Category: Portfolio Management

Everyone Needs Good Advice

Everyone Needs Good Advice

Posted on by David Merkel
Picture Credit: jen collins

===================================================

I am a fiduciary in my work that I do for my clients. I am also the largest investor in my own strategies, promising to keep a minimum of 80% of my liquid net worth in my strategies, and 50% of my total net worth in them (including my house, etc.).

I believe in eating my own cooking. ?I also believe in treating my clients well. ?I’ve treated part of this in an earlier post called?It?s Their Money, where I describe how I try to give exiting clients a pleasant time on the way out. ?For existing clients, I will also help them with situations where others are managing the money at no charge, no payment from another party, and no request that I manage any of those assets. ?I do that because I want them to be treated well by me, and I know that getting good advice is hard. ?As I wrote in a prior article?The Problem of Small Accounts:

We all want financial advice.? Good advice.? And we want it for free.? That?s why we come to the Aleph Blog, where advice is regularly dispensed, and at no cost.

But? I can?t be personal, and give you advice that is tailored to your situation.? And in my writing here, much as I try to be highly honest, I am not acting as a fiduciary, even though I still make my writings hold to such a standard.

Ugh.? Here?s the problem.? Good advice costs money.? Really good advice costs a lot of money, and is worth it, if you have enough money to spread the cost over.

But when you have a small account, you have a problem in getting advice.? There is no way for someone who is fiduciary (like me) to make money addressing your concerns.? That is why I have a high minimum for investing: $100,000.? With that, I can spend time on clients, even helping them with assets from which I make no money.

What extra things have I done for clients over time? ?I have:

  • Analyzed asset allocations.
  • Analyzed the performance of other managers.
  • Advised on changing jobs, negotiating salary, etc.
  • Explained the good and bad points of certain insurance companies and their policies, and suggested alternatives.
  • Analyzed chunky assets that they own elsewhere, aiding them in whether they keep, sell, or sell part of the asset.
  • Analyzed a variety of funky and normal investment strategies.
  • Advised on buying a building, and future business plans.
  • Told a client he was better off reinvesting the slack funds in his business that needed?financing, rather than borrow and invest the funds with me.
  • Told a client to stop sending me money, and pay down his mortgage. ?(He has since resumed sending money, but he is now debt-free.)

I take the fiduciary side of this seriously, and will?tell clients that want to put a?lot of their money in my stock?strategy that they need less risk, and should put funds in my bond strategy, where I earn less.

I’ve got a lot already. ?I don’t need to feather my nest at the expense of the best interests of my clients.

Over the last six years, around half of my clients have availed themselves of this help. ?If you’ve read Aleph Blog for awhile, you know that I have analyzed a wide number of things. ?Helping my clients also sharpens me for understanding the market as a whole, because issues come into focus when the situation of a family makes them concrete.

So informally, I am more than an “investments only” RIA [Registered Investment Advisor], but I only earn money off of my investment fees, and no other way. ?Personally, I think that other “investments only” RIAs would mutually benefit their clients if they did this as well — it would help them understand the struggles that they go through, and inform their view of the economy.

Thus I say to my competitors: do you want to justify your fees? ?This is a way to do it; perhaps you should consider it.

Postscript

Having some people in an “investment only” shop that understand the basic questions that most clients face also has some crossover advantages when it comes to understanding financial companies, and different places that institutional money gets managed. ?It gives you a better idea of the investment ecosystem that you live and work in.

Streaking Into the Record Books?

Streaking Into the Record Books?

Posted on by David Merkel

Well, this market is nothing if not special. ?The S&P 500 has gone 84 trading days without a loss of 1% or more. ?As you can see in the table below, that ranks it #17 of all streaks since 1950. ?If it can last through February 27th, it will be the longest streak since 1995. ?If it can last through March 23rd, it will be the longest streak since 1966. ?The all-time record (since 1950) would take us all the way to June.

Here’s another way to think about this — look at the VIX. ?It closed today at 10.85. ?Sleepy, sleepy… no risk to be found. ?When you don’t have any significant falls in the market, the VIX tends to sag. ?Aside from the election, which is an exception to the rule, the last two peaks of the VIX over the last six months were after 1%+ drops in the S&P 500.

The same would apply to credit spreads, which are also tight. ?No one expects a change in liquidity, a credit event, a national security incident, etc. ?But as I commented on Friday:

This is an awkward time when you have a lot of people arguing that the market CAN’T GO HIGHER! ?Let me tell you, it can go higher.

Will it go higher? ?Who knows?

