Are We Selling the US Too Short?

Almost everyday the global financial headlines discuss the decline in the value of the US dollar relative to other currencies. Many economists and others talk about a slow recovery here, and faster in Asia. Because of the difficulty in obtaining student visas for university students since 9-11-01, there is wide-spread concern that we are no longer attracting the brightest minds to study and work in the United States.

The fear (and perhaps a distaste) of investing in US stocks has been translated to Main Street. As of September 30th of this year, 53% of all money invested in Stock funds are in US Diversified Equity funds, according to my old firm. Another 6% is invested in Sector funds, some of which have a distinctive global tinge to them. Combined, Global and International funds alone account for 22% of American fund owners’ assets. These numbers understate the total exposure we have to non-US influences on our wealth. A number of analysts have estimated that over 40% of the revenues of companies within the S&P 500 come from overseas. Foreign earnings of these companies are not often disclosed, but I would not be at all surprised to learn that they represent over half of the total earnings of American companies (particularly if we include earnings from exports). I am well aware, and have benefitted from the fact, that investing globally for many years have produced better results than investing primarily in the US. This may not continue forever.

One of the first things I did as a Wall Street bank trainee was to physically account for the foreign shares in our bank’s vault (investors were issued American Depository Receipts or ADRs). Many years later my fellow trainee became one of the leading investors in both domestic and foreign bonds for central banks outside of the US. Almost from the beginning of my personal investing at the odd-lot, below the 100 share size, I invested either directly or indirectly in foreign trends. At times over recent years my foreign exposure in equities was over 40% including funds, individual stocks, currencies and some operating investments. I am no neophyte to investing globally.

One of the many lessons that I have learned from a number of older and wiser investors is to tend to invest against the headlines. The current pessimism about the long term future of the US is just such a time. For the accounts that I am responsible for (including my own), I seriously doubt that I will be adding to the international allocation in the near term.

Why do I take this point of view? Is it just to be contrary? No, while I am professionally trained to look at the other side (or sides) to any investment before making purchases, my optimism is based elsewhere.

We are incredibly fortunate to have three of our family beginning studies this year at William and Mary, Georgetown, and Carnegie Mellon. Not only are we listening to them discussing their courses, but also hearing about what their friends are doing at other leading universities here and abroad. They all appear to be working long and hard, and their courses are subjects that their parents and grandparents would like to take now. Our young will be much better prepared for the globally competitive world that they are inheriting. Their youthful enthusiasm, with some idealism thrown in, has a much more practical base to them than when I was in college. We are producing great raw material for the future.

While waiting for our young to earn their commanding positions, the current pace of technological development in many fields appears to be on the verge of major improvements for mankind. The discussions from graduates, professors and current students that I hear from my exposure to Caltech, suggest that we do not live in a static world. There will be breakthroughs in energy, medicine and their underlying physics, chemistry and biology. Big problems will be addressed and solutions identified. In the scientific fields, most of the awards are going to people who teach or were educated in the US. In science we have been punching way over our population weight class for some time and this is likely to continue at least for a few more years.

Focusing briefly on the price of the dollar, I would rather be a buyer than a seller. At some point, perhaps right now, our trading partners will want to prevent a further decline in the dollar. They will become buyers rather than sellers to protect their own export books and internal currencies.

My bottom line is I believe that one should not now be increasingly short of US dollar investments.

On Building Effective Investment Committees

Investment committees are the heart and soul of many non-profit organizations. The deliberations of these groups determine the near term and perhaps the long term ability of the organizations to accomplish their missions. Combined with the organizations’ Development (fund-raising) efforts, the scope of near term activities is determined. In an ideal world, investment should focus on the long term. In the real world, from a pure investment viewpoint, the pressure of near term funding needs often get more attention than warranted.

