The first priority of investing - protecting principle
You are right to point this out, but it was what was already being said - the myth is that to get greater returns one must take greater risks - is the same way of saying what you said - i.e. protect principle - only added that the goals are not mutually exclusive (the myth). This is false.
The truth is to get greater returns, one must have a certain (genetic) predisposition and superior clarity of thought
Making another 50% may not "change your lifestyle", but it may change the outcome of your philanthropic endeavors.
The choice is not to lose or make 50% but between average and superior returns while never jeopardizing principle - losing 50% is never an option in what is being discussed above.
What a person does with their money once they have it, is their business, however there is no rational argument against making more of it, if it can be done on a consistent basis with a significant margin of safety.
....continue to invite your questions and challenges - your ideas are right (protecting principle) - what is missing is the framework. ...believe in little time your views may change (as mine did on the business of law)
From: John Doe [mailto:JohnDoe]
Sent: Sunday, January 08, 2012 4:47 PM
To: Emmanuel Gregory Lemelson
Subject: Re: Got a little carried away, but stay with me.
Greg, thanks for the input. We strongly believe that current European situation is not akin to any of the historical situations you mention and that US markets have a significant probability of getting crushed if Europe unravels, even partially.
It may not happen, but in our view the upside over the next year is not significant enough to warrant the downside risks. I simply disagree that these existential risks can be ignored on the grounds that the world always has risks. This time is different in our view---but we shall see.
My son, Daniel, has strong background in analyzing individual companies, and he has been following many--and has full Bloomberg service. He has computer science and law degrees, plus MBA in finance from the Univ of Chicago which he obtained while working as the lead analyst for friend of mine who does distress deals and is now on Forbes 400. Daniel also had a hedge fund that was one of my most success investments--their expertise was analyzing individual companies, particularly those in distress. We also have fee based financial advisors, plus my other son, Demitri, has strong practical investment background.
We are not doomsdayers, but we are conservative at this point in regard to US and world public markets. We have substantial private investments and have continued to make them during the last year.
Individual company fundamentals did not mean much during the US financial crisis. We will be in public markets again, but not until we have some conviction that the risks are worth it.
On Sun, Jan 8, 2012 at 7:22 PM, Emmanuel Gregory Lemelson wrote:
Thank you for the response and additional info.
Do you want my [further] opinion? (do not want to overstep bounds)
If yes, will add more.
From: John Doe [mailto:JohnDoe]
Sent: Sunday, January 08, 2012 7:24 PM
To: Emmanuel Gregory Lemelson
Subject: Re: a question that should have been asked earlier...
Always willing to learn and to hear differing viewpoints
On Mon, Jan 9, 2012 at 3:10 PM, Emmanuel Gregory Lemelson wrote:
Will speak to you as a friend, and totally openly.
On "differing viewpoints"
Everyone has a different viewpoint, and it is not possible to listen to all of them. The objective therefore is not merely to listen to "differing viewpoints", which is an exercise in futility, but rather to seek to identify the "highest viewpoints" - they are not all equal.
On the "Current Situation"
Again you are correct, that the current situation is "not akin" to any of the historical situations mentioned (could not mention all of them, but consider Sept. 11th, or WWII) - history never repeats itself exactly. It is only with the clarity of hindsight that we will all understand how serious the current situation is in Europe in relation to the other extraordinary events of the last and current century - during which time the modern free markets continued to function.
To be clear the last email did not lay out an opinion on the "severity" of current events, it only made statements about the constant problems in the world, and the need for investors to keep this reality in context and finally that there is no valid argument against active and wise management of investments.
If forced to bet on what will happen with Europe (and there is NO way to know), would bet that it does NOT cause a collapse of the US equities market for the knowable reasons outlined in the last email (i.e. money supply, US debt, inflation etc.). the US's vested interest in inflation is simply too great.
On "Upside" and "Downside"
Terms such as "the upside" or "the downside" need to be examined more carefully. What is meant by "the upside" or "the downside". The upside or downside of what? The markets?
Consider the following:
- What is the difference between the market as a whole and individual companies?
- Does the performance of "the market" as a whole matter if
a) One is not buying an index fund
b) Is interested in owning (not trading) pro-rata shares in companies as a matter of investment policy.
c) Understands investment primarily as a long-term activity.
d) If companies can be found that compound returns on owners equity regardless of "market" activity.