Should it go higher? ?That’s the better question, and may help with the prior question. ?If you’re thinking strictly about absolute valuation, it shouldn’t go higher — we’re in the mid-80s on a percentile basis. ?On a relative valuation basis, where are you going to go? ?On a momentum basis, it should go higher. ?It’s not a rip-roarer in terms of angle of ascent, which bodes well for it. ?The rallies that fail tend to be more violent, and this one is kinda timid.

We sometimes ask in investing “who has the most to lose?” ?As in my tweet above, that very well could be asset allocators with low stock allocations that conclude that they need to chase the rally. ?Or, retail waking up to how great this bull market has been, concluding that they have been missing out on “free money.”

Truth, I’m not hearing many people at all banging the drum for this rally. ?There is a lot of skepticism.

As for me, I don’t care much. ?It’s not a core skill of mine, nor is it a part of my business. ?I am finding cheap stocks still, and I will keep investing through thick and thin, unless the 10-year forecast model that I use says future returns are below 3%/year. ?Then I will hedge, and encourage my clients to do so as well.

Until then, the game is on. ?Let’s see how far this streak goes.

==========================================

Streaks of over 50 days since 1950

Rank Date Streak Year
1 10/8/1963 154 1963
2 2/28/1966 154 1966
3 6/7/1954 142 1954
4 6/3/1964 131 1964
5 4/17/1961 119 1961
6 7/26/1957 115 1957
7 6/12/1985 112 1985
8 5/17/1995 110 1995
9 12/15/1995 105 1995
10 10/30/1967 103 1967
11 5/13/1958 102 1958
12 11/2/1993 95 1993
13 11/24/2006 94 2006
14 2/12/1993 87 1993
15 8/15/1952 86 1952
16 12/20/1968 85 1968
17 2/10/2017 84 2017
18 8/31/1979 82 1979
19 11/30/1964 81 1964
20 6/2/1950 75 1950
21 6/1/1965 75 1965
22 8/23/1972 74 1972
23 5/8/1972 73 1972
24 2/4/1953 70 1953
25 4/24/1962 67 1962
26 7/16/2014 66 2014
27 10/14/1958 65 1958
28 6/10/1969 65 1969
29 12/2/1996 65 1996
30 1/27/2004 65 2004
31 2/3/1994 63 1994
32 1/4/1962 60 1962
33 8/18/1976 60 1976
34 12/20/1985 60 1985
35 9/18/1961 58 1961
36 5/14/1971 58 1971
37 2/9/1989 58 1989
38 7/19/1968 57 1968
39 1/19/2006 56 2006
40 10/18/1951 55 1951
41 9/13/1978 55 1978
42 2/27/1963 54 1963
43 3/29/1977 54 1977
44 6/23/2016 54 2016
45 8/21/1953 53 1953
46 7/11/1960 53 1960
47 11/19/1969 52 1969
48 9/8/1994 52 1994
49 9/8/2016 51 2016
Yield = Poison (3)

Yield = Poison (3)

Posted on by David Merkel
Photo Credit: Brent Moore || Watch the piggies run after scarce yield!

=======================================================

If you do remember the first time I wrote about yield being poison,?you are unusual, because it was the first real post at Aleph Blog. ?A very small post — kinda cute, I think when I look at it from almost ten years ago… and prescient for its time, because a lot of risky bonds were about to lose value (in 19 months), aside from the highest quality bonds.

I decided to write this article this night because I decided to run my bond momentum model — low and behold, it yelled at me that everyone is grabbing for yield through credit risk, predominantly corporate and emerging markets, with a special love for bank debt closed end funds.

I get the idea — short rates are going to rise because the Fed is tightening and inflation is rising globally, and there is no credit risk anymore because economic growth is accelerating globally — it’s not just a US/Trump thing. ?I just have a harder time playing the game because we are in the wrong phase of the credit cycle — profit growth is nonexistent, and debts are growing.

I have a few other concerns as well. ?Even if encouraging exports and discouraging imports aids the US economy for a while (though I doubt it — more jobs rely on exports than are lost by imports, what if there is retaliation?) there is a corresponding opposite impact on the capital account — less reinvestment in the US. ?We could see higher yields…

That said, I would be more bearish on the US Dollar if it had some real competition. ?All of the major currencies have issues. ?Gold, anyone? ?Low short rates and rising inflation are the ideal for gold. ?Watch the real cost of carry go more negative, and you get paid (sort of) for holding gold.

If growth and inflation?persist globally (consider some of the work @soberlook has ?been doing at The WSJ Daily Shot — a new favorite of mine, even his posts are?too big) then almost no bonds except the shortest bonds will be any good in the intermediate-term — back to the ’70s phrase “certificates of confiscation.” ?One other effect that could go this way — if the portion of Dodd-Frank affecting bank leverage is repealed, the banks will have a much greater ability to lend overnight, which would be inflationary. ?Of course, they could just pay special dividends, but most corporations lean toward growing the business, unless they are disciplined capital allocators.