Currently, I have multi-faceted relations with several investment committees. I chair two very different investment committees, act as a consultant to some and an investment manager to others. Thus, I read with great interest an excellent seventeen page piece on investment committees by Michael Mauboussin of Legg Mason Capital Management. In his summary, he highlights twenty-one thoughts broken down into general findings, advice for committee members, and advice for committee chairs. With due regard for the patience of blog readers I will not discuss each of his excellent points, but will focus only on a handful.

The best committees are made up of members who bring different points of view from their varied experiences and thought patterns. In effect, intense discussions are the mother’s milk of a successful committee. As distinct from a reporting function which dwells on the past that can not be changed, the committee should focus on the future. Important in the deliberations should be the recognition that after exceptional performance, good or bad, the odds favor a reversal of relative, if not absolute performance. Along this line of thinking, the committee should challenge the obvious. One way to do this is for each member of the group to come to the meeting with thoughts that they share about what could go wrong. Before one can properly come to an assessment of investment risk, one should identify what could go wrong. Up to two years ago, there was no discussion of “hundred year storms,” which actually happen much more frequently. ( For those who are interested, I would be happy to discuss the similarities between the market collapse of 1987 and the defeat of the Spanish Armada.)

Perhaps the biggest contribution to increasing the success of investment committees is to record the essence of the discussions that lead to decisions. Subtly, these records can lead to a shift from an exclusive focus on outcomes to lessons gained from the process. We need to recognize that many outcomes are more a function of luck than skilled judgments. However, if our process allows for luck, or if you prefer the unexpected, we are more likely to be the beneficiary of change than those that have a high degree of certainty.

In applying the last thoughts, maybe we should spend time looking at funds that are currently performing badly, particularly those with managers that have been successful a number of times in the past. Will their successes be repeated?

What do you think?

Old Money vs. New Money Mistakes

One of the truths about investing is that to invest is to make mistakes. I am not suggesting that investing is an avoidable mistake. We have no choice but to invest our time, talents, and capital. The reason we have no choice is that these resources already exist in some form and if we do not change them, we are reinvesting them in their present forms. Innately, humans and animals instinctively know that our resources will deteriorate and perhaps disappear over time. Thus, we choose to do something with our resources. For most of us, we have no choice but to invest or attempt to improve our condition.

How we choose to invest is primarily a function of our experience. Our experience is not just what we individually have lived through, but also what we have consciously learned through the experiences of others with whom we choose to identify. Whether we like it or not, one of the inputs to our experience is our own DNA. This DNA is composed of elements of human race characteristics and more directly, family background. This is not to say that since there have been four separate (and not connected) Lipper brokerage firms, that for all time members of my family are condemned to be members of the New York Stock Exchange. What it does suggest is that we have a disposition to be attracted to transactions and services for others who transact. These tendencies can be applied to the various worlds of art and computer services among others. Luckily for the world, people are wired differently so we can find essential diversity in what we do. For the most part, our experience, no matter how formed, does not trap us into certain behavior, despite our propensities. Thus, as we enter each new theater of experience, we either treat what we are about to do as something new, or part of a continuum from the past.

Experienced investors, or if you will, old money, invest differently than those with new money. Each of us is human, and therefore makes mistakes; but often the mistakes of old money are different than the mistakes of new money.

Most of the old money that I know did not materially change the disposition of their financial assets after the experience of the last couple of years, even though their money piles are smaller. Their “normal” asset distribution might have been 5% in cash, 35% in bonds, 20% in domestic growth stocks or funds, 20% value stocks or funds and 20% international stocks. At the end of last year they may have had over 60% in cash and fixed income, 15% in value-oriented stocks or funds, 15% in international and 10% invested with a growth objective. An experienced investor believing that almost all relative performance is cyclical, might not change any commitments. For what the market takes away it will return over time. Further, from their experience, they believe after a major decline they should not change most managers or stocks of currently profitable companies. Old money has an affinity to long term records as they have had their money over the long term. They also generally prefer investing with organizations rather than in the success of any particular CEO or money manager. Thus, they chalk up the declines they have experienced as just a “normal’ cyclical decline which will be corrected by a “normal” recovery followed by some secular growth. In many ways this is almost a Newtonian view of a grand watchmaker overseeing our universe.

