I consider myself a lesser light compared to many following Warren Buffett.  Yes, I am a value investor and an actuary, so I guess I have some punch in attempting to analyze the actions of one far greater than me.

The book is organized around two main trips that the author made to the Annual Meeting of Berkshire Hathaway, with some notes from the the 2011 tacked on.

This book tries to distill the ideas of Buffett into simple concepts, and largely succeeds.  It also alleges weaknesses  in Buffett’s reasoning.  Why not consolidate similar, less profitable businesses?  Why not invest a little more in existing businesses? I partially agree: I used to call Berkshire Hathaway “a grab bag of undermanaged businesses.”  But I’ve changed my mind, mostly.

The cost of doing the first of those could be considerable.  Buffett gets certain deals because the seller knows that he will leave the business alone.  The unique culture, friendships, family relationships will be maintained.  The seller doesn’t get top dollar, but he gets the satisfaction that he was true to those he worked with and served him.  Getting these businesses cheaply is a competitive advantage for Berkshire Hathaway, even if it means a certain amount of inefficiency.  Personally, I expect the next CEO or two will centralize the company, and turn it into a normal company.

As for investing more in existing businesses, all the manager has to do is put forth the case to his boss, Buffett.  Buffett will give him a quick decision.

But the author is right, in general, Buffett has not focused on organic growth.  He has acquired all of the businesses that the owns, aside from the reinsurance business.

This book has many strengths:

  • It recognizes that there is a cult following around Buffett.  He’s a bright guy, no doubt, but few questions get asked him by shareholders about his main duty, that of being CEO of Berkshire Hathaway.
  • It points out the significance of Charlie Munger, who got Buffett to think more broadly about value, served as a “Dr. No” to Buffett’s more optimistic demeanor.
  • It doesn’t spend a lot of time on Buffett as an investor in public equities, which has contributed much less to the growth of Berkshire than the acquisition of whole companies.
  • The demographics of Berkshire’s Annual Meeting are older and white, and in general, are the patient shareholders that Buffett likes.
  • Omaha is an unusual place for such a large company, but the isolation is a plus if you are trying to do something different.
  • Understands the basic safety rules of Buffett’s investing: margin of safety, patience, think like a businessman, simplicity, read a lot, be a good judge of character, think independently, get the big ideas right, the value of cash, don’t risk the firm, etc.
  • Notes the value of ethics at Berkshire, even when significant mistakes are made, like the handling of the David Sokol incident.  Reputation matters; you only get one reputation, and it affects all aspects of your business.


  • Berkshire is primarily an insurance company.  I would have spent more time on that.
  • I would have spent less time on non-business ethical issues, like abortion, religion, etc.  Buffett is no good guide there; he is merely justifying his past actions.
  • The bit about the Hoopa Indians was interesting, but when Buffett said, “I agree that we will not exercise decisions except those ministerial in nature,” he was being very clear and simple.  Buffett is not a Christian, but he was raised in a Presbyterian household.  A minister is one who does things on behalf of another.  The issue is that there are 4 California hydroelectric plants that are old.  If the Federal government destroys them, it may help in salmon production, or farmers might like the extra water for their own use.  Buffett will simply do what the authorities want done if they are willing to pay to do it.  It is not his call in a regulated industry.
  • Buffett’s hypocrisy on taxation is not addressed.  He backs high estate taxes and high personal income taxes, but he doesn’t pay those.  The increase in his wealth though Berkshire, which does not pay a dividend is sheltered from tax, because he never sells a share.

Who would benefit from this book: Anyone who wants to invest better could benefit from it. At five bucks, it’s cheap. A Kindle application for my laptop was free with the purchase.  If you want to, you can buy it here: Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett, 2011 Edition (eBooks on Investing Series).

Full disclosure: I bought the e-book with my own money.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Our problems today stem from too much debt, both personal and governmental.  When enough of the populace is overindebted, they become conservative in spending.  When corporations see that, they become conservative as well, and cut back on production.  The same is true with governments.  As governments get more indebted, people begin to think they won’t spend as much in the future, which is a reasonable assumption.