But it is not assured that the current growth and inflation will persist. ?M2 Monetary velocity is still low, and the long end of the yield curve does not have yield enough priced in for additional growth and inflation. ?Either long bonds are a raving sell, or the long end is telling us we are facing a colossal fake-out in the midst of too much leverage globally.

Summary

I’m going to stay high quality and short for now, but I will be watching for the current trends to break. ?I may leg into some long Treasuries, and maybe some foreign bonds. ?Gold looks interesting, but I don’t think I am going there. ?I’m not making any big moves in the short run — safe and short feels pretty good for the?bond portfolios that I manage. ?I think it’s a time to preserve principal — there is more credit risk than the market is pricing in. ?It might take a year or two to get there, or it might be next month… I would simply say stay flexible and look for a time where you have better opportunities. ?There is no fat pitch at present for long only investors like me.

Postscript

To those playing with fire buying dividend paying common stocks, preferred stocks, MLPs, etc. for yield — if we hit a period where credit risk becomes obvious — all of your “yield plays” will behave like stocks in a poisoned sector. ?There could be significant dividend cuts. ?Dividends are not guaranteed like bonds — bonds must pay or it is bankruptcy. ?Managements avoid defaulting on their bonds and loans, but will not hesitate to cut or not pay dividends in a crisis — it is self-preservation, at least in the short-run. ?Even if they get replaced by angry shareholders, the management typically gets some sort of parachute if the company survives, and far less in bankruptcy.

One final note on this point — stocks that have a lot of yield buyers behave more like bonds. ?If bond yields rise above current stock earnings yields, the stock prices will fall to reprice the yield of the stock, even if there is no bankruptcy risk.

And, if you say you can hold on and enjoy the rising dividends of your high quality companies? ?Accidents happen, the same way they did to some people who bought houses in the middle of the last decade. ?Many could not ride out the crisis because of some life event. ?Make sure you have a margin of safety. ?In a really large crisis, the return on risk assets may look decent from ten years before to ten years after, but a lot of people get surprised by their need to draw on those assets at the wrong moment — bad events come in bunches, when the credit cycle goes bust. Be careful, and don’t reach for yield.

The Band Marches On

The Band Marches On

Posted on by David Merkel
Photo Credit: Mike Morbeck?|| On Wisconsin! On Wisconsin!

=============================================================

It was shortly after the election when I last moved my trading band. ?Well, time to move it again, this time up 4%, with a small twist. ?I’m at my cash limit of 20%, with a few more stocks knocking on the door of a rebalancing sale, and none near a rebalancing buy. ?(To decode this, you can read my article on portfolio rule seven.) ?Here is portfolio rule seven:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

This is my interim trading rule, which helps me make a little additional money for clients by buying relatively low and selling relatively high. ?It also reduces risk, because higher prices are riskier than lower prices, all other things equal.

There are two companies that are double-weights in my portfolio, one half-weight, and 32 single-weights. ?The half-weight is a micro-cap that is difficult to buy or sell. (Patience, patience…) ?With cash near 20%, a?single-weight currently runs around 2.2% of assets, with buying happening near 1.75%, and selling near 2.63%.

But, I said there was a small twist. ?I’m going to add another single-weight position. ?I don’t know what yet. ?Also, I’m leaving enough in reserve to turn one of the single-weights into a double-weight. ?That company is a well-run Mexican firm that has ?had a falling stock price even though it is still performing well. ?If it falls another 10%, I will do more than rebalance. ?I will rebalance and double it.

Part of the reason for the move in both number of positions and position size at the same time is that both the half-weight and one single-weight that is at the top of its band are being acquired for cash, and so they (3.5% of assets) behave more like cash than stocks.

Thus, amid a portfolio that has been performing well, I am adjusting my positioning so that if the market continues to do well, the portfolio doesn’t lag much, or even continues to outperform. ?I’m not out to make big macro bets; I will make a small bet that the market is high, and carry above average cash, but it will all get deployed if the market falls 25%+ from here.

I keep the excess cash around for the same reason Buffett does. ?It gives you more easy options in a bad market environment. ?Until that environment comes, you’ll never know how valuable is is to keep some extra cash around. ?Better safe, than sorry.

Distrust Forecasts, Part 2

Distrust Forecasts, Part 2

Posted on by David Merkel
Photo Credit: D.C.Atty || Scrawled in 2008, AFTER the crash started

=============================

Comments are always appreciated from readers, if they are polite. ?Here’s a recent one from the piece?Distrust Forecasts.