Owners of new money are full of themselves. They earnestly believe that their investment results are largely, if not totally, dependent upon themselves. They look at the current market always as an opportunity to show how bright they are relative to the mistakes of others. This personality-driven approach often identifies with specific hero CEOs or hot money managers. A somewhat over-simplification of their choices is that they believe in participating, if not leading momentum. Everyone recognizes that at any given time there are numerous unknowns that are likely to dramatically impact security prices and trends. If momentum won’t supply the answer, the new money is more likely to divine the right answers. They have more tools, or if you prefer gadgets, than the old money players and this give them an almost insurmountable advantage.

In these stylized cases, both the old money and the new money are making fundamental investment mistakes that others have committed in the past. Old money is betting on repetition, as in history repeats itself. If that was entirely true there would be no progress, as everything would circle back to our beginning point. In truth, history does show an uneven upward bias to the human condition and valuations. What many do not realize is that the upward bias is caused at least in part by the abandonment of failed, or too weak to survive, elements; as well as the pull of some new potential riches. Further progress is made by recognizing mistakes/opportunities. In the “old money” asset allocation example shown above, some wise investors might reallocate their money back to their “normal” portfolio. (There may be a seldom-declared advantage to this tactic: By increasing one’s commitment to a currently depressed area, if successful, the quicker one will get to the upper limit of the allocation causing a cut-back. One of the reasons for the dramatic declines in numerous portfolios last year was their over-investment in what was “hot” was not automatically corrected.)

New money often does not recognize that what is working so well now is very similar to similar beneficiaries of momentum in past market cycles. One of the many lessons coming out of the Great Depression of the 1930s was the peril of the extreme use of leverage or margin in the 1920’s by various utility holding companies, the great Goldman Sachs Trading Company and individual investors. Applying those lessons from the ancient past might have reduced the 2008 losses in various leveraged vehicles.

Both the stereotypical old money investor and the new money investor do not take into their considerations that they may be wrong. Their “system” like those of many disappointed race track bettors, does not contemplate that judgment mistakes are as normal as other accidents. Both set of investors can reduce their odds on big individual mistakes of judgments by using professionally sound funds. (Caveat Emptor: I manage portfolios of funds for institutions and a very limited number of individuals.) One might combine both the old money and new money approaches (using the asset allocation example above), by reweighting the equity portion of the account in favor of growth stocks or funds as momentum appears to be picking up in that direction. Another example of combining the lessons from these two habit patterns is taking the view that in terms of high-quality fixed income, it appears unlikely that interest rates will drop materially and therefore the capital appreciation potential from this particular segment is limited, and thus the commitment to high quality fixed income should be below “normal.”

Which kind of an investor are you old or new?

Seven Steps For Giving to Charities

At this time of year snail-mail and email carry an extra heavy burden of pleas to give money to any number of mostly worthy charitable causes. Due to various disclosure documents and/or if your zip code is in one of the higher income tax payment districts, one certainty is that any charitable giving this year will generate many more requests next year. These requests will come from the same group to which you gave, but also many others who learn (or guess) that you are good for a contribution.

My Seven Steps for Giving to Charities:

1. The first step is to have a CHARITABLE GIVING PLAN. There will be more urgent pleas for your money than all of your resources. (As Mark Antony was quoted by Shakespeare in Julius Caesar, “They are all honorable men.”) This plan could encompass this year or future years. Due in part (and only, in part) to high “death taxes,” charitable giving is an important part of many people’s estate plans.

As with any plan, writing the first plan is the most difficult. The writer or if you prefer the professional term, the grantor, is often paralyzed by trying to think of every conceivable element to the plan. This paralysis usually prevents the production of a plan. As one who has drawn up many business and organization plans, I recognize that the first step is a commitment to plan. Experienced planners know that plans are meant to be revised over time. Nevertheless, if shared with one’s attorney, the first plan can become one of the foundations of an estate plan with a good chance of doing what the grantor intended. As one matures in the art of preparing and revising charitable giving plans, there may be comfort in discussing the plan with selected beneficiaries, now and in the future.

