Four Investor Risks - Weekly Blog # 508”

Introduction

For equity investors and many workers, things are going well. While the upturn is relatively new it is pushing out fears of declines for many. Investing is an art form that pulsates through various themes and it would be wise to recognize past patterns of their ups and downs. Some look to history for specific fact bases to avoid. A more useful review of the past is identifying emotional/psychological patterns that repeat themselves throughout history.

One of the advantages of being steeped in the history of mutual funds is one can see repeated patterns which in the past have acted as beacons of troubled waters. These beacons identify past problems without promising avoidance of future ones. In my ongoing study of mutual funds and similar vehicles I am seeing four potential subsets of problems that current investors should be tracking in their investment thinking. Non mutual fund investors often have parallel concerns.

1.  High Growth Investing

In most stock markets most of the time there is a subset of traded securities that is leading the market higher. Often these are either reporting or expected to report higher earnings. Their products and services either at present or in the future have little in the way of completion. Some of their perceived advantages may be temporary. These high growth performers enjoy stock price momentum. In the current market place these would be the FAANG + Baidu & Tencent.  These leaders have driven the performance of a significant number of mutual funds and other managers. Their upward momentum can reverse quickly due to any real or perceived changes in their advantages.

2.  High Quality Growers

A coterie of high performing funds was divided into two groups of strongly performing funds and stocks, (1) high growth, and (2) Long-Term quality. Coming out of the recovery phase of the equity stock market decline, ending in March of 2009 and becoming more pronounced after 2015, the perceived to be high future growers gained momentum. A second group of stocks rose in prices but at a slower rate of appreciation. This second group was often developing a broader product line with a higher service component than some of their higher earnings competitors. An interesting question is when the high earnings stocks and funds enter a decline will the companies that have a better balanced business portfolio be treated better?

3.  Agent Career Risk

One of the emotional realities of employing an Investment Advisor is that often in the mind of the capital owner is the distinction as to who is responsible for the investment gains and losses achieved. Emotionally the gains are in part attributed to the wisdom of the owner and losses are largely consigned to the agent/investment advisor. 

As of the time of decision making whether an agent is to be retained or not there are two very different quandaries. The first is the past record of the account including the various alternatives that could have been used plus the cost and bother of execution. In addition, one needs to add into the mix the personality of the capital owner, including tax attitudes. Another important consideration what should be the measuring rod for comparisons and what is the relevant time period. The second set of questions starts with a belief as to the nature of the future investment period and the likely differences from the recently completed period.

4.  Capital Concussion

The future is always difficult to predict. This is particularly true today. We have entered the first of what I suspect will be a series of changes in tax laws, regulations, and court cases as well as state and local changes. Further these changes will impact both individual needs and desires of present and future beneficiaries. These evolving changes in total may dramatically alter not only each of its investments, but also the structure of the investment markets.  

__________

Did you miss my blog last week?  Click here to read.

Did someone forward you this blog?  To receive Mike Lipper’s Blog each Monday morning, please subscribe using the email or RSS feed buttons in the left margin of Mikelipper.Blogspot.com

Copyright ©  2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Introspection Can Improve Your Investing

Introduction

The holiday season and the turn of the calendar year can create an opportunity for introspection as to how you invest. While one should be just as introspective about wins, it is too difficult for most to separate brilliance and a bull market. Hopefully on the downside it is a bit easier to identify systemic elements that led to losses. To see what impulses are really working, we must shed the standard alibis – “someone lied,” an external negatively interpreted event surprised us, or the weather plus Christmas or Easter came early. While each of these excuses may have happened, your own particular losses are what you were thinking about before, during and after the market prayed upon our conscience.

The following items are what I have developed for review of my investments. I offer these points as a guide as to what one can produce through introspection.

Timing

First it is helpful to admit that very rarely can we buy at the bottom or sell at the top. For the long-term investor to be within 15% of the extreme prices would be remarkable and to accomplish both feats is just about impossible. My timing decisions for the most part are driven by internal and external needs. The internal needs are functions of incoming or outgoing cash flow requirements, a change in the portfolio structure caused by the desirability of exiting some investment and/or inflexible allocation strictures. The external forces have to do with prices or price-related ratios (price to intrinsic absolute value, price to book value, earnings or dividend yield). The external numbers can be viewed on an absolute or relative basis. A sound investment advisor can help with these decisions. In the absence of an advisor, investors are able to conduct the work themselves, accepting that one can be somewhat inefficient and can dollar cost average his or her overtime.

The result of any averaging approach is not to get the single best price. The average price is very likely to be below the best price achieved over the period. The benefit of this unaided strategy is that one has broken the paralysis of analysis. The disadvantage may be for the intervening broker (if you are not using funds), who prefers one large order rather than a series of smaller orders.