You made one statement that I don?t really understand. ?Most forecasters only think about income statements. Most of the limits stem from balance sheets proving insufficient, or cash flows inverting, and staying that way for a while.?

What is the danger of balance sheets proving insufficient? Does that mean that the company doesn?t have enough cash to cover their ?burn rate??

Not having enough cash to cover the burn rate can be an example of this. ?Let me back up a bit, and speak generally before focusing.

Whether economists, quantitative analysts, chartists or guys who pull numbers out of the air, most people do not consider balance sheets when making predictions. ?(Counterexample: analysts at the ratings agencies.) ?It is much easier to assume a world where there are no limits to borrowing. ?Practical example #1 would be home owners and buyers during the last financial crisis, together with the banks, shadow banks, and government sponsored enterprises that financed them.

In economies that have significant private debts, growth is limited, because of higher default probabilities/severity, and less capability of borrowing more should defaults tarry. ?Most firms don?t like issuing equity, except as a last resort, so restricted ability to borrow limits growth. High debt among consumers limits growth in another way ? they have less borrowing capacity and many feel less comfortable borrowing anyway.

Figuring out when there is “too much debt” is a squishy concept at any level — household, company, government, economy, etc. ?It’s not as if you get to a magic number and things go haywire. ?People have a hard time dealing with the idea that as leverage rises, so does the probability of default and the severity of default should it happen. ?You can get to really high amounts of leverage and things still hold together for a while — there may be extenuating circumstances allowing it to work longer — just as in other cases, a failure in one area triggers a lot more failures as lenders stop lending, and those with inadequate liquidity can refinance and then fail.

Three?More Reasons to Distrust Predictions

1) Media Effects — the media does not get the best people on the tube — they get those that are the most entertaining. ?This encourages extreme predictions. ?The same applies to people who make predictions in books — those that make extreme predictions sell more books. ?As an example, consider this post from Ben Carlson on Harry Dent. ?Harry Dent hasn’t been right in a long time, but it doesn’t stop him from making more extreme predictions.

For more on why you should ignore the media, you can read this ancient article that I wrote for RealMoney in 2005, and updated in 2013.

2) Momentum Effects — this one is two-sided. ?There are?momentum effects in the market, so it’s not bogus to shade near term estimates based off of what has happened recently. ?There are two problems though — the longer and more severe the rise or fall, the more you should start downplaying momentum, and increasingly think mean-reversion. ?Don’t argue for a high returning year when valuations are stretched, and vice-versa for large market falls when valuations are compressed.

The second thing is kind of a media effect when you begin seeing articles like “Everyone Ought to be Rich,” etc. ?”Dow 36,000″-type predictions come near the end of bull markets, just as “The Death of Equities’ comes at the end of Bear Markets. ?The media always shows up late; retail shows up late; the nuttiest books show up late. ?Occasionally it will fell like books and pundits are playing “Can you top this?” near the end of a cycle.

3) Spurious Math — Whether it is the geometry of charts or the statistical optimization of regression, it is easy to argue for trends persisting longer than they should. ?We should always try to think beyond the math to the human processes that the math is describing. ?What levels of valuation or indebtedness are implied? ?Setting new records in either is always possible, but it is not the most likely occurrence.

With that, be skeptical of forecasts.

 

Distrust Forecasts

Distrust Forecasts

Posted on by David Merkel
Photo Credit: New America || Could only drive through the rear-view mirror

=======================================================

This is the time of year where lots of stray forecasts get given. ?I got tired enough of it, that I had to turn off my favorite radio station, Bloomberg Radio, after hearing too many of them. ?I recommend that you ignore forecasts, and even the average of them. ?I’ll give you some reasons why:

  • Most forecasters don’t have a good method for generating their forecasts. ?Most of them represent the present plus their long-term bullishness or bearishness. ?They might be right in the long-run. ?The long-run is easier to forecast, in my opinion, because a lot of noise cancels out.
  • Most forecasters have no serious money on the line regarding what they are forecasting. ?Aside from loss of reputation, there is no real loss to being wrong. ?Even the reputational loss issue is a weak one, because Wall Street generally has no memory. ?Why? ?Enough things get predicted that pundits can point to something that they got right, at least in some years. ?Memories are short on Wall Street, anyway.
  • The few big players that make public forecasts have already bought in to their theses, and only have limited power to continue buying their ideas, particularly if they are wrong. ?This is particularly true in hedge funds, and leveraged financial firms.
  • Forecasts are bad at turning points, and average forecasts by nature abhor turning points. ?That’s when you would need a forecast the most, when conditions are going to change. ?If a forecast presumes?”sunny weather” on an ordinary basis it’s not much of a forecast.
  • Most forecasters only think about income statements. ?Most of the limits stem from balance sheets proving insufficient, or cash flows inverting, and staying that way for a while.
  • Most forecasts also presume good?responses from policymakers, and even when they are right, they tend to be slow.
  • Forecasts almost always presume stability of external systems that the system that holds the forecasted variable is only a part of. ?Not that anyone is going to forecast a war between major powers (at present), or a cataclysm greater than the influenza epidemic of 1918 (1-2% of people die), but are users of a forecast going to wholeheartedly believe it, such that if a significant disaster does strike, they are totally bereft? ?When is the last time we had a trade war or a payments crisis? ?Globalization and the greater division of labor is wonderful, but what happens if it goes backward, or a major nation like France faces a scenario like the PIIGS did?

I leave aside the “surprises”-type documents, which are an interesting parlor game, but have their own excuses built-in.

My advice for you is simple. ?Be ready for both bad and good times. ?You can’t tell what is going to happen. ?Valuations are stretched but not nuts, which justifies a neutral risk posture. ?Keep dry powder for adverse situations.

And, from David at the Aleph Blog, have a happy 2017.

Who Needs Liquidity Most?

Who Needs Liquidity Most?

Posted on by David Merkel
Photo Credit: Timothy Appnel
Photo Credit: Timothy Appnel

-==-=-=-

Here’s the quick summary of what I will say: People and companies need liquidity. ?Anything where payments need to be made needs liquidity. ?Secondary markets will develop their own liquidity if it is needed.

Recently, I was at an annual meeting of a private company that I own shares in. ?Toward the end of the meeting, one fellow who was kind of new to the firm asked?what liquidity the shares had and how people valued them. ?The board and management of the company wisely said little. ?I gave a brief extemporaneous talk that said that most people who owned these shares know they are illiquid, and as such, they hold onto them, and enjoy the distributions. ?I digressed a little and explained how one *might* put a value on the shares, but trading values really depended on who was more motivated — the buyer or the seller.

Now, there’s no need for that company to have a liquid market in its stock. ?In general, if someone wants to sell, someone will buy — trades are very infrequent, say a handful per year. ?But the holders know that, and most plan not to sell the shares, looking to other sources if they need money to spend — liquidity.

And in one sense, the shares generate their own flow of liquidity. ?The distributions come quite regularly. ?Which would you rather have? ?A bucket of golden eggs, or the goose that lays them one at a time?

Now the company itself doesn’t need liquidity. ?It generates its liquidity internally through profitable operations that don’t require much in the way of reinvestment in order to maintain its productive capacity.

Now, Buffett used to?purchase only companies that were like this, because he wanted to reallocate the excess liquidity that the companies threw off to new investments. ?But as time has gone along, he has purchased capital-intensive businesses like BNSF that require continued capital investment. ?Quoting from a good post at Alpha Architect?referencing Buffett’s recent annual meeting:

Question: ?In your 1987 Letter to Shareholders, you commented on the kind of companies Berkshire would like to buy: those that required only small amounts of capital. You said, quote, ?Because so little capital is required to run these businesses, they can grow while concurrently making all their earnings available for deployment in new opportunities.? Today the company has changed its strategy. It now invests in companies that need tons of capital expenditures, are over-regulated, and earn lower returns on equity capital. Why did this happen?

Warren Buffett?It?s one of the problems of prosperity. The ideal business is one that takes no capital, but yet grows, and there are a few businesses like that. And we own some?We?d love to find one that we can buy for $10 or $20 or $30 billion that was not capital intensive, and we may, but it?s harder. And that does hurt us, in terms of compounding earnings growth. Because obviously if you have a business that grows, and gives you a lot of money every year?[that] isn?t required in its growth, you get a double-barreled effect from the earnings growth that occurs internally without the use of capital and then you get the capital it produces to go and buy other businesses?[our] increasing capital [base] acts as an anchor on returns in many ways. And one of the ways is that it drives us into, just in terms of availability?into businesses that are much more capital intensive.

Emphasis that of Alpha Architect

Liquidity is meant to support the spending of corporations and people who need services and products to further their existence. ?As such, intelligent entities plan for liquidity needs in advance. ?A pension plan in decline allocates more to bonds so that the cash flow from the bonds will fund expected net payouts. ?Well-run insurance companies and banks match expected cash flows at least for a few years.