2. TRANSFERRING RESOURCES is similar to an equation. On one side are the resources. Most often cash or securities are deducted from one’s total and added to one or more charities. The motivation for the transfer is triggered by a belief there is a benefit from the transfer. This benefit is often difficult to measure or even define. In some cases the benefit is best summed up by the phrase, “A warm feeling.” I suggest one should be a little more precise in identifying the benefits.

The first benefit is that the specific charity can accomplish a favored endeavor that it could not do at all, or as well, without the contribution. The next possible benefit is that the charity’s work relieves others of an additional requirement that would have to be funded. (Perhaps improved educational opportunities that help children lead a productive life rather than increased taxes for incarceration.) There can be a personal benefit, other than a tax deduction, e.g. helping children learn a trade or a business that is needed for a well- functioning society. We need more plumbers, landscapers, and bookkeepers as well as classically-trained musicians, among many other skill sets. One of the benefits for giving money away wisely is to teach other, younger members of the family how to help others.

An important part of your charitable giving plan is to identify and understand the benefits of charitable giving.

3. GET TO KNOW THE ORGANIZATION. Many charities will treat contributions they receive as “manna from heaven,” and spend the money as they see fit. There are a large number of horror stories of various charities spending money that was intended for various forms of “good works” on themselves in the forms of compensation, facilities, and entertainment. Others have used money to influence the political process. Some contributions have been diverted to favored commercial activities. While each of these is improper and possibly illegal, the biggest waste of contributors’ resources is through inefficiencies or outright mismanagement. People who work in the non-profit world, in general, are attracted because they have faith in the good works of their particular charities. Often, but not always, they lack management skills and training. Quite often they are short in financial and investment skills. In dealing with these types of concerns, one should compare the size of one’s intended gift relative to the size of the organization.

I believe, if one is intending to become an important contributor to a charity, it would be wise to get involved as a volunteer. For a few non-profits, my principal contribution is to be a member, or chair, of their investment or finance committee. Over time what I can save for them (or earn for them) is much larger than my initial contribution. (I urge my children to follow a similar pattern for any non-profits that have an interest in helping.)

Your charitable giving plan should take into consideration not only your cash contributions, but other resources, most importantly the time being given. Unfortunately, a number of worthy causes are organizations that are not well managed.

4. UNDERSTAND WHAT YOU ARE SUPPORTING. Once one begins to show any sort of sincere interest in a non-profit, one quickly learns of its projects, programs and policies.

Projects typically spend money today or in the near future to accomplish a mission by a certain given date. Think of a new YMCA facility, a specialized hospital wing, or dormitory. Each of these requires an estimated amount of money to be spent on a specific funding schedule. Some of these projects require cash up-front; some require cash to meet progress payments due to contractors and others may require long-term financing for mortgages or equity for the charity.

Programs are often a continuous activity of involvement, with the people the charity sees as its audience. Most often, this takes the form of providing education or medical services to a community that can not afford to pay for these needed services. Instead of brick and mortar spending, program spending is mostly about paying people to work with those in need. “As the poor will always be with us,” the funding needs will almost always be with us. However, the size of the funding support can change based on the flow of contributions and perception of the immediate need.

Policies often deal with the charity’s desire to change the world. This may entail focusing public opinion on a need or attending to a problem. In working toward this goal, interacting with various levels of government is required. This activity is labeled “educating the government,” not specifically lobbying. While the mission of most charities won’t change, their policies can change slowly or dramatically depending on visibility and the political focus.

Understand what you choose to support; projects, programs, or policies. Each can have different funding needs and opportunities.