The value of the last conversation

In both the military and in various theatrical shows the last conversation usually places everything into perspective and then there can be an immediate action to solve the issue at hand. The last action may well be, but not necessarily, the most current information on a moving target. Like with all elements of information the last one needs to be evaluated in terms of quality of information: (how much is factual rather than opinion?), accuracy (do the “facts” tie in with previous information?), and motivation of the source (what does the provider in the long run expect in return?). In a world bound by concerns of inside trading and full disclosure regulations, the game has become more difficult but more rewarding. The SEC has accepted the “Mosaic Theory” approach to building investment conclusions, which is actually a defense against accusations of using insider information. This is a very tricky area. 

Many years ago I was managing money for a foundation that had a large block of the late founders’ stock in a large, listed deteriorating retail company with some representation from the company on the foundation’s board but not its investment committee. I was urging an immediate plan to move out of the stock as quickly as possible based on the fact I could not find any leading analyst following the company. The foundation’s external lawyers said that a sale would violate the insider selling rules as the foundation knew that the current management was incompetent. The founder’s company soon thereafter went bankrupt and a significant amount of scholarship money was lost. Bottom line: some additional insight is good, but too much is dangerous.

Looking too hard for negative indicators

Over time I have found it difficult to find individuals that have a spotless record of correct decisions. The best are right 2/3rds of the time and perhaps in a very rare instance ¾ of the time. On the other hand there are other people that have a superior history of being wrong. In the current environment certain political leaders and central bankers have been great negative indicators. One of the reasons I am increasingly cautious is the growing enthusiasm for the immediate future. A good example of this is a columnist for a major NY newspaper over the weekend discussed a bullish view of the future which is okay and could be correct. However, he said he could not find anyone that was extremely cautious to somewhat negative. He didn’t look very hard as we have seen significant sales of public stock by well-known investors and an increasing number of Small Cap mutual funds closing to new money additions. Thus, I am confirmed in my cautious attitude, but I must be on guard to the fact that every now and then a negative indicator could be correct.

How smart am I?

My brother tells me that our grandfather warned us that the person on the other side of the trade was likely to be at least as smart as we were and could possibly have better information than we did. This warning predated the SEC, but is as valid today as in the last century. The only way I can deal with this reasoned fear is recognizing that the buyer and seller may well have different time frames that they are being measured. Most of the time the seller has an immediate need for cash and the buyer is looking for a longer-term reward.

Too much attention to today

We can describe yesterday’s price with extreme accuracy to many digits beyond the decimal point. We have the headlines and perhaps more importantly, the buried smaller news articles for today. Almost all of the various pundits will focus on the current. As a long-term investor for my clients and my family, I should be more concerned about future valuations based on future conditions. Clearly, I can not view the future with any degree of precision, but in some ways these outlooks are of much greater value in building and sustaining wealth than the current obsession with precision and today’s market “news.”

When I visit good managers, it is difficult but rewarding to discuss how they see the future.

Too low a discount of expected future returns

In a period of manipulated interest rates there is a tendency to use current rates to discount future cash flows. As the current rates do not take into consideration the business and human risks present today and likely to be in the future, many investors, corporate executives, and investment committees are in my opinion over-valuing future flows of cash. Alternatively, I would suggest that a discounted rate should be the higher of a sound pension fund’s actuarial assumption or the yield on High Yield (junk) bonds to cover the risks and uncertainties. I am having difficulties finding suitable long-term investments meeting these criteria.

What introspections have you done or are likely to do in the future? Please let me know.

_____________________     

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 - 2014

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

Active Grandparents Can Be Good Investment Managers

Introduction

Investing is an abstract art that is non-sensible to many. To the contrary, I believe that investing in general and portfolio management specifically is representative of the real world. In most cultures, most of the time, we celebrate what was done well in the past. Most educational institutions base their pedagogical outlines on learning what were good achievements in the past, and not enough about past mistakes or failures. In many families passing down of this knowledge is done by the grandparents.

Portfolio management should benefit from grandparents

I spend almost all of my waking hours and some of my sleeping hours looking for good investments for my clients, my family and the beneficiaries of the charitable institutions that I serve. While the rewards for finding a single great investment can be huge, in many cases the search is akin to the search for lost gold mines of El Dorado, which thus far has proven to be mythical. For me and those whom I serve, a better use of my time is the search for good portfolio managers during their periods of both leading and lagging performance. I am increasingly drawn to portfolios of managers that combine what is new (if anything), sound past practices, useful thinking, and perhaps even wisdom.

Grandparents come in different sizes, shapes and experiences

One of the better questions to ask a possible investment manager is, “Who was your mentor and where did you learn about life?” If the answer only includes academics or other people in the business, you are getting the rehearsed expected answers. When I press further, I am often told that an older person served as a mentor; either parent, grandparent, uncle, aunt, and in some cases the person responsible for the day-to-day childcare. Few, if any of these people can impart portfolio management skills. They can and do explain the rise and fall of their life’s rewards. If none of these life teachings go into problems encountered, either the prospective manager is naïve or is not forthcoming, not a good beginning to a relationship.

