs to take command of difficult situations even when you lack enough information.

Securities Analyst

A single financial statement in and of itself is relatively useless. Early in the game of analysis we learned to compare one company against the other, usually by numerical comparisons. The next step was to compare to price. On a statistical basis one security is cheaper than the other. This is unfortunately where a lot of analysts and investors stop. Cheaper does not always equal better. Often there are other factors including qualitative items that the market values higher than a pure statistical measure. At times a premium price is warranted.

Investment Lesson:  While numbers are very important, they are not everything.

Entrepreneur

I believe I have a tremendous advantage over many other CFAs and analysts. I started a business. At times I turned around failing products. I met a payroll and paid employees and suppliers as well as corporate taxes. Too many armchair analysts tell corporations what they should do while they themselves have never done it. Today most corporate managers do a pretty good job on what they believe to be the objective. In analyzing a company in addition to its sheer survival, one needs to understand what management believes is the objective. All too often history has shown that professional analysts make lousy business leaders. 

Investment Lesson: We should be respectful of the specific competence required in securities analysis, in business and in non-profit organization management.   

Business Consultant

Because my firm produced the most complete data on mutual funds, and to some degree on brokerage firms, I was frequently asked to consult with CEOs of various fund and other financial organizations. The real world problem was that the statistical or ‘school solution’ answer to the presenting question could not be executed for a host of reasons. The challenge just as in the Marine Corps was, “When blocked, how to go around the enemy and /or improvise with new and often on the spot solutions?” The more consulting jobs I completed, the more I came to the conclusion that the real problem was people and how they acted or will act under change of circumstances. Often the biggest problems were the CEOs who hired me; even when they recognized that they were part of the problem.

Investment Lesson: As investors: we are the biggest hurdle to better performance.  

Understanding and overcoming these limitations may be key to this exercise.  For example, I often harbor a reluctance to sell when short-term disappointment is likely. The short-term can turn into long-term, with the possible result a long period of under-performance.


Investment Manager

By the time one gets the responsibility of managing large amounts of other people's money, one should know exactly how to construct the portfolios for optimum results. Even with so-called discretionary accounts there are specified constraints and unspecified constraints. The latter is what I call the wrinkled nose syndrome. When discussing an investment or a strategy with a client or a high influencer, the nose or some other non-verbal feature indicates a weariness or disappointment.

Investment Lesson: At this point an alert manager should recognize the flashing caution light. The manager can proceed at his/her own risk, but if the particular investment strategy or single investment does not work, the manager has entered the regions of career risk.

Trustee

For those of us who have been something of a success in the investment and other businesses and want to give back to a generous society more than just cash; donating time and effort come to mind. One is often asked to become a trustee of a non-profit organization. Thus, from time to time I find myself in the position of wrinkling my nose due to perceived incomplete research. With no ‘spare time’ to speak of, I usually must decline.

Investment Lesson:  You must be as careful investing your time as you are with your capital.  

At the same time I am empathetic with the managers and their staffs who are trying to deliver expected results while staying within the specified and unspecified guide lines.

In summation

I have performed all of these roles and they have significantly influenced my investment decisions. Through this exercise I am coming to a better understanding as to what makes me tick as an investor. Perhaps each of the readers of this blog could benefit from such an exercise. Let me know what you have revealed to yourself about the impact of the roles that you have played.

_______________________

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Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Are Too Many Long-Term Investors Too Short-Term?

Many of us who claim to be long-term investors (LTI) worship at the feet of Warren Buffett and actually own shares in Berkshire Hathaway as I do both personally and in the private financial services fund that I manage. While “the Sage of Omaha” claims his favored investment period is forever, as noted in a recent column  by Chuck Jaffe, a study of his actual publicly-traded portfolio transactions suggests a holding period of four to five years. I suspect his two relatively new portfolio managers (who like Mr. Buffet have a background in managing hedge funds) have a shorter period of satisfaction with their holdings.

