Sunday, March 1, 2015

Investing Your Time for Better Results



Introduction

In my 2008 book MONEYWISE, I suggested that one’s investment results are more a function of how one spends his or her time on investing and giving than the size of the original capital or the initials after one’s name. This week I had reasons to think about what George Soros, Jesse Livermore, Irving Kahn, Warren Buffett, and two bank CEOs have said.  Each of these gentlemen had worthwhile messages for investors, perhaps particularly at this time when so many people are indecisive as to their investment posture.

George Soros and Jesse Livermore on market direction

[While I have met Mr. Soros and supplied his firm fund information in the past, I do not really know him but respect his skills. Jesse Livermore may well have traded a margin account through my Grandfather’s brokerage firm, I did not know him.] The source of the thoughts that I share with you is from a reader who publishes his own personal weekly blog, Teddy Lamade of Brown Advisory. Teddy quotes George Soros as saying, “Markets are constantly in a state of uncertainty and flux. As a result, money is made by discounting the obvious and betting on the unexpected.” This is in effect the motto of those of us who have been called contrarians. On the other hand, Jesse Livermore said, “The public wants to be led, to be instructed, to be told what to do.” He indicated that people will become a mob as they want the comfort of others going in the same direction.

I am not being diplomatic, but analytical when I state that both of these managers are correct. One should recognize that George Soros above all else wished to survive and go on to future paydays. Jesse Livermore was much more interested in the size of his winnings during the game.
My current investment outlook is that for awhile the trading instincts of Livermore will lead us to higher levels of stock prices as the crowd of investors on the sidelines or in broad market index funds and ETFs will become a mob chasing various pundits and politicians in the obvious trends that Mr. Soros feared. This in turn will lead to financial and psychological collapse. This is the psychological underpinning to my +20%/-20% call which could happen sometime soon either this year or next.

The hard search for value

The dichotomy between Soros and Livermore is why finding great investment value is so difficult and is the basis of the lesson that Charlie Munger taught Warren Buffett after Buffett’s training by Benjamin Graham. Livermore was a believer in price momentum as all who participate in the ultimate bullish phase of a market surge. Ben Graham’s point of departure in seeking value was price. When he started his writing as a guide to students at Columbia University, he was ably assisted by Professor David Dodd, who for many years had the difficult task of teaching myself and others Securities Analysis. In addition, Graham had a teaching assistant named Irving Kahn who just passed away at 109 years young. (More on my friend Irving will be found below.)

Dodd had much more of an accounting background than Graham. This is why he instructed us to reconstruct financial statements before we applied any ratio analysis. For example, writing in the Depression Era of the 1930s he wrote down or completely off any inventory, particularly work in process and raw materials. He wanted us to include unfunded pension amounts before determining book value. We then had to do similar exercises on competing firms. Often he had us look at corporate financials from the standpoint of the bond holder. In some cases with proper analysis the stated equity value should have been greatly reduced. With bonds selling at steep discounts from their par value, if one could get enough bonds one could force the corporation into bankruptcy with the bond holders representing the new equity. That practice as is being done today is called “loan to own.” In some ways Graham, Dodd, and Kahn in their Graham Newman fund became the equivalent of today’s activist investors, but often using bonds as their entry point. Max Heine, who later founded the Mutual Shares Fund that eventually Mike Price sold to Franklin Resources, played a similar game. Others had followed similar practices on railroads so much of the rolling stock of America fell into financial hands. Thus, many so-called value investors were essentially adjusted book value investors looking for the ultimate liquidation or sale of their companies. As we came out of the Depression and World War II periods, general prosperity lifted stock prices so it was more difficult to find statistically cheap investments. In recent years it became even more difficult. In the past it might takes months that stretched into quarters of the year to find suitable candidates. Today with almost all the financials available on easy to manipulate data banks and a large number of activists who want to play, the number of statistically cheap investments has shrunk.

As with almost all trends that eventually are played out, newer versions appear. Irving Kahn, Ben Graham’s teaching assistant and founder of Kahn Brothers, was a successful broker/investment adviser who became the prototype of the new Value investor. Irving went beyond the numbers into what was the company’s particular advantage. Often he found some gems through his life-long interest in science and often found some pioneering work at reasonable stock prices. Irving believed in the global professional securities analysis business. While he was an important founder of the New York Society of Securities Analysts, he was also a member of the London Society  and had some successful investments in Japan when few others did. Until recently he traveled extensively and we met his late wife with him on one of his many analysts’ trips.

