Posts tagged ‘Charles Ellis’

Winning the Loser’s Game

During periods of heightened volatility like those recently experienced, it’s easy to get caught up in the emotional heat of the moment. I find time is better spent returning to essential investing fundamentals, like the ones I read in the investment classic by Charles Ellis, Winning the Loser’s Game“WTLG”.  To put my enthusiasm in perspective, WTLG has even achieved the elite and privileged distinction of making the distinguished “Recommended Reading” list of Investing Caffeine (located along the right-side of the page). Wow…now I know you are really impressed.

The Man, The Myth, the Ellis

For those not familiar with Charley Ellis, he has a long, storied investment career. Not only has he authored 12 books, including compilations on Goldman Sachs (GS) and Capital Group, but his professional career dates back prior to 1972, when he founded institutional consulting firm Greenwich Associates. Besides earning a college degree from Yale University, and an MBA from Harvard Business School, he also garnered a PhD from New York University. Ellis also is a director at the Vanguard Group and served as Investment Committee chair at Yale University along investment great David Swensen (read also Super Swensen) from 1992 – 2008.

With this tremendous investment experience come tremendous insights. The original book, which was published in 1998, is already worth its weight in gold (even at $1,384 per ounce), but the fifth edition of WTLG is even more valuable because it has been updated with Ellis’s perspectives on the 2008-2009 financial crisis.

Because the breadth of topics covered is so vast and indispensable, I will break the WTLG review into a few parts for digestibility. I will start off with the these hand-picked nuggets:

Defining the “Loser’s Game”

Here is how Charles Ellis describes the investment “loser’s game”:

“For professional investors,  “the ‘money game’ we call investment management evolved in recent decades from a winner’s game to a loser’s game because a basic change has occurred in the investment environment: The market came to be dominated in the 1970s and 1980s by the very institutions that were striving to win by outperforming the market. No longer is the active investment manager competing with cautious custodians or amateurs who are out of touch with the market. Now he or she competes with other hardworking investment experts in a loser’s game where the secret to winning is to lose less than others lose.”

 

Underperformance by Active Managers

Readers that have followed Investing Caffeine for a while understand how I feel about passive (low-cost do-nothing strategy) and active management (portfolio managers constantly buying and selling) – read Darts, Monkeys & Pros.  Ellis’s views are not a whole lot different than mine – here is what he has to say while not holding back any punches:

“The basic assumption that most institutional investors can outperform the market is false. The institutions are the market. They cannot, as a group, outperform themselves. In fact, given the cost of active management – fees, commissions, market impact of big transactions, and so forth-85 percent of investment managers have and will continue over the long term to underperform the overall market.”

He goes on to say individuals do even worse, especially those that day trade, which he calls a “sucker’s game.”

Exceptions to the Rule

Ellis’s bias towards passive management is clear because “over the long term 85 percent of active managers fall short of the market. And it’s nearly impossible to figure out ahead of time which managers will make it into the top 15 percent.” He does, however, acknowledge there is a minority of professionals that can beat the market by making fewer mistakes or taking advantage of others’ mistakes. Ellis advocates a slow approach to investing, which bases “decisions on research with a long-term focus that will catch other investors obsessing about the short term and cavitating – producing bubbles.” This is the strategy and approach I aim to achieve.

Gaining an Unfair Competitive Advantage

According to Ellis, there are four ways to gain an unfair competitive advantage in the investment world:

1)      Physical Approach: Beat others by carrying heavier brief cases and working longer hours.

2)      Intellectual Approach: Outperform by thinking more deeply and further out in the future.

3)      Calm-Rational Approach: Ellis describes this path to success as “benign neglect” – a method that beats the others by ignoring both favorable and adverse market conditions, which may lead to suboptimal decisions.

4)      Join ‘em Approach: The easiest way to beat active managers is to invest through index funds. If you can’t beat index funds, then join ‘em.

The Case for Stocks

Investor time horizon plays a large role on asset allocation, but time is on investors’ side for long-term equity investors:

“That’s why in the long term, the risks are clearly lowest for stocks, but in the short term, the risks are just as clearly highest for stocks.”