Buffer funds are typically low-yielding assets of high quality and short duration — short maturity bonds, CDs, savings and bank deposits, etc. ?Ordinary people and corporations need them to manage the economic bumps of life. ?Expenses are up, and current income doesn’t exceed them. ?Got cash? ?It certainly helps to be able to draw on excess assets in a pinch. ?Those who run a balance on their credit cards pay handsomely for the convenience.

In a crisis, who needs liquidity most? ?Usually, it’s whoever is at the center of the crisis, but usually, those entities are too far gone to be helped. ?More often, the helpable needy are the lenders to those at the center of the crisis, and woe betide us if no one will privately lend to them. ?In that case, the financial system itself is in crisis, and then people end up lending to whoever is the lender of last resort. ?In the last crisis, Treasury bonds rallied as a safe haven.

In that sense, liquidity is a ‘fraidy cat. ?Marginal borrowers can’t get it when they need it most. ?Liquidity typically flows to quality in a crisis. ?Buffett bailed out only the highest quality companies in the last crisis. Not knowing how bad it would be, he was happy to hit singles, rather than risk it on home runs.

Who needs liquidity most now? ?Hard to say. ?At present in the US, liquidity is plentiful, and almost any?person or firm can get a loan or equity finance if they want it. ?Companies happily extend their balance sheets, buying back stock, paying dividends, and occasionally investing. ?Often when liquidity is flush, the marginal bidder is a speculative entity. ?As an example, perhaps some emerging market countries, companies and people would like additional offers of liquidity.

That’s a major difference between bull and bear markets — the quality of those that can easily get unsecured loans. ?To me that is the leading reason why we are in the seventh or eighth inning of a bull market now, because almost any entity can get the loans they want at attractive levels. ?Why isn’t it the ninth inning? ?We’re not at “nuts” levels yet. ?We may never get there though, which is why baseball analogies are sometimes lame. ?Some event can disrupt the market when it is so high, and suddenly people and firms are no longer so willing to extend credit.

Ending the article here — be aware. ?The time to take inventory of your assets and their financing needs is before the markets have an event. ?I’ve just completed my review of my portfolio. ?I sold two of the 35 companies that I hold and replaced them with more solid entities that still have good prospects. ?I will sell two more in the new year for tax reasons. ?My bond portfolio is high quality. ?My clients and I are ready if liquidity gets worse.

Are you ready?

Be wary of surrendering liquidity

Be wary of surrendering liquidity

Posted on by David Merkel
Photo Credit: darwin Bell || You ain't getting out easily...
Photo Credit: darwin Bell || You ain’t getting out easily…

=================================================

How would you like a really good model to make money as a money manager? You would? Great!

What I am going to describe is a competitive business, so you probably won’t grow like mad, but what money you do bring in the door, you will likely keep for some time, and earn significant fees.

This post is inspired by a piece written by Jason Zweig at the Wall Street Journal:?The Trendiest Investment on Wall Street?That Nobody Knows About. ?The article talks about interval funds. ?Interval funds hold illiquid investments that would be difficult to sell at a fair price ?quickly. ?As such, liquidity is limited to quarterly or annual limits, and investors line up for distributions. ?If you are the only one to ask for a distribution, you might get a lot paid out, perhaps even paid out in full. ?If everyone asked for a part of the distribution, everyone would get paid their pro-rata share.

But there are other ways to capture assets, and as a result, fees.

  • Various types of business partnerships, including Private REITs, Real Estate Partnerships, etc.
  • Illiquid?debts, such as structured notes
  • Variable, Indexed and Fixed Annuities with looong surrender charge periods.
  • Life insurance as an investment
  • Weird kinds of IRAs that you can only set up with a venturesome custodian
  • Odd mutual funds that limit withdrawals because they offer “guarantees” of a sort.
  • And more, but I am talking about those that get sold to or done by retail investors… institutional investors have even more chances to tie up their money for moderate, modest or negative incremental returns.
  • (One more aside, Closed end funds are a great way for managers to get a captive pool of assets, but individual investors at least get the ability to gain liquidity subject to the changing premium/discount versus NAV.)

My main point is short and simple. ?Be wary of surrendering liquidity. ?If you can’t clearly identify what you are gaining from giving up liquidity, don’t make the investment. ?You are likely being hoodwinked.

It’s that simple.

[bctt tweet=”If you can’t clearly identify what you are gaining from giving up liquidity, don’t make the investment.” username=”alephblog”]

The Rules, Part LXII

The Rules, Part LXII

Posted on by David Merkel
Ben Graham, who else?

================================================================
Well, I didn’t think I would do any more “Rules” posts, but here one is:

In markets, “what is true” works in the long run. “What people are growing to believe is true” works in the short run.