Corporate CEOs have little true confidence in the steadfastness of their institutional shareholders, with the possible exception of index fund holders if the companies are cursed or blessed by being found within one or more indexes or ETFs. Assuming no large earnings or other shortfalls, most particularly large corporations have the same CEOs for five years. In terms of transformational investments, ten years is a reasonable planning period to examine the success of many companies. For those businesses that make large capital expenditures in fixed plants or ground-breaking R&D, particularly in pharmaceuticals, twenty years or even longer is a reasonable measurement period.

Those of us who are investing for the education and future of our grandchildren will take our money to the ultimate fulfillment. For those of us like me that serve on boards and investment committees of large tax-exempt groups that are responsible for universities and hospitals, the time horizons are even longer. Think about granting tenure to a forty year old professor who could be teaching for forty or more years voluntarily and an administration without an easy ability to either improve the quality of the teaching or cutting the expenditures. As far as hospitals are concerned, the outer skins of the buildings are likely to hold up for fifty to one hundred years, that is if they weren't built to federal government specifications and by low-bid contractors. However, with the marches of science and regulations many if not all of the physical plants will have to be reworked rather frequently due to perceived obsolescence.

Faulty starting points of too many LTIs

Too often we become captives of both history and the headlines of the day. Any study of past investment mistakes shows that over-confidence in our wisdom and our ability to foretell the future leads to disastrous results. I have learned through meetings with existing and potential investment managers and investment consultants that many confuse the difference between a book report and a book review. The report form abbreviates the history of their investments both statistically and thematically. A review has to do with the ability of the managers to successfully negotiate the future, or more importantly futures. I am in the continuous process of meeting with existing managers that we use and candidates for future use. To the extent that the portfolio managers and their chief investment officers (CIOs) think deeply about the future or futures, I will be probing them with some of the questions shown below and other items they or I think are important.  In addition, I ask the readers of this post to react to these queries publicly or privately.


For the sake of the future, "Are profit margins too high?"

This is not a mirrored concern of my good friend Byron Wien and others that are worried that margins will surprise many by coming down in the second half of the year. My concern is different and perhaps deeper. As an entrepreneur I know that profit margins are not just a result, but to some extent are the outcomes of a very important series of operating asset allocations. Final operating margins are the consequence of a series of simultaneous equations between personnel management, development spending, foreign exchange management, balance sheet concerns and the mix of interest received and paid. Often margins are the beneficiaries of past acquisitions bringing the acquired margins up to the level of the new corporate parent. The simple statistic of profit margin does not reveal enough about its present and future composition for wise investors to properly evaluate the investment's long-term attractiveness.

Why can margins be too high?

I am not a socialist, but I raise the question, “As a society, outside of government, are we paying too little to employees?”

Because of the prior demands of individuals and organized labor, plus government intervention, we have encouraged the substitution of technology and to a lesser extent foreign workers, for domestic workers. My concerns are two. The first concern is the actual and implied replacement of domestic workers. One example is that we are not getting enough useful new ideas from our senior and professional staffs. There are untold numbers of instances where a relatively low paid worker on the factory floor or in the mail room recognized something of value to the process that was missed by the executives.

The second concern comes from Henry Ford, certainly no radical labor leader. Ford raised wages to an unheard of $5 per day. The history books record that his decision to raise his workers' pay was so they could afford to buy the increasingly mass produced Model T automobile. The growth of high corporate revenues needs strong consumer demand.

Currently one of the concerns of investors is that while earnings progress is surprisingly good, domestically produced revenues are flat with the gains attributed to record profit margins. The news from the job front is at best misleading. While the number of new hires is marginally good, the quality of the jobs being filled is at lower levels of pay and satisfaction. Two of the indicators to watch are short-term sales in stores that cater to the middle class and the purchase of new homes.

Will the current wave of M&A lead to tears?

As pointed out by London's respected Marathon Asset Management, one of the reasons for the good margins has been bringing an acquired company's margins up to the new parent's levels. However this is a one time occurrence accomplished by tighter financial management and bigger discounts from bulkier corporate buying.