- What is the difference between "value" and "price"?
- If the "market price" of something changes, does the "value" also change?
- Who determines the value?
- Who determines the price?
- How many market participants does it take to move the price of a company's stock?
- Is the short term price evaluation of these market participants important if their motives are not understood?
- Who has the superior ability to appraise value and determine price?
a) large groups of participants who are often known for their emotional/ irrational behavior
b) Rational Individuals with a rational framework for finding and appraising value
- How important are short term fluctuations in price (even lasting say 2 years)? The last crisis lasted about one year, before prices began to reverse.
- Can the value of an asset continue to rise, even if the "market price" does not? What does this mean to a patient owner of such a security?
- Were there companies whose actual value increased during the last crisis periods (Q2 2008 - Q1 2009), even though their price declined temporarily?
- Should an investor be primarily interested in price or value?
- What does a speculator / trader focus on?
- What is the difference between speculation and investment?
At no time are Risks to be "ignored"
It is important to understand what the last email actually said. At no time was the suggestion made that risks be ignored. What was said, is that risks should be analyzed that can actually be known - rather than speculating on ones which cannot. There is a big difference in the two statements.
For example, is sitting on "lots of cash" risky?
It depends on one's view of inflation. The question is where is the analysis and calculus of this risk? After all inflation is a risk which can be known and calculated with far more accuracy than the vague risks to the Dow index brought up in the email.
"This time is different"
Could not agree with you more - indeed the cycles of history while repetitive always take on a different form in each iteration.
For example, there are some articles on Amvona.com that talk about a little problem with about 7 trillion in US originated RMBS and the related demise of clear ownership rights in real property.
If true this would be a unique and "different" risk in a way not seen before in the US (real property laws are the foundation of our democracy). Is the risk to the securities market of this greater than the civil war? Not sure.
The author has made the opinions boldly and with confidence going back almost two years when the thought was unimaginable that people may be paying on a mortgage that will never lead to clear title to their properties.
One of the recent articles had ~4,000 shares on Facebook, was featured in the mainstream financial media, and appears to have reached about half a million readers. The suggestion at the end of that article appears to have given rise to the "occupy homes" movement which has replaced the OWS movement.
If the author is wrong, it would be reputational suicide (for it is a far more bold prediction than Dow 5000 - which was made privately). However, since those ideas were first presented some years ago, receiving much scoffing and even death threats, the reality has gradually seeped into mainstream thinking.
So how is this different than the Dow 5000 theory?
Well for one it does not rely on what "they" said. Rather, the arguments rest on more than 20,000 words formed into rational arguments, evidence presented, and the thesis packaged into articles that anybody is free to debate on the basis of rational argument and evidence. The same cannot be said of the issue raised in the email regarding the Dow 5000 theory - where are the arguments? How can they be countered or responded to? The proclamations are supremely vague.
The "no property rights" thesis is one hell of a prediction and nowhere in those ~20,000 words is it suggested that this "real" risk (not existential) be "ignored" rather very specific advice and instructions were given going back many years - i.e. if your mortgage has been securitized - stop paying it, regardless of financial ability.
Apparently more than a few million people have since "signed up" for the "no property rights" thesis:
(there is also a superb article in the recent addition of Harpers weekly which covers the same topic)
It is also different from Dow 5000 theory because rather than leading to fear, it is viewed as opportunity. While nobody is running out to buy stocks , as Prince would say "like it's 1999", they haven't seemed to have noticed, that ownership rights in the equities of companies has been perfectly preserved, and with far better regulatory oversight than real estate ever had to begin with (historical property recording practices can be called "scary" at best).
Since ownership rights to 7 trillion in real estate assets are now corrupted, suddenly stocks look even better and have less competition, but apparently many a psyche have not recovered from 2000 and from 2008 to notice- no matter what the numbers actually indicate, and how good the bargains are.
Even some very fine investment thinkers were wrong on the whole "if real estate is not valid, it's good for stocks" connection...
More on the relationship between credentials and returns
It is no secret that a good many billionaires are college drop outs. Why would investing be different? Education was categorized in the last email under the "not necessary" sub-heading.
That is not to discount the importance of education - having spent 9 years in a university, that would be hypocritical - however, it is important to recognize that while a classical education which edifies the intellect is desirable, there is little to prove a relationship between an education essentially in technical data (the ancient Greeks had 3 words to define the differences - τεχνι, γνώσης and σοφία) and an ability to generate wealth (not to be confused with a higher "paycheck").