What can be learned from grandparents?

In the following discussions about the value of grandparents imputes, I am generalizing well beyond my and my family’s direct experience and including those families that have shared their experiences.

This time is different

One of the impatiences of youth and inexperienced investors is the belief that the old patterns of behavior will not apply to the “new, new” environment. This powerful idea will overcome people’s greed, fear, inefficiency, counter-balancing forces and the application of the unpredictable laws of nature. Those who have been walking around upright for years can inform those who are willing to listen that they have seen and believed similar things in the past.

I can play the Bigger Fool Game better

In past posts, I have mentioned that studies have shown that many of those who have been caught up in these bubbles have recognized the fallaciousness of the “new, new thing,” but they think they are going to be able to jump out of harm’s way. The historical odds are that in a steep decline when the bubble is broken, very few can exit and stay out.

My children and their partners will do exactly what I say

Every generation wants to show to their parents that they are smarter than their parents. Thus, they do not follow the proscribed rules laid out by their parents. One of the ironies is that when the children have children the grandchildren also do not follow their parents’ dictates. In some respects, grandchildren are the retribution delivered to the children. Eventually the children then begin to believe that their parents have gotten much more intelligent than they were when they were growing up.

Translating into portfolio terms

The best defense against the wipeout caused in many bubbles is to be broadly diversified. This is easier to say than to accomplish. The bigger the bubble gets the more it will suck money from other portions of the global economy. In turn this will weaken the credit conditions of the late-comers. Thus, the latest “new, new thing” could affect the credit quality behind pensions, bank, insurance companies, suppliers and other communities. This is precisely where the boring work of a detailed security analyst can be extremely valuable. Most of this kind of diligence is done by buy-side organizations including some credit oriented hedge funds.

The wisdom of families in terms of estates

Any in-depth analysis of families will reveal that any one generation with all of its knowledge of their decedents did not fully anticipate all of the following possible, and some may say impossible actions of the decedents:

• Premature deaths
• Change in various tax laws 
• Lack of legal competence
• Unexpected medical conditions
• Divorces
• Change of domiciles of people and assets
• The willingness of various family members to take responsibilities for others (some of which they hardly know)

Probably the most difficult decisions have to do with children of unequal needs and abilities. All of these require the very careful work of one or more trust and estate attorneys in conjunction with an extremely knowledgeable tax accountant and an investment advisor who can structure the initial portfolio but also to keep it in appropriate balance as conditions change.

Post-estate governance

While Wills and Trust documents provide a framework for the continued governance of the assets, there is a much larger set of issues. One can not truly predict the changes in personalities after there has been a disposition of the assets, the critical issues remain how well various individuals carry out their deemed responsibilities including the management of their assets and those of others that they may influence.

November gives us a governance clue

In November two individuals who have donned additional political power are President Xi Jinping in China and New Jersey Governor Chris Christie. Each portrayed himself as someone in the middle of his political spectrum. Clearly, I do not know what they will do in the future. The lesson from these two leaders is that while each could have shown more political strength, they opted to take the somewhat safer middle. Translating this into Trust and Estate Management, suggests staying in the middle is the safest and gives the most maneuver room.

What did you learn from your grandparents and what are you teaching?

_______________________

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.

Confessions of a Holder: Be Not a Buyer or Seller Now

I appear to be semi-frozen in my portfolio right now, not wanting to buy or sell significant parts of our investments. I speak not only as a paid investment advisor who wishes to continue to be paid, but also as a steward of my family’s and personal accounts. The continuation of payment from a long-term strategic investor has caused many advisors to make changes to portfolios look as if they are busy earning their fees. While there are almost always chances of significant deterioration of the long-term prospects of an investment as well as newly discovered research/analysis that makes previously bypassed investments attractive, many portfolio changes are disruptive and I suspect are done merely to look busy. In managing my own and family money as well as serving pro bono on investment committees, there is no need for me to appear to be looking as I am in action rather than observing. Thus, these privately focused accounts are a helpful guide to my professional responsibilities.

With those thoughts in mind, I want to explore with you my current thinking about my personal rather than professional investment duties.

Where are we in the current investment cycle?