But what do the pundits suggest?  Borrow more.  If you only would borrow more, and allocate the money to our favored projects, things would improve.  But that is more of the “hair of the dog that bit you” reasoning.  More debt does not solve the problem of too much debt.

In general, the more of the economy that we hand off to the government, economic growth will be less.  The government rarely grows anything, except itself.

I realize in the short-run that reductions in the growth of debt, much less reductions in debt will be viewed negatively by many.  The question becomes whether you want a solution, or you want to continue the disease, and hope for a miracle.

This problem is not limited to the US.  It extends to the Eurozone and China, and indirectly to the rest of the developed and semi-developed world.  In the Eurozone, the ECB and EFSF buy the debts of the weakest nations in order to back the Euro.  Imagine the Fed buying Puerto Rican and Californian bonds.  Ugly, and I hope the Fed does not become more imaginative.  It is too speculative already.

The Eurozone is transforming what was a fringe problem into a core problem and CDS spreads of Germany and France are greater than those of the UK, which has its own currency.  If the Eurozone were a nation, it would be in roughly the same shape as the US, which means not good.

As for China, the government forces loans that are not economic on the banks.  There are many projects that seem to have no economic purpose, but might have political purpose.  Why build ghost cities?  Why build a highway to Xingjang, and plan a model city there?  For the latter it is to control the Uighurs; for the former, I am not sure, aside from distorting GDP statistics.

China also has its issues with owning US debt.  They have to own US debt to keep their currency cheap for exporting.  This is just another way that China discriminates against their consumers in favor of exporters who are political cronies.

Coming back to the US, the Fed encouraged more debt todayby saying that financing rates would remain low for two years.  That may push up asset prices, and allow the highest quality borrowers to borrow more, but is useless in stimulating the economy, because credit spreads do not respond to the Fed when the economy as a whole is overlevered.

The world is led by debt junkies who think that debt doesn’t matter.  They are leading us to a greater crisis where the only thing that does matter is debt, and for political reasons, some governments will not be willing to pay in full.

June 2011August 2011Comments
Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected.Shades down their view of GDP again.  I think they need to hire better modelers.
Also, recent labor market indicators have been weaker than anticipated.  The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan.Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up.Shades down their view of employment further.  Wishful thinking regarding transitory factors disappears… Japan does not have that big of an impact on US employment, nor do food and energy prices, which have been going up for some time.

(See 2 boxes below.)

Household spending and business investment in equipment and software continue to expand.  However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed.  However, business investment in equipment and software continues to expand.Shades down their view of household spending, otherwise similar.
 Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity.New sentence that takes back part of their wishful argument from last month.  They were grasping at straws.
Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions.Inflation picked up earlier in the year, mainly reflecting higher prices for some commodities and imported goods, as well as the supply chain disruptions.Basically the same.
 More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks.What evidence do they have that overall inflation is declining?  I don’t see it; this is more grasping at straws.
However, longer-term inflation expectations have remained stable.Longer-term inflation expectations have remained stable.Basically the same.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.  The unemployment rate remains elevated; however, the Committee expects the pace of recovery to pick up over coming quarters and the unemployment rate to resume its gradual decline toward levels that the Committee judges to be consistent with its dual mandate.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.  The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.Shades down their view of the recovery overall.  The misplaced optimism is declining.
Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate.  However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.


Moreover, downside risks to the economic outlook have increased. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further.  However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.Shades down their views on inflation, but for little good reason.
To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.No change.
The Committee continues to anticipate that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate for an extended period.The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.Defines the “extended period to be 2 years.
The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month and will maintain its existing policy of reinvesting principal payments from its securities holdings.The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.No real change.
The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.No change
The Committee will monitor the economic outlook and financial developments and will act as needed to best foster maximum employment and price stability.The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.The Fed doesn’t have any good tools left.  All they can work with are the bad tools, and work they will.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.Note dissenters below.
 Voting against the action were: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.They would have preferred the old language not specifying how long the extended period would be at minimum.  This is a pretty weak dissent; there is a lot more to be objected to in our monetary policy.