This is a more general variant of Ben Graham’s dictum:

?In the short run, the market is a voting machine but in the long run, it is a weighing machine.?

Not that I will ever surpass the elegance of Ben Graham, but I think there are aspects of my saying that work better. ?Ben Graham lived in a time where capital was mostly physical, and he invested that way. ?He found undervalued net assets and bought them, sometimes fighting to realize value, and sometimes waiting to realize value, while all of the while enjoying the arts as a bon vivant. ?In one sense, Graham kept the peas and carrots of life on separate sides of the plate. ?There is the tangible (a cheap set of assets, easily measured), and the intangible — artistic expression, whether in painting, music, acting, etc. (where values are not only relative, but contradictory — except perhaps for Keynes’ beauty contest).

Voting and weighing are discrete actions. ?Neither has a lot of complexity on one level, though deciding who to vote for can have its challenges. (That said, that may be true in the US for 10% of the electorate. ?Most of us act like we are party hacks. 😉 )

What drives asset?prices? ?New information? ?Often, but new information is only part of it. It stems from changes in expectations. ?Expectations change when:

  • Earnings get announced (or pre-announced)
  • Economic data gets released.
  • Important people like the President, Cabinet members, Fed governors, etc., give speeches.
  • Acts of God occur — earthquakes, hurricanes, wars, terrorist attacks, etc.
  • A pundit releases a report, whether that person is a short, a long-only manager, hedge fund manager, financial journalist, sell-side analyst, etc. ?(I’ve even budged the market occasionally on some illiquid stocks…)
  • Asset prices move and some people mimic to intensify the move because they feel they are missing out.
  • Holdings reports get released.
  • New scientific discoveries are announced
  • Mergers or acquisitions or new issues are announced.
  • The solvency of a firm is questioned, or a firm of questionable solvency has an event.
  • And more… nowadays even a “tweet” can move the market

In the short run, it doesn’t matter whether the news is true. ?What matters is that people believe it enough to act on it. ?Their expectation change. ?Now, that may not be enough to create a permanent move in the price — kind of like people buying stocks that Cramer says he likes on TV, and the Street shorts those stocks from the inflated levels. ?(Street 1, Retail 0)

But if the news seems to have permanent validity, the price will adjust to a higher or lower level. ?It will then take new data to move the price of the asset, and the dance of information and prices goes on and on. ?Asset prices are always in an unstable equilibrium that takes account of the many views of what the world will be like over various time horizons. ?They are more volatile than most theories would predict because people are not rational in the sense that economists posit — they do not think as much as imitate and extrapolate.

Read the news, whether on paper or the web — “XXX is dead,” “YYY is the future.” ?Horrible overstatements most of the time — sure, certain products or industries may shrink or grow due to changes in technology or preferences, but with a few exceptions, a new temporary unstable equilibrium is reached which is larger or smaller than before. ?(How many times has radio died?)

“Stocks rallied because the Fed cut interest rates.”

“Stocks rallied because the Fed tightened interest rates, showing a strong economy.”

“Stocks rallied just because this market wants to go up.”

“Stocks rallied and I can’t tell you why even though you are interviewing me live.”

Okay, the last one is fake — we have to give reasons after the fact of a market move, even anthropomorphizing the market, or we would feel uncomfortable.

We like our answers big and definite. ?Often, those big, definite answers that seem right at 5PM will look ridiculous in hindsight — especially when considering what was said near turning points. ?The tremendous growth that everyone expected to last forever is a farce. ?The world did not end; every firm did not go bankrupt.

So, expectations matter a lot, and changes in expectations matter even more in the short-run, but who can lift up their head and look into the distance and say, “This is crazy.” ?Even more, who can do that precisely at the turning points?

No one.

There are few if any people who can both look at the short-term information and the long-term information and use them both well. ?Value investors are almost always early. ?If they do it neglecting the margin of safety, they may not survive to make it to the long-run, where they would have been right. ?Shorts predicting the end often develop a mindset that keeps them from seeing that things have stopped getting worse, and they stubbornly die in their bearishness. ?Vice-versa, for bullish Pollyannas.

Financially, only two things matter — cash flows, the cost of financing cash flows, and how they change with time. ?Amid the noise and news, we often forget that there are businesses going on, quietly meeting human needs in exchange for a profit. ?The businessmen are frequently more rational than the markets, and attentive to the underlying business processes producing products and services that people value.