Expanding on that point, Ellis points out the following:

“Any funds that will stay invested for 10 years or longer should be in stocks. Any funds that will be invested for less than two to three years should be in “cash” or money market instruments.”

While many people may feel stock investing is dead, but Ellis points out that equities should return more in the long-run:

“There must be a higher rate of return on stocks to persuade investors to accept risks of equity investing.”

 

The Power of Regression to the Mean

Investors do more damage to performance by chasing winners and punishing losers because they lose the powerful benefits of “regression to the mean.” Ellis describes this tendency for behavior to move toward an average as “a persistently powerful phenomenon in physics and sociology – and in investing.” He goes on to add, good investors know “that the farther current events are away from the mean at the center of the bell curve, the stronger the forces of reversion, or regression, to the mean, are pulling the current data toward the center.”

The Power of Compounding

For a 75 year period (roughly 1925 – 2000) analyzed by Ellis, he determines $1 invested in stocks would have grown to $105.96, if dividends were not reinvested. If, however, dividends are reinvested, the power of compounding kicks in significantly. For the same 75 year period, the equivalent $1 would have grown to $2,591.79 – almost 25x’s more than the other method (see also Penny Saved is Billion Earned).

Ellis throws in another compounding example:

“Remember that if investments increase by 7 percent per annum after income tax, they will double every 10 years, so $1 million can become $1 billion in 100 years (before adjusting for inflation).”

 

The Lessons of History

As philosopher George Santayana stated – “Those who cannot remember the past are condemned to repeat it.” Details of every market are different, but as Ellis notes, “The major characteristics of markets are remarkably similar over time.”

Ellis appreciates the importance of history plays in analyzing the markets:

“The more you study market history, the better; the more you know about how securities markets have behaved in the past, the more you’ll understand their true nature and how they probably will behave in the future. Such an understanding enables us to live rationally with markets that would otherwise seem wholly irrational.”

 

Home Sweet International Home

Although Ellis’s recommendation to diversify internationally is not controversial, his allocation recommendation regarding “full diversification” is a bit more provocative:

“For Americans, this would mean about half our portfolios would be invested outside the United States.”

This seems high by traditional standards, but considering our country’s shrinking share of global GDP (Gross Domestic Product), along with our relatively small share of the globe’s population (about 5% of the world’s total), the 50% percentage doesn’t seem as high at first blush.

Beware the Broker

This is not new territory for me (see Financial Sharks, Fees/Exploitation, and Credential Shell Game), and Ellis warns investors on industry sales practices:

“Those oh so caring and helpful salespeople make their money by convincing you to change funds. Friendly as they may be, they may be no friend to your long-term investment success.”

Unlike a lot of other investing books, which cover a few aspects to investing, Winning the Loser’s Game covers a gamut of crucial investment lessons in a straightforward, understandable fashion. A lot of people play the investing game, but as Charles Ellis details, many more investors and speculators lose than win. For any investor, from amateur to professional, reading Ellis’s Winning the Loser’s Game and following his philosophy will not only help increase the odds of your portfolio winning, but will also limit your losses in sleep hours.

investment-questions-border

http://www.Sidoxia.com

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 16, 2016 at 3:15 am 1 comment

The 10 Investment Commandments

Moses ascended Mount Sinai to receive the powerful spiritual words of the Ten Commandments from God on two stone tablets and then went on to share the all-important, moral imperatives with his people. If Moses was alive today and was a professional investor, I’m sure he would have downloaded the “10 Investment Commandments” from Charles Ellis’s Winning the Loser’s Game on his e-reader, and then share the knowledge with all investors. I’m the furthest thing from Moses, but in his absence, I will be happy to share Ellis’s valuable and useful 10 Investment Commandments for individual investors:

1)      “Save. Invest your savings in your future happiness and security and education for your kids.”

2)      “Don’t speculate. If you must ‘play the market’ to satisfy an emotional itch, recognize that you are gambling on your ability to beat the pros so limit the amounts you play with to the same amounts you would gamble with the pros at Las Vegas.”

3)      “Don’t do anything in investing primarily for tax reasons.”