Irving got started in the investment business in 1928 and was conscious of my Grandfather’s firm on which he was complimentary. As a future- oriented investor he was aware of periodic market declines which is why he combined what many might have said was aggressive stock picks with half his portfolio in or near cash. Basically what he did was to redefine value to include the corporate advantage that some today call moats on top of his statistical analysis. He and his sons would require managements to keep shareholders first in their deliberations. In many ways he was among the first modern investors.

The lessons that Warren Buffett learned

Like many followers of Berkshire Hathaway, Saturday morning was devoted to reading this year’s letter from Warren Buffett and Charlie Munger. While I could devote a lot of time and space as to what was said and why most investors in the stock will be happy with it, I would like to finish this post with comments about value investing.
In Buffett’s early years he followed Ben Graham’s model of investing in “mediocre companies at bargain prices” which produced gains but with some losses. That changed with the advent of Charlie Munger on the scene who converted Warren to buying great companies at fair prices. This has worked much better than the value-oriented investments in the past. The other general comment that is worthwhile to all investors is the need to be prepared for periodic 50% drops. (I will be happy to discuss my other comments on the Berkshire letter. At some point I may devote a lot of space to it or hold it to report with my impressions of the Berkshire annual meeting weekend.)

What to do?

As Shakespeare would say “to your own self be true,” follow your instinct. If you are a growth investor enjoy the crowd’s surge and ride out periodic dips of 50%. If you are a value investor you will need to practice patience and look for value beyond what is just plain cheap.

The beauty of the L Time Span PortfoliosTM is that either or both growth and value oriented managers can be utilized. In most of our managed accounts we use both in different proportions based on the individual accounts needs.

Question of the Week: Where are you on the Growth-Value spectrum? 
 

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Copyright © 2008 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
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Sunday, February 22, 2015

Investment Strategy & Tactics



Introduction

Developing the best strategy and tactics for our clients’ investments is never far from my mind. Thus, Saturday night at the annual birthday dinner for George Washington at Mount Vernon,  I listened to and spoke briefly with David Rubenstein, the co-chair of the Carlyle Group, a very generous contributor of his time and fortune to numerous non-profit organizations.

This was the second time in the last couple of years Mr. Rubenstein spoke at this dinner.  During the first he discussed his $10 million donation to Mount Vernon,  a non-government supported charity to maintain the General’s estate and the legacy of his incredible contribution to the success of the United States. In the Saturday evening keynote discussion Mr. Rubenstein labeled George Washington as an inventor which in today’s consciousness is higher than general or president. The three “inventions” that he is crediting George Washington with were: 

(1) The creation of the first organization that the thirteen very separate colonies had was the American Army, which when paid and equipped were much poorer than the various colonial militias.

(2) The political drive to create the US Constitution which for the first time created an executive government ruling with the consent of the Senate.

(3) The rotation of power; setting a precedent in declining a third term or life-term as President.

Translating David Rubenstein’s three Washington’s inventions into investment focuses I came away with the following thoughts:

To win a war of independence it is necessary to have sufficient sized forces to eventually win the war even though various battles may be lost.

What was not lost was the battle for survival. The second invention, while written by others, was adopted by the Second Constitutional Congress chaired by George Washington and stressed the need for controls and appropriate consultation without great interference with executive execution.

You will see these inventions are similar in logic to part of our development of L Timespan Fund  Portfolios TM (Lipper Time Span Portfolios) but before we discuss one of these portfolios, we should recognize that this past week demonstrated that the surge that was mentioned last week has begun.

The surge

In last week’s post I discussed the one main missing element to the surge that can lead first to a significant price performance of 20%+ (which will be followed by a larger decline). During the week both the Dow Jones Industrial Average and the Standard & Poor’s 500 went to new high readings. European stock indices are at a seven year high, Japan’s market is also at a high point and the UK’s FTSE 100 is only 15 points away from a new high. These global price moves suggest that many investors are showing profits in their aggregate portfolio. Many investors with cash on the sidelines or invested in bonds are very likely to be worried that they are being left behind and will commit to purchasing stocks or equity funds of various types.