As with most things I write about, the basic ideas are easy, but they work out in hard ways. ?We may not live long enough to see what was true or false in our market judgments. ?There comes a time for everyone to hang up their spurs if they don’t die in the saddle. ?Some of the most notable businessmen and market savants, who in their time were indispensable people, will eventually leave the playing field, leaving others to play the game, while they go to the grave. ?Keynes, the great value investor that he was, said, “In the long run we are all dead.” ?The truth remains — omnipresent and elusive, inscrutable and unchangeable like a giant cube of gold in a baseball infield.

As it was, Ben Graham left the game, but never left the theory of value investing. ?Changes in expectations drive prices, and unless you are clever enough to divine the future, perhaps the best you can do is search for places where those expectations are too low, and tuck some of those assets away for a better day. ?That better day may be slow in coming, but diversification and the margin of safety embedded in those assets there will help compensate for the lack of clairvoyance.

After all, in the end, the truth measures us.

Patience and a Little Courage

Patience and a Little Courage

Posted on by David Merkel
Photo Credit: G E M

===================================================

If I had to suggest two attitudinal adjustments for the average retail investor, I would encourage patience and a little courage. ?Why these two?

Patience is needed for a wide variety of reasons. ?There is almost never a need to act quickly. ?If a few days matters to a decision, such that you feel that you have to act NOW, you’re probably playing the wrong game. ?Of course don’t dawdle when you know what you need to do, but don’t let markets, relatives or salesmen push you around.

One example of that hit me recently when I realized that I had acquired 0.1% of the market cap of a microcap stock. ?It rarely if ever trades, so it took three weeks to patiently source that many shares by waiting patiently on the bid price of the market. ?The amount I have gotten already has exceeded my expectations, but I’m still bidding for more, quietly.

I’m usually pretty patient in trading, which means occasionally some trades won’t get done. ?That’s okay, there are usually multiple opportunities, and alternative stocks to buy if you can’t get one of the stocks that you want at the price that you want.

Patience is also useful when the market is rising or falling quickly. ?Many people will get tempted to greed or fear, but someone who is patient and has his emotions under control can wait and then make a more rational decision without concern.

Patience is also needed for just maintaining an asset allocation over a long time. ?Remember, you don’t make money while you buy and sell, you make money while you wait. ?For average investors, those that are patient do best.

That is why some courage is also needed. ?Many investments will lose money for a time. ?I would estimate that 2/3rds of the stocks that I currently hold have been at a unrealized capital loss for over a month of time at some point at minimum. ?At present, almost all are at?unrealized capital gains. ?So much for the bull market.

There will be a lot of people who try to scare investors. ?Some mean well; some don’t — they are just trying to sell you on their services. ?A little courage pays here. ?Remember that the investors that buy and hold almost always do better than traders — and this is true of all mutual funds including ETFs.

And now for something completely different

I wrote these three pieces at unpopular times:

If indeed you bought and held from February of 2009, you did quite well. ?Even from March of 2012 you did well.

But what of now? ?How will you do in the future if you buy-and-hold now? ?I can tell you two things:

  • Better than most of those that trade, and
  • Likely not as well as in 2009 or 2012. ?In 2009, we were staring at 16%+/yr returns over the next ten years, and people were scared to death. ?In 2012, it was 8.5%/year for the next ten years. ?Now it’s around 6%.

If you were to say to me, I don’t think 6%/yr?is worth playing for, you would get an ambivalent answer from me. ?I would tell you that I am staying in, but that you should do what you are comfortable doing, if you can avoid future panic and greed.

Though the rewards are likely lower now than previously, you still have a decent number of players that don’t believe the rally, and probably have not had a lot of exposure to the market for a while. ?The psychology of?most people lends itself toward self-justification. ?If they have missed much of the rally, they are likely to pooh-pooh it now. ?Only a rare person would switch now, though if you saw a lot of people switching to bull mode, then it would be time to worry, and maybe, lighten up.

Personally, I don’t see it, and together with my other studies, it leads me to hold on. ?And guess what, that could be wrong, at least in the short-run. ?But when you take into account the odds of making two correct timing trades — out now, in later, and the cost of the taxes on my taxable account, the incentives for reducing equity exposure now look poor.

Back to the Beginning

That’s why you need patience and some courage. ?Those will steady you through the hard times. ?Hard times will come, and I can’t tell you when. ?If you want to sell a little now, go ahead, and leave it in a fund that is safe. ?Then set up a googlebot to track both “buy-and-hold” and “dead.” ?When you begin to get a lot of pings, invest the money again.

But for most of us, we will be best off maintaining a constant risk posture, because it is?too hard to time the market, especially after taxes. ?So, be patient and little courageous.

PS — I don’t say be a LOT courageous, because I’ve seen guys make significant errors taking large chances. ?Remember, moderate risk wins in the end.

Theme: Overlay by Kaira.