4)      “Don’t think of your home as an investment. Think of it as a place to live with your family-period.”

5)      “Never do commodities….Dealing in commodities is really only price speculation. It’s not investing because there’s no economic productivity or value added.”

6)      “Don’t be confused about stockbrokers and mutual fund salespeople. They are usually very nice people, but their job is not to make money for you. Their job is to make money from you.”

7)      “Don’t invest in new or ‘interesting’ investments. They are all too often designed to be sold to investors, not to be owned by investors.”

8)      “Don’t invest in bonds just because you’ve heard that bonds are conservative or for safety of either income or capital. Bond prices can fluctuate nearly as much as stock prices do, and bonds are a poor defense against the major risk of long-term investing – inflation.”

9)      “Write out your long-term goals, your long-term investing program, and your estate plan – and stay with them.”

10)   “Distrust your feelings. When you feel euphoric, you’re probably in for a bruising.”

We all commit sins, some more than others, and investors are no different. A simple periodic review of Charles Ellis’s “10 Investing Commandments” will spiritually align your portfolios and prevent the number of investment sins you make.

Read More about Charles Ellis (article #1 and article #2)

investment-questions-border

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

November 21, 2015 at 9:34 am 6 comments

Playing the Field with Your Investments

For some, casually dating can be fun and exciting. The same goes for trading and speculating – the freedom to make free- wheeling, non-committal purchases can be exhilarating. Unfortunately the costs (fiscally and emotionally) of short-term dating/investing often outweigh the benefits.

Fortunately, in the investment world, you can get to know an investment pretty well through fundamental research that is widely available (e.g., 10Ks, 10Qs, press releases, analyst days, quarterly conference calls, management interviews, trade rags, research reports). Unlike dating, researching stocks can be very cheap, and you do not need to worry about being rejected.

Dating is important early in adulthood because we make many mistakes choosing whom we date, but in the process we learn from our misjudgments and discover the important qualities we value in relationships. The same goes for stocks. Nothing beats experience, and in my long investment career, I can honestly say I’ve dated/traded a lot of pigs and gained valuable lessons that have improved my investing capabilities. Now, however, I don’t just casually date my investments – I factor in a rigorous, disciplined process that requires a serious commitment. I no longer enter positions lightly.

One of my investment heroes, Peter Lynch, appropriately stated, “In stocks as in romance, ease of divorce is not a sound basis for commitment. If you’ve chosen wisely to begin with, you won’t want a divorce.”

Charles Ellis shared these thoughts on relationships with mutual funds:

“If you invest in mutual funds and make mutual funds investment changes in less than 10 years…you’re really just ‘dating.’ Investing in mutual funds should be marital – for richer, for poorer, and so on; mutual fund decisions should be entered into soberly and advisedly and for the truly long term.”

No relationship comes without wild swings, and stocks are no different. If you want to survive the volatile ups and downs of a relationship (or stock ownership), you better do your homework before blindly jumping into bed. The consequences can be punishing.

Buy and Hold is Dead…Unless Stocks Go Up

If you are serious about your investments, I believe you must be mentally willing to commit to a relationship with your stock, not for a day, not for a week, or not for a month, but rather for years. Now, I know this is blasphemy in the age when “buy-and-hold” investing is considered dead, but I refute that basic premise whole-heartedly…with a few caveats.

Sure, buy-and-hold is a stupid strategy when stocks do nothing for a decade – like they have done in the 2000s, but buying and holding was an absolutely brilliant strategy in the 1980s and 1990s. Moreover, even in the miserable 2000s, there have been many buy-and-hold investments that have made owners a fortune (see Questioning Buy & Hold ). So, the moral of the story for me is “buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or down in price. Wow, how deeply profound!

To measure my personal commitment to an investment prospect, a bachelorette investment I am courting must pass another test…a test from another one of my investment idols, Phil Fisher, called the three-year rule. This is what the late Mr. Fisher had to say about this topic:

“While I realized thoroughly that if I were to make the kinds of profits that are made possible by [my] process … it was vital that I have some sort of quantitative check… With this in mind, I established what I called my three-year rule.” Fisher adds, “I have repeated again and again to my clients that when I purchase something for them, not to judge the results in a matter of a month or a year, but allow me a three year period.”