Any study of history shows that in almost any activity there is a pattern of expansion and contraction. Even in terms of differing philosophies, they move further apart or become more concentrated in some form of a Hegelian synthesis, until there is another period of disruption of central tendencies. Cycles are endemic to human behavior. Thus, we regularly find investment markets moving in a cyclical format.  We clearly had a market peak in 2007 and an economic/financial fall in 2008 and a stock market bottom in March 2009. Numerous commentators will use these dates to chronicle the latest expansion with comments that some stocks and some funds have risen past their 2007 highs. The politically-oriented economists will focus on 2008 as the turning point and surviving market investors will judge performance from March 2009. (I suspect that many advisor “pitch” books and advertisements will start trumpeting five year performance numbers as well as the consultants’ favored three year period to show investment expertise rather than recoveries from depressed levels.)   

In the light of the above thoughts, I look at my own personal accounts which are loaded with stocks of financial services companies with heavy emphasis on investment managers and broker/dealers both in the US and elsewhere.  The recoveries in general have been remarkable. Careful analysis of the names in the portfolio can be grouped into two categories. The first are the leaders in their segments which have recovered the most. The second group were perhaps value traps; companies that were selling way below the cost to recreate them in sectors that traditionally large companies wished to enter to fill out their product offerings. While these have regained some of their lost ground in terms of stock prices, they have underperformed the leaders. This dichotomy between the two groups leaves me in a quandary and as usual I turn to the study of the current market structure for a guide to the future different from the extrapolation of current trends.

What am I seeing?

The leadership group’s stock prices are back into their “normal” levels; thus I continue to hold them in the belief that if the current expansion cycle ends soon, I will want to hold the leaders for the next expansion when we may see a full uplift to the global economy and its needs for viable financial services leadership. Up to this point I have labeled leadership companies without describing the basis of their leadership. Statistically these companies are among the biggest in their defined sectors, but not necessarily the largest. They have grown internally without the benefit of large acquisitions, but with the occasional willingness to bring a few talented outsiders into key decision making roles. Some of their larger competitors were put together through mergers and acquisitions which make their management focus on political decisions within their expanded empire.

Saturday night I was thinking about the nature of great leadership. My wife and I attended a birthday party for George Washington at his Mount Vernon home. (Actually it was to celebrate his 281^st birthday.) The speaker was Ron Chernow, the author and historian, who discussed Washington’s leadership in his two terms as president. What struck me was that General Washington, not Congress, created the concept of a cabinet within the US government. His was only three: Hamilton in Treasury, Jefferson in State and Knox in the War Department. He chose men who were better educated and in many ways more intelligent than him. He encouraged vigorous debate and tolerated strident disagreements, particularly between Hamilton and Jefferson. Yet in his two terms as President, including turning down a third term, he established more policies and better practices than any of the presidents that followed him.

In my mind I applied the lessons from Washington to my list of leadership companies’ attributes:

1.    Attract the best available minds, even those that are smarter than the leader (CEO).

2.    Encourage debate within a small select group.

3.    After listening to critical experts, the CEO should thoughtfully make up his/her own mind.

4.    Knowing when to leave, hopefully at the top.

I will continue to look for other companies with similar leadership attributes, hopefully with not too demanding stock prices.

While I am content with my portfolio’s leadership positions, what concerns me are the holdings in companies that in some respects are worth more dead through acquisition than currently alive. When I carefully analyze my bets in these companies, they are really dependent upon market actions (or to be blunt, waves of speculation). At this time I may have the winds at my back to push these stock prices higher. The winds in my favor are:

1.    A rising tide of merger & acquisitions as commented upon by Moody’s^* and others.  The credit rater is worried that these deals will weaken the acquirers’ balance sheets. On the positive side, the stock prices of a number of mid-sized investment banking firms are selling at above market price/earnings ratios which seems to assume that they see their earnings will rise on the basis of the fees they will earn by representing buyers and sellers in these deals.

2.    The market appears to be concerned about the apparent “take-under” of Dell, unless you see it as a discount that the current owners need to pay to get out from under Michael Dell’s leadership. The market responded positively to the surprise announcement of the purchase of Heinz by 3G and Berkshire Hathaway*. Part of the positive reaction to this deal was that it showed Warren Buffett’s technique of negotiating the issuance of a high dividend rate preferred stock (9%) for a larger amount than the purchased equity.

3.    The interest of investors appears to be increasingly speculative. For example, in the five trading days ending Friday, seven of the ten largest stocks in terms of dollars traded were ETFs. These included two investing in the international developed markets, one in emerging markets, one in smaller market caps, and gold as well as the leader, S&P500. The other three stocks were Bank of America**, Citigroup** and JP Morgan**. With the financial stocks as the best single sector last year, some may be speculating that the three large banks will continue to be performance leaders. (Rarely does the same sector lead two years in a row unless it comes from severely depressed prior periods.) 

Disclosures:

*        Long positions held in my private financial services fund

**      Held personally

The difference between my leadership group and my potential acquisition targets is that I might add to my leadership holdings if there is a serious market break, but I may even sell if the targets’ prices drop as my patience could be worn out.

Please share with me privately how you look at your portfolio.

_________________________________

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.