5. UNDERSTAND THE DIFFERENCES BETWEEN TRADITIONAL CHARITIES vs. MORE VENTURE DRIVEN CHARITIES. Many of the new-multi millionaires have generated their wealth quickly from being involved early in successful companies funded along the way by various venture capitalists. With their newly-achieved fortunes, they want to use the methods that made money for them when they invest in non-profits. I use the term “invest” intentionally, as this is their attitude. They look for a clear mission statement, which appears do-able. They want to see capable management in place, or at least specifically identified. They expect a timetable with specific milestones. Further, they want to see the same level of intensity in the non-profit that they “invest in” as they employed in building their fortunes. Since many made their money in new companies, often they favor new charities. But do not expect them to work their way through the various seats on a board of directors/trustees in the traditional path before they become the anointed leaders!

Understand the differences the way established charities work versus the more venture driven new charities and determine where your comfort level is.

6. MEASURE THE RESULTS. We live in a results-driven world. One of the elements of a well- thought out plan is the measurement of results. Many charities publish self-congratulatory annual reports which trumpet their perceived successes, and the even larger needs facing them. These are like other corporate annual reports or fund reports, which give one side of the story. An intelligent grantor should come up with his/her expectations and measurement yardsticks. In assessing the relative success of a potential gift, one should include personal benefits. For example, listening to great concerts, meeting interesting people, or gaining a deeper understanding of important factors about the community. If other family members have benefitted from these experiences that is also important.

In very human terms, we should periodically measure our efficiency in giving as well as living.

7. SELF-CORRECT. The final stage in any business plan or charitable-giving plan is the feed-back loop so corrections can be made and errors of judgment corrected. Facts believed will prove to be incorrect. One’s knowledge of what is important, will evolve. All of these elements should lead to the next edition of our charitable giving plan.
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*One of the advantages of publishing a blog is that I receive feedback. Often some of the most insightful comments are from my family. The topic of this week’s blog was suggested by my writer son, Don, who believes that some multi-millionaires need help in thinking through their gifts to charities. Thanks, Don.

WRONG-HEADLINE RISK

The frequency of similar financial headlines today tell us much more about current perceptions than future risks and opportunities. This misaligned focus has been true ever since there has been financial gossip emanating from market places. Instead of deriding these calls for attention, we should array these headlines in a reasonably normal progression from total collapse to a glorious future, as a indication of where we are in a normal progression.

Beginning in the fall of last year and through the first quarter of 2009, great concern was expressed as to the closing down and liquidation of financial and industrial enterprises. While Lehman Brothers is in various forms of liquidation, no other large scale enterprise has been closed putting almost all of its employees out of work. Many employees are still drawing paychecks from corporations that are working their way through bankruptcy and other arrangements to restructure their debts. Analysts are now celebrating companies that are generating cash. (Note the cash is before various non-cash charges such as depreciation to pay for the costs of past capital expenditures including, in some instances, acquisitions.)

The next series of headlines will be when companies like the auto makers actually earn a full net income, albeit probably not accruing income taxes due to past losses. At this point we are likely to see equity offerings from the auto companies as a way to pay back the government (us). Soon we may see reports suggesting that even if there is another leg down in the economy, various companies have developed survival earnings that can keep their doors open in a decline. (Many companies world-wide are probably there today.)

After surviving in a defensive bunker, we will see an increase in the number of analytical reports that will declare various stocks are cheap in that they are selling at relatively low multiples of earnings power. As most analysts and most management are not good at estimating future earnings, they will rely on the past. Earnings power will be determined as the average earnings per share developed over the last five or ten years. The thought is that the future, on average, won’t be a great deal different than the past.

The more venturesome investors will look at the very best earnings, or perhaps margins, achieved in the past and declare that stock prices are real cheap when compared to the past. While they do not come out and say it, they are hinting that most market indexes will accede to their old highs. (This would suggest a doubling or more for NASDAQ, and even more for Japanese securities.)