Certainly, there will be situations where an investment thesis is wrong, valuation explodes, or there are superior investment opportunities that will trigger a sale before the three-year minimum expires. Nonetheless, I follow Fisher’s rule in principle in hopes of setting the bar high enough to only let the best ideas into both my client and personal portfolios.

As I have written in the past, there are always reasons of why you should not invest for the long-term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) valuation; 6) change in industry regulation; 7) slowing economy; 8 ) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea.

Don Hays summed it up best: “Long term is not a popular time-horizon for today’s hedge fund short-term mentality. Every wiggle is interpreted as a new secular trend.”

Peter Lynch shares similar sympathies when it comes to noise in the marketplace:

“Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.”

Every once in a while there is validity to some of the concerns, but more often than not, the scare campaigns are merely Chicken Little calling for the world to come to an end.

Patience is a Virtue

In the instant gratification society we live in, patience is difficult to come by, and for many people ignoring the constant chatter of fear is challenging. Pundits spend every waking hour trying to explain each blip in the market, but in the short-run, prices often move up or down irrespective of the daily headlines. Explaining this randomness, Peter Lynch said the following:

“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”

Long-term investing, like long-term relationships, is not a new concept. Investment time horizons have been shortening for decades, so talking about the long-term is generally considered heresy. Rather than casually date a stock position, perhaps you should commit to a long-term relationship and divorce your field-playing habits. Now that sounds like a sweet kiss of success.

investment-questions-border

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 9, 2015 at 12:33 pm Leave a comment

Sidoxia’s Investor Hall of Fame

Investing Caffeine has profiled many great investors over the months and years, so I thought now would be a great time to compile a “Hall of Fame” summarizing some of the greatest of all-time. Nothing can replace experience, but learning from the greats can only improve your investing results – I’ve benefitted firsthand and so have Sidoxia’s clients. Here is a partial list from the Pantheon of investing greats along with links to the complete articles (special thanks to Kevin Weaver for helping compile):

Phillip Fisher –  Author of the must-read classic Common Stocks and Uncommon Profits, he enrolled in college at age 15 and started graduate school at Stanford a few years later, before he dropped out and started his own investment firm in 1931. “If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never.” Not every investment idea made the cut, however he is known to have bought Motorola (MOT) stock in 1955 and held it until his death in 2004 for a massive gain. (READ COMPLETE ARTICLE)

Peter Lynch – Lynch graduated from Boston College in 1965 and earned a Master of Business Administration from the Wharton School of the University of Pennsylvania in 1968.   Lynch’s Magellan fund averaged +29% per year from 1977 – 1990 (almost doubling the return of the S&P 500). In 1977, the obscure Magellan Fund started with about $20 million, and by his retirement the fund grew to approximately $14 billion (700x’s larger). Magellan  outperformed 99.5% of all other funds, according to Barron’s. (READ COMPLETE ARTICLE)

William O’Neil –  After graduating from Southern Methodist University, O’Neil started his career as a stock broker. Soon thereafter, at the ripe young age of 30, O’Neil purchased a seat on the New York Stock Exchange and started his own company, William O’Neil + Co. Incorporated. Following the creation of his firm, O’Neil went on to pioneer the field of computerized investment databases. He used his unique proprietary data as a foundation to unveil his next entrepreneurial baby, Investor’s Business Daily, in 1984. (READ COMPLETE ARTICLE)

Sir John Templeton – After Yale and Oxford, Templeton moved onto Wall Street, borrowed $10,000 to purchase more than 100 stocks trading at less than $1 per share (34 of the companies were in bankruptcy). Only four of the investments became worthless and Templeton made a boatload of money. Templeton bought an investment firm in 1940, leading to the Templeton Growth Fund in 1954. A $10,000 investment made at the fund’s 1954 inception would have compounded into $2 million in 1992 (translating into a +14.5% annual return). (READ COMPLETE ARTICLE)