  • The FOMC defines the “extended period to be 2 years.  Short-intermediate part of the Treasury curve flattens.  Long end goes on a speculative tear.  Hope the FOMC likes that, but it will only allow high quality borrowers to borrow more cheaply, not average people and small businesses. The Fed’s policy can’t bring down credit spreads, not that it should.
  • Still engages in wishful thinking regarding inflation, thinking that it is declining.  Points at energy and commodities, but that’s not the largest part of what drives inflation.
  • Finally shades down its views on GDP and employment growth.
  • The Fed ends much of its wishful thinking regarding transitory employment factors… Japan does not have that big of an impact on US employment, nor do food and energy prices, which have been going up for some time.
  • The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.  As a result, the FOMC ain’t moving rates up, absent increases in employment, or a US Dollar crisis.  Labor employment is the key metric.
  • The hawks finally flew with a weak dissent, objecting to specifying how long the extended period would be at minimum.
  • The Fed is not shrinking its balance sheet anytime soon.
  • The Fed is out of good policy tools, so it will use bad policy tools instead.

Questions for Dr. Bernanke:

  • How big is the effect on employment from higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan?
  • Couldn’t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
  • Isn’t stagflation a possibility here?  I mean, no one expected it in the ‘70s either.
  • Could we end up with another debt bubble from keeping short rates so low?
  • If the Fed ever does shrink its balance sheet, what effect will it have on the banks?
  • Is it possible that you don’t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?

Rating agencies grew up rating corporate credit risk.  The nice thing about corporate credit risk is the failures happen at least every seven years.  There was a sideline on municipal credit risk, but since munis rarely defaulted, it was not very relevant.

Guess what?  Moody’s, S&P, and Fitch are very good at predicting corporate default.  Some new players are better still, but their ratings change more rapidly, which has pluses and minuses.  They are faster to identify failing entities, but they also have more “false positives” where they signal failure, and it does not happen.


Go back to the late ’80s.  The rating agencies were trying to evaluate the newly popular 401(k) investment Guaranteed Investment Contracts [GICs].  Guess what?  No GICs had ever failed.  What’s the right rating for all the companies offering them?  If the history is so positive shouldn’t everyone be AAA?

Though some of the larger companies had corporate debt that traded, GICs were not obligations of the holding company, but of the insurance subsidiary.  Not only that, unlike bonds, GICs (in most states) were policyholder obligations, not debt per se.  GICs were often super-senior obligations of subsidiaries of the company.

So, how to rate them?  Since there were few historical losses, and the rating agencies lacked a forward-looking view of what might happen, they rated most GICs AAA or AA.

After a few GIC-issuing companies went into insolvency, those ratings changed rapidly over the next seven years, leading to many exits by marginal players who did not default, a few defaults (with almost no losses), and a much smaller GIC industry dominated by synthetic GICs that relied upon insurance company derivatives.


Because the regulators required ratings, the rating agencies were willingly drawn in to rating structured products.  With the GSEs it was easy — there is no credit risk, so they are AAA.  With the non-guaranteed whole loans, it was tougher — no GSE guarantee.  How to rate?  This was a new product, a new risk, and so the rating agencies looked at resident mortgage default rates in the past.

Very much like the error of health insurers in the ’60s, where they tried to calculate utilization of healthcare services from the non-insured and apply that to the insured, mortgages retained by originators defaulted less frequently than those that were sold to third parties.

The rating agencies could get the math right on securitization, but could not get the parameters right.  All of their loss data came from an era where lenders held onto their loans.  Selling loans, and having servicing as a separable function was totally unknown to the past.

Much as those who implemented securitization were relatively farsighted, they did not take into account the agency problems involved in “selling to securitize.”

The rating agencies did the best that they could in a competitive environment, with little relevant loss data to guide them.

I suspect that they will do better before the next cycle of failures transpires.


In short, my point is this: the rating agencies, blundered with ratings on securitization.  They will be better in the future, because they finally have real data to work with.  They are trying to be more forward looking on sovereign issuers, with some degree of pushback.  My view is that those that object more should be downgraded further, within reason.  I differ from the rating agencies, because I am more skeptical, and imaginative.

“Figures don’t lie, but liars will figure.” Issuers are not objective with respect to their own debts.  Rating agencies should ignore the issuers, and work off  of publicly available data, lest they be subverted by the issuers, as has happened.