To create the desire to buy at elevated prices one needs to have increasing confidence in the future.  My old firm, now known as Lipper Inc., a ThomsonReuters company, has four separate growth fund classes based on the average market capitalization of the stocks in their portfolios. In a market where last year’s big long-term winner (Government bonds) are essentially flat through the 20th of February, the four growth fund averages on a year to date bases are up between 4.18% and 5.16%. A tight performance group of leaders, the four Small Company Growth fund groups are slightly behind. (I expect that some time during this surge they will lead.)

While performance numbers may be a spur to some, many others need an enthusiastic story to lure them into the marketplace that has already seen a significant advance. The classic case is Apple which I have owned for many years, but have no special knowledge about. Carl Icahn, currently a multi-billion dollar owner of the stock, has been publicly touting an eventual price of $216 compared to the current price of about $129. The media is jumping on with a story in this week’s Barron’s suggesting that the stock could rise 25% this year. Others state that the stock is selling at a discount to its value with the forward price/earnings ratio of 14.7 times. I have no idea whether any of these projections will come true, what I am focused on is that these and similar stories on some other stocks can be the propulsion of enthusiasm which is needed to create a major top.

To me, the surge is on. Be careful how one dismounts this animal, many have done it unsuccessfully.

Creating successful portfolios through science and art

For a long time I have been constructing investment portfolios for institutions and individuals, often using tools that David Rubenstein credits George Washington with as his inventions. One of our readers, a professional portfolio manager has asked how we would construct our time series portfolios. Thus this week I will outline, in many ways the single most important of the portfolios, the Operational Portfolio.

All of the time span portfolios should be viewed as platforms that within their bounds can have aggressive or defensive positions or some combination of them.

Great portfolios are the results of the interplay of science or if you will, numbers and ratios as well as future-oriented judgments. All great artists be they musicians, sculptures, or painters use both schools to reach the desired result.

The Operational Portfolio is designed to meet the current year’s estimated spending requirements and a reasonable guess as to the following year’s needs. In all likelihood these needs will consume all of the capital and income of the portfolio. Even under the best of circumstances surprise demands for spending will occur. Thus all investments in the Operational Portfolio must have weekly, if not daily liquidity and therefore should be reported weekly to the authorized spenders. Because of liquidity concerns at least half of the portfolio should have stop loss orders or similar arrangements, such as  “Good ‘til Cancelled” (GTC) which should be monitored at least weekly.

Clearly this Operational Portfolio is critical to the current needs of the beneficiaries. One can assure more comfort to these spenders and their guardians by increasing the size of the portfolio. However, any increase in size of the Operational Portfolio will decrease the capital to be invested longer-term at higher returns. This may well be the place where George Washington’s type of skills are needed to produce the most effective compromise for the good of the whole effort.

I have said that these Timespan portfolios are platforms which can be populated with various combinations of aggressive to defensive securities. The defensive issues could include US Treasury Bills of various maturities, insured deposits of sound banks and the highest quality portfolio of commercial paper. The aggressive securities could include short-term loan participation portfolios, some broadly based index funds and perhaps some ETF-like vehicle that has a larger mutual fund (which could provide liquidity to the ETF if there was a redemption run on the ETF) and Foreign US dollar pay or hedged short-term foreign treasuries. Populating the specific portfolio for the client is where the art form will shine.

The other three Lipper time span™ will be discussed in future posts.

Question of the week: Do you see signs of a surge?
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Copyright © 2008 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Sunday, February 15, 2015

Reading the Market Surge



Introduction

We all look at the world first through the lens of our experience. Even while I was still on active duty in the US Marine Corps I read Barron’s weekly whenever I could find it in oversea ports or posts within the US. While the articles were of interest, the back part of the magazine had and still has within it the most comprehensive pages of weekly market and economic data. When I started to look at mutual funds as clients for my research analysis pieces some fifty years ago, I tried to create a similar compendium of fund data. Thus, today I look at the global stock and bond markets first through reviewing fund data to get my bearings.

Six weeks into 2015

Dow Jones has combined a good bit of the Barron’s data with its own statistics and includes in its online Market Data Center mutual fund indices and investment objective averages from my old firm. Through Friday the 13th of February there are four fund types that are up between 3% and 4 %. These are three growth-oriented fund groups that are labeled Growth funds investing in various sized market capitalizations, excluding Small-caps; plus a fourth group investing in Science and Technology companies. The only fund classification to show better results, (surprising to some) are the International funds, up 4.14%. What implications do I draw from the data?