Charles Ellis –  He has authored 12 books, founded institutional consulting firm Greenwich Associates, a degree from Yale, an MBA from Harvard, and a PhD from New York University. A director at the Vanguard Group and Investment Committee chair at Yale, Ellis details that many more investors and speculators lose than win. Following his philosophy will not only help increase the odds of your portfolio winning, but will also limit your losses in sleep hours. (READ COMPLETE ARTICLE)

Seth Klarman – President of The Baupost Group, which manages about $22 billion, he worked for famed value investors Max Heine and Michael Price of the Mutual Shares. Klarman published a classic book on investing, Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which is now out of print and has fetched upwards of $1,000-2,000 per copy in used markets. From it’s 1983 inception through 2008 his Limited partnership averaged 16.5% net annually, vs. 10.1% for the S&P 500. During the “lost decade” he crushed the S&P, returning 14.8% and 15.9% for the 5 and 10-year periods vs. -2.2% and -1.4%. (READ COMPLETE ARTICLE)

George Soros – Escaping Hungary in 1947, Soros immigrated to the U.S. in 1956 and held analyst and management positions for the next 20 years.  Known as the “The man who broke the Bank of England,” he risked $10 billion against the British pound in 1992 in a risky trade and won. Soros also gained notoriety for running the Quantum Fund, which generated an average annual return of more than 30%. (READ COMPLETE ARTICLE)

Bruce Berkowitz -Bruce Berkowitz has not exactly been a household name. With his boyish looks, nasally voice, and slicked-back hair, one might mistake him for a grad student. However, his results are more than academic, which explains why this invisible giant was recently named the equity fund manager of the decade by Morningstar. The Fairholme Fund (FAIRX) fund earned a 13% annualized return over the ten-year period ending in 2009, beating the S&P 500 by an impressive 14%. (READ COMPLETE ARTICLE)

Thomas Rowe Price, Jr. – Known as the “Father of Growth Investing,” in 1937 he founded T. Rowe Price Associates (TROW) and successfully ramped up the company before the launch of the T. Rowe Price Growth Stock Fund in 1950. Expansion ensued until he made a timely sale of his company in the late 1960s. His Buy and Hold strategy proved successful. For example, in the early 1970s, Price had accumulated gains of +6,184% in Xerox (XRX), which he held for 12 years, and gains of +23,666% in Merck (MRK), which he held for 31 years. (READ COMPLETE ARTICLE)

There you have it. Keep investing and continue reading about investing legends at Investing Caffeine, and who knows, maybe you too can join Sidoxia’s Hall of Fame?!

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and WMT, but at the time of publishing SCM had no direct position in MOT, TROW, XRX, MRK, FAIRX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 16, 2012 at 11:12 am 1 comment

Mr. Market Bullying Investors

Source: Photobucket

There’s been a bully pushing investor’s around and his name is “Mr. Market.” Volatility is Mr. Market’s partner in crime, and over the last 10 trading days Mr. M has used volatility to school equity investors to the tune of 1,600+ point swings, which has contributed to equity investors’ failing grade over the last few months. Who is Mr. Market? Charles Ellis, author of Winning the Loser’s Game (1998) described him best:

“Mr. Market is a mischievous but captivating fellow who persistently teases investors with gimmicks and tricks such as surprising earnings reports, startling dividend announcements, sudden surges of inflation, inspiring presidential announcements, grim reports of commodities prices, announcements of amazing new technologies, ugly bankruptcies, and even threats of war.”

 

How has Mr. Market been stealing investors’ lunch money? The process really hasn’t been that difficult for him, once you consider how many times investors have been heaved into the garbage can over the last decade, forced to deal with these messy events:

• 2001 technology bubble beating
• 2006 real estate collapse
• 2008 – 2009 financial crisis and recession
• 2010 “flash crash” and soft patch
• 2011 debt ceiling debate and credit rating downgrade

With this backdrop, investors are dropping like flies due to extreme bully fatigue. Over the last four months alone, approximately $75 billion in equities been liquidated, according to data from the Investment Company Institute – this is even more money withdrawn than the outflows occurring during the peak panic months after the Lehman Brothers collapse.