However, some people use certain academic institutions more like social networks, whereby they leverage "who" they know rather than "what" they know - but, this does not apply well in investing over the long run, which is the most pure of all business endeavors, and requires both independent thinking and ideas.
If your response was read correctly, it sounds like extraordinary connections lead to the ability to create a fund which did well. Here are some questions:
- Did the fund do consistently well?
- If so, is it still in operation?
- If the fund did do consistently well and is not in operation why?
- If it was not able to do "consistently" well than could it have benefited from the real engine of growth "compounding"?
Above all, it should be noted that there is really only one figure which matters - that is the average annual return referenced against a benchmark.
Amvona's results are published.
It never ceases to amaze, how very intelligent businessmen will generate huge returns in their business, then settle on single digit returns on their investments. For example you must have produced a multi-hundred thousand percent return on your investment in your [type omitted] law practice.
The only detailed figures shared so far in your investments has been:
- A (seemingly) lost private investment in a social music site
- A lost investment in an esoteric [bank name omitted] product (although it was recovered through legal action)
- An 8% return on the settlement outstanding
Surely there are more positive returns and probably other losses. However, you would not believe how remarkably similar what you say is to almost everyone else worked with - in each case, have found a situation of:
a) High broker fees
b) Hits and misses running at about a 50/50 ratio with no consistently high returns
c) A great deal of anxiety about the whole affair
Two recent examples come to mind a) a friend with only 100k and b) another friend with ~5 mln (and estimate your situation involves ~100x the later example).
All three cases involve highly intelligent individuals, but when they begin to discuss investing it is hard to parse out anything more thoughtful than a nebulous echo of CNBC's schizophrenic headlines - in all 3 cases prior and existing brokers appear to have done a great deal to encourage this.
Email correspondence from any of these three could easily be mistaken for the other - each believing their "insight" and "special knowledge" set them apart, and yet they seem to be completely unaware that they fall into a rather large group of like-minded persons.
The other two along with many others (through conversation such as this) over a period of weeks and months changed their views, and sleep better at night - and now have consistently high returns. If this dialogue continues, believe will be the same result in your case.
On private and VC investments:
If risk is the focus, is it not legitimate to point out that VC bets often represent some of the most risky bets one can make?
Does the fact that private investments do not have a liquid public market make them safer? Do not both lack 100 years of evolution in government regulatory oversight?
Why would there be a trend towards not only private growth, but trading in private concerns (think the rise of private market places), unless public or government scrutiny was undesirable?
The average VC fund achieves an acceptable rate of return only because of the "old boys club" culture in which often valueless properties are sold to "friends" in backroom deals. While there is the rare exceptions which create huge wealth for a few VC's, on average, nobody thinks of VC funds as capable of creating say 25% annual compound growth over say 5 decades - a metric easily achieved by good value investors.
A few VC's as you know become extraordinarily wealthy through early investments in the right companies, but being able to replicate this is nearly impossible. Unfortunately many if not most VC endeavors never lead to real enduring shareholder value, and all to often resemble a sort of pyramid scheme instead - predicated on incestuous board positions. The VC world is truly a world of high risk - you could make it big here, but the odds are not in favor of sleeping well at night along the way.
For these folks, "compounding" is a dead word, because the goal is getting rich "quick", there simply is no time to allow "compounding" to kick in.
On the Forbes 400
The Forbes 400 is nice but is this the correct canon?
The magazine tells us how each person created there wealth and got on the list, but what they do not tell us is how they also fall off the list. While names are mentioned for those who no longer "made it" yearly, they do not give an explanation for this losing performance (bad investments is the universal culprit, inflation is a close second).
Consider the following:
1. How many on the Forbes 400 have been able to stay on the list for even 10 years?
2. What does this imply about these 400 people's ability to safeguard their wealth and grow it (consistently compound returns)?
It is known that some will make great wealth - sometimes through good fortune, timing, hard work, once in a lifetime opportunity, etc. etc. - however, this should never be confused with the ability to consistently and wisely invest and grow wealth - the majority of Forbes 400 participants do not possess this ability, which is why they often fall back off the list (or down the list) in a relatively short period of time.
It has been said:
"It requires a great deal of boldness and a great deal of caution to make a great fortune; and when you have got it, it requires ten times as much wit to keep it." (Nathan Mayer Rothschild)
On "US and world public markets"
What does this mean to say one is "conservative... in regards to US and world public markets"?