Growth vs. Value

Over very extended periods of time those funds that follow the growth religion produce roughly the same long-term results as those followed by the value investors. To the extent that value does somewhat better, it may be a function that in their portfolios there are stocks that are acquired while growth companies (using their higher valued stock) are the acquirers. The plain truth, on balance, is that acquisitions don’t work out for the acquirers. However, the rotating performance leadership between growth and value investors can inform investors as to where we are in the sinusoidal, or if you prefer, cyclical market unfolding pattern. The single most important touch point for a value investor is current price relative to the estimated intrinsic value of the company. The growth investor's first focus is what the future is likely to bring to the investment under consideration. In markets that are fearful of a return to periodic declines, the pragmatic skills of the value investor are rewarded. They are very much “now” people. The growth investor lives in a world of expectations. These two polar opposites lend themselves to the currently popular designations of “risk on or risk off.”

"Risk On" phase

Have we entered a risk on phase? The Growth fund leadership suggests we have. The NASDAQ market index has rallied more than the more senior exchange indicators. (Part of that is due to the preponderance of Science & Tech plus Biotech issues listed there which may suggest that in time Small-cap Growth funds will be part of the leadership group.) The broadest gauge of the US market, the Wilshire 5000, went to a new high last Thursday. Other “Risk On” indications may be in weeks of rising US dollar values, when mutual funds are regularly seeing redemptions of domestic-oriented funds and money pouring into International funds. One doesn’t do that if one believes that globe’s leading equity market will be collapsing. Even Bond funds are participating in the move to take on more risk with flows into High Current Yield portfolios and withdrawals in some other types of Bond funds.

Is this bullish or bearish?

The plain answer is both. Markets rise on the basis of renewed hope and accelerating expectations of very positive future results. As regular readers of this blog may remember, I have felt that the lack of great enthusiasm has protected us from more than a normal 25% or so drop which regularly happens in most decades. For a bigger decline, of a once in a generation type, we will need to draw many more people into participating into the enthusiasm. Some will quit their day jobs to trade the market. Families will rearrange their long-term safety nets to participate in new wealth and advanced spending. This is not happening yet.

Future clues

The fund flow data mentioned above has within it some useful clues. The aggregate data mentioned includes both the traditional mutual fund data and their newer and more institutionally-oriented Exchange Traded Funds (ETFs) and similar products. While the combined data is showing “Risk On” characteristics, it is  being driven by the materially smaller ETF community and by much more active, trading-oriented hedge funds and similar managers. In many cases these traders are relatively short-term holders of these vehicles as they are using them as substitutes for more expensive futures with less liquidity. A much better clue will be the morning coffee klatch and cocktail parties and social receptions where the loudest talkers will be bragging about their “brilliant purchases of individual securities or hedge or mutual funds.

Individuals: What to do?

To your own self be true. Individually most of us have gone through a number of downturns and thus tend to be more value-oriented than growth buyers. Stay with what you know and be prepared to pick up deep bargains if they appear. Others that are schooled and comfortable with science and technology can have a reasonable portion of their wealth in growth and have the wisdom to understand and take advantage of periodic disappointments.

Institutions: What to do?


As investment committees are made up of individuals with different backgrounds and investment proclivities, some combination of the two approaches is often the best. The approach that we recommend has to do with our series of time span portfolio constructs. In both the Operational and Replenishment Portfolios it is reasonable to assume a market decline is coming followed by a recovery. In view that we have not had a shakeout since 2009, one should be expected. These two portfolios should be as small as possible to meet current and replenishment needs. More of the sound, long-term institution's needs should be in the Endowment Portfolio with a time horizon of fifteen years and the Legacy Portfolio for the next generations' needs. These portfolios should not be utilizing market timing approaches and should invest for the long run.  By definition there are too many sold out bulls in a recovery.

Question of the Week: Will your current portfolio wisely handle the next bull and bear market?

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Did you miss my blog last week?  Click here to read.

Comment or email me a question to MikeLipper@Gmail.com .

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Copyright © 2008 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.