I don’t fault the rating agencies much with respect to sovereign ratings.  They seem mostly rational to me, though  there is little real default data to guide them.

That’s the crux of the issue here — they don’t have many sovereign fiat currency defaults to guide them.  Does that mean the odds are low?  By no means.  A larger model, including political motivations, and using game theory would indicate that there are possibilities where no coalition governs that debts will be paid.

I hate the simplistic models of the Keynesians and their bastard progeny.  One has to think more broadly, and consider the wide range of what might happen, because (surprise!) people/institutions aren’t always rational as economists view them.


I leave you with this: imagine that you run a rating agency, and your clients ask you to rate debts that you don’t have a good model to use.  You have competitors, and they are seeking advantage as well.  Add into the mix that the issuers can choose who they want.  How do you react to a new class of credit?  The question is a hard one.


And thus, to those who trash the rating agencies because of bad past decisions, I say, “Could you have done better, you have the benefit of hindsight?”

The rating agencies are flawed but are mostly honest dealers who used bad models on structured credit, because no one knew better.  They took the risk and put forth some bad ratings.

For this reason I say to the fools who argue against the S&P downgrade of the US, “How do you know?”  For once a rating agency is trying to be proactive, and they get a lot of abuse.  Watch the trading in the market, it will tell you a lot more than the downgrade.

So S&P downgraded the US.  Big deal.  It should have happened long ago, and many other sovereigns deserve to be downgraded as well.  Now if you want my summary views, positive and negative one the rating agencies, they can be found here:

I have another set of writings as the financial guarantors were downgraded.  I was one of the early callers that the guarantors were nor AAA.  I made the same call on the GSEs.

My point is that the initial downgrades of a AAA entity come hard, but once they come, they come with vigor and speed.  S&P has cleared the way for Moody’s and Fitch to downgrade as well.  The cost for them to downgrade is a lot lower now, and they can go lower than Aa1/AA+ if they choose.  Without significant change, the ratings of the US go lower from here.

Now, some will say that there are no limits to what amount of debt a nation that controls its own currency could issue.  Typically, these are radical Keynesian economists, that like Keynes, have a simplistic model, but no sense of human nature or politics.  What could happen:

  • A blocking coalition against inflation elects a congress against additional borrowing, forcing a crisis versus demanded spending.
  • A constitutional convention removes the Fed, and/or repudiates external debts.
  • We could have another situation like the last one, and this time it doesn’t resolve, and we have a technical default.

The thing is, politics matters.  If we have a fiat currency, then it is politically driven.  If our politics with respect to debt repayment are unstable, then we don’t deserve a AAA.

But much as I don’t like the t-party, I do not blame them for this outcome.  I blame Obama, Bush, Clinton, Bush, Reagan, Carter, Nixon, Johnson, Kennedy, Eisenhower and CONGRESS.  They have overspent. They have created many useless programs.  They have created burdensome programs, they have turned medical care into a zoo of red tape. THEY HAVE NOT CARED FOR THE FUTURE OF THE NATION, BUT ONLY THE PRESENT!!

They have engaged us in wars that we have no business fighting.  I have not been in favor of any war we have fought since my birth in 1960.  Shrink the Defense department, please, and all the contractors that parasitically suck on it.  Shrink entitlements as well, we will not be able to afford Medicare.

It is amusing to see certain “wonks” who are not, trumpet Obama plundering Medicare to claim that he eliminated expenses there.  Do the liberals care that he is eliminating care to the elderly, because fewer doctors, and no quality doctors will serve them?

Most of the changes made in the recent agreement were an illusion. Few specific cuts were made, and a deficit commission would find changes, or else across-the-board cuts would happen.   But given the polarization in politics, who thinks that there will be easy compromise in the future?  I don’t.


Now as a bond manager, I tell you there should be little change from the change in ratings. Why?

  • The rating of the US is still AAA, which is the average of Aaa/AA+/AAA
  • Downgrades of bonds rarely result in price changes on average.
  • Whenever major sovereign downgrades occur, covenants, collateral haircuts, investment guidelines, risk-based capital charges, etc. all get changed to make sure that nothing happens as a result.  Why? Ratings are an opinion, nothing more.  No one wants actions to occur on a sovereign because of a downgrade.