The Atomic Wedgie

Exhibit I (Source: Photobucket)

Mr. Market understands the severity of these prior economic scars, which have been even more painful than atomic wedgies (reference Exhibit I above), so he opportunistically is taking advantage of fragile nerves. Introducing the following scary scenarios makes collecting lunch money from panicked investors much easier for Mr. Market. What is he using to frighten investors?

  • A potential Greek sovereign debt default that will trigger a collapse of the Euro.
  • Slowing growth in China due to slowing developed market economic activity.
  • Possible double-dip recession in the U.S. coupled with an austerity driven downturn in Europe.
  • Lack of political policy response to short and long-term economic problems in Washington and abroad.
  • Impending deflation caused by decelerating global growth or likely inflation brought about by central banks’ easy monetary policies (i.e., printing money).
  • End of the world.

Bully Victim Protection

Of course, not all of these events are likely to occur. As a matter of fact, there are some positive forming trends, besides just improving valuations, that provide protection to bully victims:

  • Not only is the earnings yield (E/P – 12-month trailing EPS/share price) trouncing the yield on the 10-year Treasury note (~8% vs. ~2%, respectively), but the dividend yield on the S&P 500 index is also higher than the 10-year Treasury note yield (source: MarketWatch). Historically, this has been an excellent time to invest in equities with the S&P 500 index up an average of 20% in the ensuing 12 months.
  • Jobs data may be poor, but it is improving relative to a few years ago as depicted here:

    Source: Calafia Beach Pundit

Source: Calafia Beach Pundit

  • Record low interest rates and mortgage rates provide a stimulative backdrop for businesses and consumers. Appetite for risk taking remains low, but as history teaches us, the pendulum of fear will eventually swing back towards greed.

Source: Calafia Beach Pundit

As I say in my James Carville peace from earlier this year, It’s the Earnings Stupid, long term prices of stocks follow the path of earnings. Recent equity price market declines have factored in slowing in corporate profits. How severely the European debt crisis, and austerity have (and will) spread to the U.S. and emerging markets will become apparent in the coming weeks as companies give us a fresh look at the profit outlook. So far, we have gotten a mixed bag of data. Alpha Natural Resources (ANR) acknowledged slowing coal demand in Asia and FedEx Corp. (FDX) shave its fiscal year outlook by less than 2% due to international deceleration. Other bellwethers like Oracle Corp. (ORCL) and Nike Inc. (NKE) reported strong growth and outlooks. In the short-run Mr. Market is doing everything in his power to bully investors from their money, and lack of international policy response to mitigate the European financial crisis and contagion will only sap confidence and drag 2011-2012 earnings lower.

Punching Mr. Market

The warmth of negative real returns in cash, bonds, and CDs may feel pleasant and prudent, but for many investors the lasting effects of inflation erosion will inflict more pain than the alternatives. For retirees with adequate savings, these issues are less important and focus on equities should be deemphasized. For the majority of others, long-term investors need to reject the overwhelming sense of fear.

As I frequently remind others, I have no clue about the short-term direction of the market, and Greece could be the domino that causes the end of the world. But what I do know is that history teaches us the probabilities of higher long-term equity returns are only improving. Mr. Market is currently using some pretty effective scare tactics to bully investors. For those investors with a multi-year time horizon, who are willing to punch Mr. Market in the nose, the benefits are significant. The reward of better long-term returns is preferable to an atomic wedgie or a head-flush in the toilet received from Mr. Market.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, and FDX, but at the time of publishing SCM had no direct position in ANR, ORCL, NKE, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

September 24, 2011 at 2:18 pm 1 comment

Performance Beauty in Eye of Beholder

The average person may be a good judge in picking the winner of a beauty contest, but unfortunately your average investor is ill-equipped to sift through the thousands of mutual funds and hedge funds and thoughtfully discern the relevant performance metrics for investment purposes.