However, there are longer-term negative impacts of these deals. Often the senior management of the acquired company is locked into the acquirer as an indentured servant for a specified period of years. After their Liberation Day most of the original people are gone including, perhaps those at above-scale wages. At this very point it will become clear whether the combined company has the breadth of management needed to make this work out well in the long-term. One of the historic problems for companies like General Electric is the belief that a good manager can manage anything well. In a more complex world it doesn’t happen all the time. Rarely do we see the practice that I followed with some tiny acquisitions: while I liked the products the acquired firm produced, what I really wanted was the new management to join us and play a bigger role in the overall growth of the firm. This is not happening today.

The big risk for the acquirers is that not only do the former senior managers leave the "Mother Ship" but they bring along with them or attract the bright young and entrepreneurial people that will develop the new leading edge competition.  As a partial answer to these concerns  I believe, along with others, that we will see more spin-outs or strategic sales. To accomplish this well and to keep the loyalty of the former parent company's workers will require skills only a few firms have.

Are you prepared for the next bubble?

In our economy we normally don't fix the inflating force that created the bubble, we just remove the flow of the assets that created the bubble. But the assets go somewhere. Most of the time investors still search for above-normal yields and because of their confidence in their own selection skills or those of their managers, dealers or brokers, they remain speculative. We are at the point of looking at mutual fund flows worldwide to suggest that the High Yield Bond fund bubble is deflating. Where is this money going to go? Wherever it goes eventually, it will likely prove to be disruptive.

What to do?

Try to look to the next visible time horizon and beyond to what may be large mistakes that in some future time periods can be corrected. Do not have too much confidence in the correctness of your present, firmly held investment beliefs. As they say, many roads to Rome (investment success).  One should be on multiple routes, the more the better.

Please share your thoughts.   

_______________________

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Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

     

Special Bulletin

Before we posted our normal Sunday thoughts below, we received an email from London stating that Ralph Acampora is now looking for a 23% correction. To me this is an important message.

Ralph Acampora is in my opinion and others, the Dean of Technical Analysts. He has taught courses all over the world on the use of charts and other quantitative data to predict price movements of stocks and markets. He has help found market analysts groups in many places and helped to develop their own qualifying exams.

Ralph has been a bull on the US market since 2009 and this is the first that I have heard of his turning bearish. Not only is he a friend but I deeply respect his talents. Nevertheless, I need to put his warning into perspective. My study of market history has me prepared for a 25% decline from peak levels three times in any ten year period. Once a generation a 50% drop is normal. Our performance and those of others have produced in 2012 and for the first seven months of 2013 way above “normal” returns. Thus, some give back was likely before this. However, in the context of a long-term investor who invests conservatively without leverage, a decline of 23% is painful, but tolerable.

Asian markets

On this weekend of indecision in Washington and other capital cities, Bloomberg Television reports on Sunday evening that the Asian markets do not appear to be negatively reacting in terms of currencies or stock prices. 

The next ten days could prove the old Chinese curse “May you live in interesting times.”

And now back to the statistical Ranch of my normal post……

Wrong messages from fund flows

All too often various published and internal pundits quote the size and direction of mutual fund net fund flow data as having some predictive power of future market directions. If they only took more time and analysis they might get some more useful insights. Both my former firm, Lipper Inc., and the Investment Company Institute (ICI) as well as some others regularly report on actual or estimated fund flows. While we get monthly data as an associate member of the ICI, much of the trade association's public release is also printed in Barron's magazine.

The analysis is time-period dependent

After the sluggishness of August one tends to forget the sharp recovery in July from June's disappointing results. In terms of mutual fund net flows, itself a mixed metaphor for investors’ drives, July saw a net positive flow of $19 billion over June's net redemption of $26 billion. Few if any pundits mentioned that the July gain in 2013 was less than the $28 billion in July of 2012. "Is the glass half full or half empty?" The answer depends on your bias. Yes, there was a swing of $45 billion from net redemptions to net sales, but the July 2013 net sales were behind $19 vs. $28 billion a year earlier. I suggest that looking at the next level down as to flows into various investment objectives shows a considerably more speculative attitude on the part of fund investors. For the most part speculators are much more short-term oriented than long-term investors.