There are a lot of naive people speaking and writing about the downgrade as if it means something big, and they have never managed bonds in their lives.  I am not the be-all or end-all on this topic, but I would encourage people to read the opinions of those active in the bond markets before making definitive statements that have no reality behind them.

Events like this have happened before, and the US is still AAA for now. Prudent fiduciaries will make adjustments to reflect that AAA is not the standard for making investments, capital charges, etc.  There is no crisis here.  Don’t act like there is one, because there is none.


US vs Moody’s, S&P and Fitch

I repost this to indicate that Maryland is a de minimus state.  Thank you, State of Maryland, for your prompt response, unlike Louisiana.

I find it interesting that only two states, Texas and Arkansas, are file on the first client states, for out-of-state advisers.  Perhaps one day, state regulation will be uniform in the US regarding investment advisers.


This post is different, therefore it has to start with a disclaimer.

I am not a lawyer. Yes, I am good at reading legal documents, such as securitization agreements, structured securities, insurance contracts, insurance laws and regulations, etc., but that is not the same as having legal training.  I make mistakes, and how much more so when I am operating near the edge of my field of competence?

So don’t rely on this.  This is not legal advice. This is just my faltering attempt to figure out a legal question that faces my business.  For all the small investment advisers out there who face similar problems, use this as a springboard in your discussions with your lawyers, or for your own research if you don’t employ a lawyer.  I am providing links to laws that I think, but don’t know, are current as of today.  Use them at your own risk.

I make no representation or warranty that this is accurate. I did my best.  Since my website is free, please realize that you get what you pay for.  You’re paying nothing, so don’t expect miracles, and don’t sue me, please?

There. I feel better now.  Here’s the question: if you are a State-registered investment adviser, how many clients can you have in a state where you have no physical presence before you have to register with the state?

This is an important question for me, because I am best known for what I have written at Aleph Blog and RealMoney.com.  I get most of my clients “out of the blue,” e-mailing me and asking what I am doing.

When I was at a meeting with the head of the Maryland Division of Securities last February, she asked if any of us were “internet only” advisors.  I was the only one that raised my hand.  I have far more clients outside of Maryland than inside Maryland.

That ‘s the reverse of most small RIAs that I interact with in Maryland.  They tend to be Maryland-centric.  Good for them.

Back to the question: if you are a State-registered investment adviser, how many clients can you have in a state where you have no physical presence before you have to register with the state?

For most states, the answer is you can have five clients.  Before you take on client number six, on a one year rolling threshold, you must register, which means a lot of paperwork and the payment of fees on an annual basis thereafter.

Note: when you register in 15 states, you have the option of moving to Federal regulation, even if you are still below the $100 million Asset Under Management limit.

Now, unlike other sites that have tried to answer this question, I am giving you links to the state laws that answer this question.  But state laws change.  Links get broken.  Sometimes links don’t get broken, and you get an old version of the law.  Use this as a springboard for your own research, not as a substitute for it.

Here are the states that have the five client “de minimus” limit:

Wyoming does not have registration of investment advisers, as far as I can tell.

Here are the states that require registration on the first client:

One more note: occasionally states cite section 222 from the Investment Advisers Act of 1940, which gives a national “de minimis” standard.  But that’s not a national standard, and thus Louisiana, Maryland and Texas require filing on the first client, and in Wyoming, you never file.

On the journey to gather this data, I found that some states have very good websites and some are quite poor.  Some go out of their way to help investment advisers, and some seem to have little interest in that.  Some follow the model law in one of its historical variations, and some are eclectic, or even weird.  Still, there seems to be more standardization in securities law for investment advisers than for life insurers.  That’s not saying much.

For those reading this, let me know about errors, broken links, law changes, etc.  I might repost this again someday.

And remember, this could all be wrong, outdated, etc., so do your own due diligence or hire a lawyer.

This post is for average 401(k) investors.  I’m going to let you in on a secret that is not so secret, but does not get talked about much.  It’s a simple idea as well, and would be common sense, if sense were common.