For corporate managements contemplating meaningful capital expenditures, they need to deal with payback periods of five to twenty-five years. To give a go ahead for such spending, they probably need to see net cash generation growth on the order of 15% or more. We are actually seeing those kinds of commitments being made selectively in mining and pharmaceutical companies.

There are some unreconstructed optimists that believe that there will be other large scale developments that will generate massive earnings power as has the Internet and cell phones in the past twenty-five years. (I am awaiting a list of these opportunities from you, the readers of this blog.)

The popular fears that accompany each step in this progression from a bear market collapse to a bubble bull market are unlikely to materialize because too many are expecting it, and have already made some preparations. The progression from bear to bull won’t be smooth with regular steps up. There will be falls along the way for geopolitical disturbances, fraud, forced liquidations of visible capital positions handled poorly, and disappointments in people, products and services.

Less than a year after the point of feared liquidations of employment and capital, I look at the long term horizon positively. Do you?

Who are Better Equipped to Make Decisions?

History often seems to be a tale of decisions made by many versus those made by few. Humans recognize that the results of various decisions can turn out poorly for us individually. In search to improve the odds, we crave some form of central authority. In the distant past, people invested these roles of all-knowing and all-powerful in external forces, supported by strong religious beliefs. In more modern times, we have substituted various forms of governments to play the role of God on Earth. The question is, what level of authority should we invest in the government to make critical decisions for us?

After reading the above paragraph, you are preparing yourself for a long polemic about healthcare and the other issues of the day. What follows is about portfolio management, much lighter, but perhaps more immediately meaningful for many investors.

When we seek advice, traditionally we seek “experts.” While various governmental or trade associations require those who put themselves out as “experts” to have passed various examinations about a generally accepted body of knowledge and codes of ethics in dealing with clients, none of these exams measure the success of picking the correct investments. As a very poor substitute for this measure of success, so called “track records” are proffered. As the early developer of one of the largest and most accurate data banks on investment companies (popularly known as mutual funds), I urge caution in the application of these “track records.” The data shown is point to point, is flat and has a lack depth or narrative. For example, earlier this week I was discussing with an associate the search for a new technology focused fund to add to a specific portfolio. My associate suggested a relatively new fund that is managed by a manager who had a very good record in the distant past when technology stocks were flying. I demurred, for I distinctly remembered that the fund in question benefitted from the buying power of its group to load up on “hot” IPOs, between quarterly statements. There are many other examples of important factors that are not captured within performance records.

Worse than an ordinary expert, is a well-known expert or a minor celebrity. I experienced that treatment in my own home Saturday night. Ruth and I were hosting a cocktail party for friends who had recently returned from their honeymoon. The party included many of their long-time friends, some we did not know.

Allow me to make a composite of several conversations. The composite couple (not the newlyweds) had very impressive positions at learned institutions. They wanted a brief shopping list as to where they should invest their money. There was not much discussion as to any of the factors what would go into a proper prescription to their needs.

I found this ironic. While we did not talk current politics with our guests that evening, I am under the impression that they believe that healthcare decisions should be left almost exclusively in the hands of the medical/scientific community, for they are the only ones equipped with the knowledge of what worked in the past (most of the time) and through appropriate diagnosis of a patient, select what would be medically the best solution. They understood the individualized need of the patient but not the investor.

In such situations, some might provide a “school solution.” This approach calls for 30% in money market or other high quality short term funds, 10% in somewhat longer term funds of intermediate investment grade quality bonds, 20% in international or global funds, 20% in domestic-oriented growth funds spread by market capitalization, and the final 20% in large domestic valued oriented stock funds. The advantage of the school solution is that many will adhere to it. Disclosure point: None of the accounts that we manage would follow the exact school solution, as it would not fit their needs.

The school solution would be authoritative, not because I said it, but it is close to the overall mutual fund industry taxable composite.

In the world of investments, be wary of all experts, particularly celebrities. Central authorities lead eventually to unstable conditions, as other solutions prove to be more beneficial for many.

Happy Labor Day

Happy Labor Day to our readers, we will be back next week.