Leading investment objective net flows

Comparing June 2013 to July 2013 and focusing on the $45 billion swing to net sales from net redemptions, the following investment objective activity caught my eye:

• The largest contributor was the retirement favorite of Growth & Income: $12 B.  
• The next biggest swing was the insistent search for yield, Strategic Income:  $11B. 
• Next was the retail favorite, Growth funds: $11B.
• Seeking price protection were Short-term Corporate Bond funds:  $8B.
• Finally, Aggressive Growth funds: $6B.

These groups represent the entire swing; while there were other contributors to net sales they were offset by a number of investment objectives which were increasingly in net redemptions. The key message that I get looking at these and other fund statistics is that the fund business is serving investors with very different needs and proclivities. The aggregate numbers are like population numbers, but not particularly helpful in setting sales strategies.


Channels show the business side of the story

I am starting with the proposition that in general, funds are sold not bought, which means there are forces beyond an investor’s desires that lead to a purchase of a fund or other investments. Today there are multiple ways to reach all investors who have the combination of needs and money. There is considerable overlap within these channels of distribution with individual investors being welcomed into formerly exclusively institutional products and services as well as the other way around. Many manufacturers and distributors of fund products are active in most channels. Nevertheless, the ICI, the trade association for the fund business attempts on the basis of surveys to allocate fund sales to a number of specific channels. In terms of the swing into net sales from a year ago one can look at the change in the levels of sales by channels.

• The biggest change in the month of July was in the institutional channel with net sales up $43B.
• Followed non-proprietary sales forces: $14B.  
• Direct Marketed funds: $10B.
• Proprietary Bank funds: $3B.

What these numbers suggest is that just as there are multiple of investment objectives attracting money, there are  a number of different ways money can flow into funds.

What does this mean to me as an investor?

As an example, to a car buyer the aggregate production and sales numbers for the automobile industry are of small importance. As a customer, you  are interested in the production schedule of the vehicle you want and within your range of comfort, also what are the locations that you can buy and service the car. However as an analyst, fund sales data can be very useful. Most investment management organizations manage funds alongside other accounts. These other accounts do not regularly publish performance or portfolio information. Thus, through intelligent analytical work on funds, one can see more of the institutional mind sets.

What do I see?

On this first day of September I see a strong desire for the world to become clearer both economically and politically. However, many investors no longer have the choice of sitting on the sidelines. They are in effect making the "risk on" bet by rearranging their fixed-income into both shorter-term maturities and employing money in more risky fashion. On the equity side while the bulk of money is invested in Growth plus Growth & Income oriented funds, they are increasingly adding to Aggressive Growth and less diversified Sector funds. There is a great deal of talk of trying to find European investments near their bottoms and some willingness to take a very long view on selected emerging and frontier markets. These various strategies may work out well, but they are not generating a lot of comfort. One caution is that I would separate the data on Exchange Traded Funds (ETFs) from that of the traditional mutual funds, which for the most part are being used by investors as a place for their money in terms of years. (The more the better.) In the last week, five out of the six securities that produced the most volume on the New York Stock Exchange were ETFs. I believe that most transactions in ETFs are for short-term purposes. Investors are using them to quickly modify their base long-term portfolios. It is these long-term portfolios that we manage for institutions and individuals.

Getting perspective

Future posts will reach you from London and Budapest. There are many investors there that have a lot they can teach me. Not only do they see things from a different prospective, but also they use securities differently because of their tax and other regulations. Hopefully I will return wiser.

How do you use mutual fund and ETF data?

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Did you miss Mike Lipper’s Blog last week?  Click here to read.

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 MikeLipper.Blogspot.com .

Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.