401(k) investors tend not to change their allocations often, except to panic when things are going bad, or arrive late in bull market, and buy near the top.  In general, if you don’t have a lot of investment knowledge, it is good to come to a place where you “set it, and forget it.”  Remember, those with no experience are far more prone to the errors of fear and greed than most experts are.  Those arrive late to a rise or a fall in the market, and say, “Look what I have missed out on,” or ‘Look at how much I have lost,” are going to make the wrong move again and again.

There are temptations as an investor to not diversify.

  • “I’ll just hold all my assets in a money market fund.  I don’t want to lose anything.”  Money market funds preserve value at best.  They won’t help you build value.
  • “I’ll just hold all my assets in gold.  I don’t want to lose anything.”  Gold preserves value at best.  It won’t help you build value.
  • “This manager is the greatest.  I’m putting it all on him.”   Sadly, managers have hot and cold streaks.  Many people join in near the end of hot streaks.  The quote I heard this from was a professional in 1999, deciding to invest all his money with Bill Miller.  Bad timing.
  • “Stocks win in the long run.  I am investing only in stocks.”  If you have a really long time horizon, and you are certain that your nation will not go through a revolution, or something close to it, that will work.  Otherwise, you are taking a risk.

There are more, but I think you get the point.  In most of life, those who do the best are the ones that take prudent risks.  Prudent risks are where the likely rewards outweighs the likely risks.

Think of it: in business, the guy who never takes risk does not do well.  The guy who takes huge risks blows up frequently, and does not do well on average.  The guy who takes moderate, prudent risks tends to do well.

The same is true of bond investing.  Those who invest in bonds of medium risk (BBB/Baa) tend to do best, those that play it safe or risk it all do less well.

The same is true of stock investing.  Stock investing is risky by nature, and in general, those who take less risk tend to earn better returns over time.  Ignore the canard: more risk, more return.  It ain’t so.

So what would I do if I were a 401(k) investor facing a limited menu of choices?

  • Put 60-70% in conservative, value-oriented stock funds. (US and Foreign)
  • And 25-35% in moderately risky bond funds. (US and Foreign)
  • And 5% in cash.
  • And rebalance yearly.  Do it after you complete your taxes, or something like that.

Avoid complexity.  Even if the plan offers a wide number of choices, winnow it down to a few funds, say five at most.  Over the long run, your investments should prosper, because you are doing things that few investors will do, and enjoy  returns from bearing risk successfully.

After the recent piece Waters Uncharted, I received this comment:

Why do you have a large portion of your fixed income portfolio allocated to foreign bonds?

Are you afraid of a large devaluation in the U.S. dollar?

It seems like American corporate balance sheets are very healthy (especially relative to sovereigns and personal balance sheets).

I have a rule.  I look at the spreads offered for various classes of domestic bond risk.  I buy bonds in the areas where I believe the incremental risks are more than adequately rewarded in the spreads.  If few or no areas offer adequate compensation for risk, I invest in foreign debts, because it is a statement that the US Dollar itself is overvalued.

Think of it this way: if I were a Swiss investor looking in at the US, and concluded that the opportunities weren’t great, would I buy anyway?  No, I would look elsewhere in the world for opportunities.

At present, my bond portfolios are invested:

  • 40% in Foreign Bonds
  • 30% in long US Treasuries
  • 20% in preferred stocks, and
  • 10% in US Dollar-denominated emerging markets bonds

There are several forces at play here.  The actions of the US Government and the Fed tend to weaken the US Dollar — it’s the additional debt, and low fed funds rates, as well as the residual effects of QE.  So I invest in foreign bonds; it’s not ideal, but it is the best of a bunch of opportunities.

The US is still a safe haven currency.  With the difficulties in the Eurozone, some are giving up yield to gain safety, or at least predictability for now. That’s why the position in Long  Treasuries, and my, hasn’t it run of late.

The preferred stocks reflect a part of the credit market that hasn’t gotten whacked too bad, offering a decent yield for the junior debt on healthy companies risk.

I used to hold more emerging markets debt, but I have been trading out of it as the momentum has been weakening.  Economic troubles are rising in the emerging markets, and the eventual result might be ugly.

Back to the original question, yes, corporate balance sheets are in good shape, aside from the banks. But spreads reflect that or better, and so I don’t want to play there now.

Will any decrease in the valuation of the dollar be large? No, I expect it to be moderate, but yes, a decline.