Investment firms however, are well-equipped with smoke, mirrors, and a tool-chest filled with numerous tricks. Here are a few of the investment firms’ gimmicks:

  • Cherry Picking: Fund firms are notorious with cutting out the bad performance numbers and cherry picking the good periods. As investment guru Charles Ellis reminds us, the wow factor results of “investment performance become quite ordinary by simply adding or subtracting one or two years at the start or the end of the period shown. Investors should always get the whole record – not just selected excerpts.”
  • Limited Time Period: Often the period highlighted by investment firms is insufficient to make a proper conclusion regarding a manager’s outperformance capabilities. Ellis acknowledges that  gathering enough yearly performance information can be practically challenging:
“By the time you had gathered enough data to determine whether your fund manager really was skillful or just lucky, at least one of you would probably have died of old age.”
  • Fee Disclosure: Some managers’ performance figures look stupendous until one realizes once hefty fees are subtracted from the reported figures, what previously looked top-notch is now average or below-average. It is important to read the small print or ask tough questions of the broker peddling a fund.
  • Audited Figures: Legitimacy of performance is key, and there are different levels of audited figures. Global Investment Performance Standards (GIPS) compliance is an industry accepted standard. For pooled investment vehicles, audited results from regional or national accounting firms can be important too. 
  • Misused Rating Systems: Morningstar is the 800 pound gorilla in the mutual fund world and provides some useful data. Unfortunately, most Morningstar investors use the data incorrectly. A 2000 study by the Journal of Financial and Quantitative Analysis discovered, “There is little statistical evidence that Morningstar’s highest-rated funds outperform the medium-rated funds.” On this subject, Charles Ellis points out the following:
“While Morningstar candidly admits that its star ratings have little or no predictive power, 100 percent of net new investment money going into mutual funds goes to funds that were recently awarded five stars and four stars…Indeed, in the months after the ratings are handed out each year, the five-star funds generally earn less than half as much as the broad market index!…Morningstar ratings are misleading investors into buying high and selling low.”

 

Investors need to be careful in how they use the ratings – simply buying 4-5 star funds and selling star-losing funds can be a heartburning recipe for bad results. Buying high and selling low usually doesn’t turn out very well.

Find Winners…Then What?

Even if you are successful in identifying the winning funds, those same funds tend to underperform in subsequent periods. Ellis, a believer in passive index investing, noticed only 10% of active managers outperformed over 25 years, and the odds of sustaining outperformance in subsequent periods diminished even further.

Charles Ellis also noticed a fat-tail syndrome of losers versus winners. For example, Ellis found 2% of active managers outperformed over a set time period, but a whopping 16% underperformed the market over a similar timeframe. Consistent with these findings, Ellis stresses that past performance does not predict future results, with one exception: “The worst losers do tend to keep losing. If you do decide to select active investment managers, promise yourself you will stay with your chosen manager for many years…changing managers is not only expensive, but it usually doesn’t work.”

Professionals to the Rescue

Well, if individuals are not in a position to pick future winning fund managers, then thank heavens the professional consultants can help out…not exactly. Ellis was blunt about the capabilities of those professionals selecting active investment managers:

“Pension executives and investment consultants who specialize in selecting the best managers have, as a group, been unsuccessful at selecting managers who can beat the market.”

 

Ellis uses a respected firm as an example to prove his point:

“Cambridge Associates reports candidly, ‘There is no sound basis for hiring or firing managers solely on the basis of recent performance.’”

 

At the end of the day, finding current winners is not a problem, but sifting through the massive quantity of funds and selecting future winners is very challenging for individuals and professionals alike. The financial industry would like you to believe picking the future performance beauty winner is a simple task – the data seems to indicate otherwise. Rather than wasting your money attempting to pick the beauty winner, perhaps your money would be better spent on purchasing a tiara for yourself.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MORN, Cambridge Associates, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 30, 2011 at 11:31 pm 4 comments

Playing the Field with Your Investments

For some, casually dating can be fun and exciting. The same goes for trading and speculating – the freedom to make free- wheeling, non-committal purchases can be exhilarating. Unfortunately the costs (fiscally and emotionally) of short-term dating/investing often outweigh the benefits.

