Mike Lipper’s Monday Morning Musings
History: Good Lessons & Not Great Predictors
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
Human Minds
We are all wagering machines. When we wake up day or night we make a bet, most of the time extrapolating the current trend. We remain on this journey and deviate based on internally accepted historic lessons, modified by predictions of change. Pundits, or so-called teachers, are often the sources of these perceived historic lessons. In the few minutes they have our distracted attention they simplify what initiated the change. These summaries are rarely subjected to evidentiary rules and opposing views, or the mood of the times.
An example of how the viewing of financial data has evolved from my college days is evident in this weekend’s Bloomberg interview with Josh Friedman, Co-CEO of Canyon Partners, a very successful institutional manager of credit portfolios. He is a fellow trustee of Caltech and former Chair of its Investment Committee. His cogent analysis of the investment market suggests that much of what is happening relates to the sale of assets, not earnings, with institutional prices the result of carried interest/performance fees. The skill sets at Josh’s firm include asset accounting.
In the late 1950s, as an undergraduate taking graduate courses, I had the great honor of taking Securities Analysis under Professor David Dodd. He was the principal writer of the textbook with Benjamin Graham (Graham & Dodd). Showing more guts than brains, I questioned his focus on the proper valuation of assets and liabilities, considering his data started shortly after the trough of the Depression, when the first edition of the textbook was published. I felt it was outmoded in a world that was paying for earnings, particularly earnings growth. Smiling, he divulged how much money an investment in his fund had made by investing in assets selling at a discount.
Columbia offered two courses in the second year of accounting. Cost accounting, popular with aspiring accountants, and asset accounting, tied to the Graham & Dodd investment practice. Asset accounting, unlike cost accounting, did not focus on the historic cost of assets and liabilities and created a much different valuation, similar to what Canyon Partners practices today. Perhaps the most valuable lesson from that course was the final exam, where 50% of the score was devoted to the critical aspects of a business not captured by the accounting statements.
Both the late David Dodd and I were right. In the 1960s and some of the 1970s, stocks with earnings and earnings growth were the standout investments. Later during that period, Mike Milken spotted Keystone custodian funds having a junk bond fund with significantly superior performance to its stablemate, a high-quality corporate bond fund. Milken, through Drexel Burnham (*), began a very successful sales campaign to sell high-yield or junk bonds to insurance companies and savings institutions. It was so successful that there was soon a shortage of paper to fill high-yield demand during this period of low interest rates. Much later, rising interest rates cratered the market price for “junk” bonds, brought on by increased regulatory pressure and Volcker attacking inflationary pressures. At much lower prices, another era of asset accounting value surfaced.
(*) I was a junior analyst at Burnham in the mid-1960s, still chasing earnings.
Cycle Repeats, Lessons Should Have Been Learned
During the early part of the first Obama term, they created stimulus programs to give cash to consumers, hoping their increased spending would influence the mid-term election. However, a good bit of the money was saved or used to pay off debts, reducing the economic lift. With some of the same people in the White House today as in 2009, they should have learned that excess stimulus will create inflation in the years to come, as recovery from the lockdowns creates expansion.
Lesson of Lessons
Each lesson should be adjusted for historical perspective and given a different weight under different conditions. You should also consider when a particular strategy or tactic won’t work. It is also useful to evaluate what else is happening at the time and consider its influence on the result or the value of the result. Although pundits try to deliver a forceful simple statement that immediately solves problems, life is rarely binary. We need to accept that we are complex people living in a complex world.
Predictability
One reason all investors should pay attention to mutual funds is they reveal what individuals and institutions are doing or not doing. Before delving into fund performance statistics, a few general comments might be useful:
- The main use of mutual funds is to meet retirement or legacy needs.
- Funds, even no-loads, are sold with involvement of an intermediary.
- As long-term investments they are rarely disrupted.
- Most redemptions are completions or reflect changes of needs.
- The former commission broker is now a wealth manager getting an annual advisory fee, making an ETF the likely choice.
- Fund owners have other financial assets.
- Salary savings - 401k, 457, and 403 are pension replacements.
- Funds are being used by a growing number of institutions.
At least weekly, if not daily, I examine fund performance. From an investment policy standpoint, I pay particular attention to two mega collections of funds encompassing most of the equity assets of mutual funds. There are 18 peer groups of US Diversified Equity Funds (USDEF) and 13 Sector Equity Funds. (At times I pay attention to global, international, commodity, and mixed asset funds as well.) After the end of each month, I look at a report that portrays total return performance for 8 periods, from one week to ten years. One screen I use for some accounts is to see which investment objective peer groups perform better than the average of all S&P 500 Index Funds. The analysis to the end of May shows two important elements.
- For the year-to-date period, 10 of 18 USDEF and 8 of 18 Sector Groups beat the S&P 500 Index Funds’ average. This is unusual because index funds have lower fees, less turnover, and less cash. This is a trend that has been happening since the bottom of the market and may not last a long-time.
- Contrasting the YTD figures with 10-year performance, one can see the difficulty in beating “the market”. Only 3 of the 18 US Diversified Fund Groups and 4 of 13 Sector Fund Groups beat the S&P 500 Index Funds’ averages.
What was the frequency of various peer group averages beating the market during the 8 periods? Small-Cap Value, Multi-Cap Growth, and Tech Funds each did it 5 times. Large-Cap Growth and Natural Resources did it 4 times.
This suggests that superior investment selection is difficult and possibly should not be an appropriate goal. A subject for a later blog. For those that are interested, I recommend two articles in the Saturday Financial Times on selection difficulties. They are titled “Racing Industry Looks to Epson Derby for Galileo Heir” and “Tiger Cubs on Prowl after Robertson built dynasty in hedge fund jungle”.
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Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2021/05/mike-lippers-monday-morning-musings_30.html
https://mikelipper.blogspot.com/2021/05/faulty-comparisons-weekly-blog-682.html
https://mikelipper.blogspot.com/2021/05/extreme-views-can-be-good-lessons.html
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