I have a saying, “Fast moves mean-revert, slow moves persist.”  It makes me a little edgy with the long Treasuries, because the move has been so fast.  I may sell some in the near term if prices rocket higher.  If they edge higher, I might not sell.  Flat or slight selloff, do nothing.  Big selloff, sell into it.

Bonds are a funny mix of momentum and mean reversion.  Good bond managers get a sense of when momentum is overdone, and act against it, but follow when the momentum is gentle.

It’s difficult balance.  I remember buying long Treasury bonds in 2006 when the timing was just right.  Hard negative momentum had just broken.  I remember the trader coming back to me weeks later and saying, “How do you do it?” and I said, “I don’t,”  then saying that nothing is certain when you enter into such a trade.  Market sentiment was horrible, so we legged into the trade, nibbling as prices fell, entering the full position as prices began to rise, once the cascade of forced selling abated.  A few months later, we legged out of the position for a good-sized profit in bond terms.

It’s my opinion that bonds trend more than equities, and that it is easier to calculate the downside risk of most positions.  There are cycles:

  • Credit
  • Currency
  • Hedging of interest-rate-sensitivity (otherwise known as duration)
  • Liquidity

These are not totally independent of each other, but neither are they totally dependent, which makes the game complex.  At present, credit conditions are declining, the US Dollar is not attractive, except compared to the Euro.  There seems to be a grab for the long end of the yield curve, agents buying bit of the far future, perhaps to fund or immunize long liabilities.  Finally, liquidity seems to be slipping — too many markets with abnormalities in the short end of the yield curve.  That will eventually affect the prices of bonds where the value proposition is less than clear, unless the Central bankers decide to do another round of ill advised “stimulus.”

Enough for now, we’re still in uncharted waters, but maybe we have a few guides to aid us in managing fixed income in an era where monetary policy does not work, and governments borrow madly.

A Ponzi scheme needs an ever-increasing flow of money to survive.  Same for a market bubble.  When the flow’s growth begins to slow, the bubble will wobble.  When it stops, it will pop.  When it goes negative, it is too late.

Here’s how a Ponzi scheme works for the promoter:

Prior Net Assets + Receipts + True Investment Earnings (if any)  – Withdrawals – Expenses = Net Assets

But this is what it looks like to the investor:

Investor Prior Net Assets + Receipts + Reported Earnings – Withdrawals = Investor Net Assets

The investor’s view of the assets is higher than the actual assets by the cumulative difference between reported and true investment earnings, and cumulative expenses. The promoter wants to keep the good times rolling, and keep the ratio of actual to investor net assets as high as possible.  But to do that requires additional receipts, and a lack of withdrawals, which in turn requires an attractive reported rate of earnings, higher than what could be ordinarily achieved. But the higher the reported rate of earnings goes, the further behind the promoter gets.  Also, at very high levels, the authorities take interest.  At very low levels, the Ponzi dies.  Part of the evil genius of Madoff was striking the balance.  He also did four other things:

  • Soft-peddled the marketing so that it was like joining an exclusive club.
  • Discouraged withdrawals by saying you would not get back in (for some).
  • Deluding regulators into thinking that it was a front-running scam.
  • He did not rake off much.

Most Ponzi schemes die rapidly because of the greed and impatience of the promoters.  All Ponzi schemes eventually fail. So how does this relate to market bubbles?  With a market bubble, the increase in market values significantly exceeds the increase in intrinsic values.  This could be due to a number of factors:

  • Players see that borrowing to chase a rising asset is a winner.
  • Promoters make it easy to do for inexperienced investors.
  • An easy monetary policy lowers financing costs, aiding bubble financing.
  • Players seek stock gains, and disdain debt claims.
  • At the end, investors have to feed the asset to keep it afloat, giving up current income to support the “asset.”

Positive cash flow into the bubble asset class supports valuations for a time, the cash flows driven by momentum, but eventually positive cash flows are overwhelmed by negative cash flow from an overvalued asset class. My advice: avoid speculating on momentum, particularly after it has gone on for a few years.  Put a margin of safety first in your investing, such that you will always be around to invest in the future, no matter how bad the  investment environment is.