Fortunately, in the investment world, you can get to know an investment pretty well through fundamental research that is widely available (e.g., 10Ks, 10Qs, press releases, analyst days, quarterly conference calls, management interviews, trade rags, research reports). Unlike dating, researching stocks can be very cheap, and you do not need to worry about being rejected.

Dating is important early in adulthood because we make many mistakes choosing whom we date, but in the process we learn from our misjudgments and discover the important qualities we value in relationships. The same goes for stocks. Nothing beats experience, and in my long investment career, I can honestly say I’ve dated/traded a lot of pigs and gained valuable lessons that have improved my investing capabilities. Now, however, I don’t just casually date my investments – I factor in a rigorous, disciplined process that requires a serious commitment. I no longer enter positions lightly.

One of my investment heroes, Peter Lynch, appropriately stated, “In stocks as in romance, ease of divorce is not a sound basis for commitment. If you’ve chosen wisely to begin with, you won’t want a divorce.”

Charles Ellis shared these thoughts on relationships with mutual funds:

“If you invest in mutual funds and make mutual funds investment changes in less than 10 years…you’re really just ‘dating.’ Investing in mutual funds should be marital – for richer, for poorer, and so on; mutual fund decisions should be entered into soberly and advisedly and for the truly long term.”

 

No relationship comes without wild swings, and stocks are no different. If you want to survive the volatile ups and downs of a relationship (or stock ownership), you better do your homework before blindly jumping into bed. The consequences can be punishing.

Buy and Hold is Dead…Unless Stocks Go Up

If you are serious about your investments, I believe you must be mentally willing to commit to a relationship with your stock, not for a day, not for a week, or not for a month, but rather for years. Now, I know this is blasphemy in the age when “buy-and-hold” investing is considered dead, but I refute that basic premise whole-heartedly…with a few caveats.

Sure, buy-and-hold is a stupid strategy when stocks do nothing for a decade – like they have done in the 2000s, but buying and holding was an absolutely brilliant strategy in the 1980s and 1990s. Moreover, even in the miserable 2000s, there have been many buy-and-hold investments that have made owners a fortune (see Questioning Buy & Hold ). So, the moral of the story for me is “buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or down in price. Wow, how deeply profound!

To measure my personal commitment to an investment prospect, a bachelorette investment I am courting must pass another test…a test from another one of my investment idols, Phil Fisher, called the three-year rule. This is what the late Mr. Fisher had to say about this topic:

“While I realized thoroughly that if I were to make the kinds of profits that are made possible by [my] process … it was vital that I have some sort of quantitative check… With this in mind, I established what I called my three-year rule.” Fisher adds, “I have repeated again and again to my clients that when I purchase something for them, not to judge the results in a matter of a month or a year, but allow me a three year period.”

 

Certainly, there will be situations where an investment thesis is wrong, valuation explodes, or there are superior investment opportunities that will trigger a sale before the three-year minimum expires. Nonetheless, I follow Fisher’s rule in principle in hopes of setting the bar high enough to only let the best ideas into both my client and personal portfolios.

As I have written in the past, there are always reasons of why you should not invest for the long-term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) valuation; 6) change in industry regulation; 7) slowing economy; 8 ) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea.

Don Hays summed it up best: “Long term is not a popular time-horizon for today’s hedge fund short-term mentality. Every wiggle is interpreted as a new secular trend.”

Peter Lynch shares similar sympathies when it comes to noise in the marketplace:

“Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.”

 

Every once in a while there is validity to some of the concerns, but more often than not, the scare campaigns are merely Chicken Little calling for the world to come to an end.

Patience is a Virtue

In the instant gratification society we live in, patience is difficult to come by, and for many people ignoring the constant chatter of fear is challenging. Pundits spend every waking hour trying to explain each blip in the market, but in the short-run, prices often move up or down irrespective of the daily headlines. Explaining this randomness, Peter Lynch said the following:

“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”

 

Long-term investing, like long-term relationships, is not a new concept. Investment time horizons have been shortening for decades, so talking about the long-term is generally considered heresy. Rather than casually date a stock position, perhaps you should commit to a long-term relationship and divorce your field-playing habits. Now that sounds like a sweet kiss of success.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 28, 2011 at 1:03 am 1 comment

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