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Why it is Hard to Win in Investing

Before I start this evening, I want to say something about many investment books that I have been reading of late.  In terms of information toward the stated goal of the book, there is often a lot of build up, some of it necessary, some not, some of it interesting, some not, occasionally some unique insights, but most of the time not.  Much of it is filler that could be eliminated.  And, if you eliminated the filler, and boiled down the part of the book that attempts to prove the stated goal, you would have something the size of a long-form blog post.  That’s why there is the filler — you would have a hard time selling a single chapter book, even though that contains the real value of the book, and would save your reader the time of wading through filler material.

Also, when I review books, I read them in entire.  If I don’t read them in entire, I state that plainly at the beginning of the review, along with why I thought I could review the book without reading it.  But after some of the books I have read lately, editing to condense the volume and stick to the topic at hand would be a help.

Finally, if the author doesn’t prove his case in an ironclad way, maybe the book shouldn’t be written.  I often get to the end of a book disappointed, because the author promised a significant result, and did not deliver.

Onto tonight’s topic:

When is the best time to invest?  When everyone else is scared to death of investing.  It’s when friends come up to you and say, “I’m never investing in stocks ever again.”  When the magazine covers proclaim “The Death of Equities,” it is time to invest.

Guess what?  Very few people do invest then.  It’s too painful to contemplate throwing away your money when nothing is going right, and losses are cascading.  Remember, we are not rational, we are mimics.

When do people like to invest?  When it’s popular to do so. When prices have been rising for a while, and the lure of “free money” is in the air.  Books on easy money flipping homes proliferate, and there is a brisk business in seminars teaching an easy road to riches.  It’s that time when people say, “Let the market pay your employees.”

I’ve talked about the fear/greed cycle many times before.  I’ve also talked about time-weighted vs dollar-weighted returns before. I’ve talked about vintage years in lending before, and about absolute return investors before.  I’ve talked about industry rotation before, as well as long-term mean reversion.  These are all manifestations of the same phenomenon in investing — it is best to invest in any given area when few are doing so, and worst to invest when almost all are doing so.

Let me give a bunch of parallel examples to make this clear.

Why do great mutual fund managers cease to be great?  When they are great, they have less money to manage than their ideas could bear managing.  But money follows performance because we are not rational, we mimic.  Eventually enough money comes in  such that the talented investor no longer has good places to put incremental money, and can’t just leave some of the money in cash, or an index fund… from a business angle, it would not fly.

Lest you think that this does not happen to passive investing, money follows performance there also.  It also happens in open-ended index funds, ETPs, and closed-end funds of any sort (expressed through the premium or discount).

This also applies to quantitative investment strategies — even those with broad themes like momentum and valuation.  Let me illustrate this with a slide from a presentation I have done before a large CFA Society:

Efficient Markets versus Adptive Markets


And this applies to lending whether securitized or direct.  When money is being thrown at a sub-asset class, like subprime RMBS in 2006-7, or manufactured housing ABS in 2000-1, the results are bad.  The best results occur when few are lending, and only the best deals are getting done.  But that means that few get those high returns.  That is the nature of the markets.

The same applies to corporate bonds.  It is wise to avoid the area of the market where issuance is well above average.  When I was a corporate bond manager, I sold out my auto bonds, and my questionable telecom bonds, amidst much issuance.  I had many brokers puzzle over why I would not buy their deals, even though they were cheap relative to their ratings.

The same applies to private equity.  When a lot of money is being applied there, it is a time to avoid it.  As it is now, private equity is throwing money at promising companies, many of which hold onto the money for safety purposes, because they don’t have place to invest it.  That doesn’t sound promising for future returns.

Finally, we have a few absolute return investors like Klarman, Grantham, and Buffett.  They are reducing allocations to risk assets, at least in relative terms.  Opportunities are not as great, and so they wait.


The intelligent investor estimates likely returns, and invests if the returns are worth the risk.  I am reducing my risk positions, slowly, as I see best for my clients and me.

Most profitable investing takes an uncomfortable view versus the consensus, and buys when the market offers good deals.  If there are no good deals, profitable investing sits on cash, and waits for a better day.

Bonds, Portfolio Management, Real Estate and Mortgages, Stocks, Structured Products and Derivatives, Value Investing | RSS 2.0 |

4 Responses to Why it is Hard to Win in Investing

  1. […] David Merkel, “If there are no good deals, profitable investing sits on cash, and waits for a better day.”  (Aleph Blog) […]

  2. […] David Merkel is talking about the value of cash in a portfolio. It’s kind of a meta post, starting by explaining how maybe books should be only one chapter (avoid the filler) before ending with the only sentence that matters: If there are no good deals, profitable investing sits on cash, and waits for a better day. In other words his blogpost could have been just one sentence. A friend runs a cash-equity portfolio. Interestingly, they seem most comfortable, and successful, when the portfolio is 80-20 to equity. Any higher and they’re pushing their ideas too hard. They feel too market aware, rather than idea aware. I tend to agree, I like cash.  […]


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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