Consider the following:
- Does this statement require bearish sentiment on inflation? Is share price not heavily influenced by monetary policy, just as cash in general is?
- Are large companies and their performance not a reflection of the economy as a whole?
- If global economics are poor, why would private companies fair any better than public ones which are often run much better and have the benefit of public and government oversight, not to mention long, publicly verifiable performance track records?
- Do dislocations in price/value ratios occur more often when the number of market participants increases (public accessibility vs. private)?
The incestuous nature of "private deals" more often than not creates greater risk, not less.
The fact remains that the principles of sound investing do not change much from instrument to instrument (either it is a sound investment, with a significant margin of safety or it is not), but is seems that a great many participants in these investment classes are not actual interested in value, fundamentals or "margin of safety" when they invest in VC or private endeavors, instead they are typically focused solely on future "promise", which most often does not materialize.
Like raining Gold:
Have observed a remarkable thing about the majority of public market participants - Most invariably believe they have:
a) "An edge", some special insight, or talent, or secret information that puts them ahead of everyone else
b) Exceptional "intelligence" and "ability"
c) A special insight into where "the markets" are headed
The investment world, perhaps more than any other single industry is wrought with Hubris.
If one studies the last hundred years of stock market investor behavior, more often than any other subject the direction of "the markets" is discussed - nearly all having strong opinions one way or another - and universally they are wrong - for no-one has the ability to see into the future. Despite all the evidence that "timing the market" or knowing in what direction it is headed is virtually impossible to do, it remains the sole focus of mental energy for a great many otherwise very highly intelligent men.
This is truly a remarkable feature of public markets - how could so many bright participants be distracted with an exercise proven to be futile. For those who are not distracted it is like the stock markets are "raining gold".
Parallels with the Legal world:
Obviously because a few will make money and a majority will lose it (by definition gains have to be asymmetrical), the above 3 points cannot be true for the majority.
Is it in the best interest of a "fee based" advisor that your thinking is "straight" and "clear" on these points?
If you're thinking is not clear, you will have to depend on the fee-based advisor to think for you, not just to work for you - (The danger zone for the client).
Once the thinking is straight, a certain type of manager can be chosen, whose results are consistently high and is compensated for performance (the danger zone for the broker)
Again it is no different then the legal world - an attorney and a client's interests are only ever fully aligned in a fee-contingent arrangement - that is when the law is most "business like" and that is when investing is most "business like"
If the attorney really knows what he is doing, why would he want it any other way, he stands to make far more from mutual success with the client than from merely collecting a fee.
The arrangements must be no different with money managers. If there performance is good (high watermark - relation to benchmark), they should be paid well -and a client making 25+% on average per annum would be happy to pay such a fee. (50 mln. compounded at 25% pe year is 122 mln. in only 5 years. - 372 mln. In 10 yrs)
If the performance is poor, the manger should not be paid a dime.
Much like the law, misaligned interests are the most serious structural problem in money management today.
There is never a reason to pay a fee - either the guy can do it, and repeat, or he can not.
The greatest disservice advisors can do for a client is affirm in their mind that they need "special expertise" and the the landscape is complicated, filled with esoteric and difficult to understand dangers, and equally complicated and esoteric products are necessary - when the clients head is done spinning, he will realize he will never have enough time or ability on his own to possibility understanding how to do this whole "investing" business successfully - precisely how a great many clients of lawyers feel about the law and the courtroom? Their confusion so profound, that they will not even ask basic question and in their confusion can be lead into just about any bad investment or judgment.
Religion functions no differently. There are the gatekeepers of "special knowledge" and they must be paid their due.
Albert Einstein once said:
"If you can't explain it simply, you don't understand it well enough"
Is the opinion of someone who does not collect a fee intrinsically more valid?...
A few more questions:
Why do so few focus on this? Because they do not have the ability to formulate and execute an investment philosophy which produces consistent returns - it is only through producing consistently high returns that the real engine of growth ignites - that is to say compounding.
Do you think Warren Buffett:
a) Got lucky
b) Is an anomaly?
c) His track record is not noteworthy (1964-2010 overall gain is 490,409%)
Are there are others out there with these abilities or more?
Berkshire Hathaway (BRK.A) as the most obvious example has beaten the S & P 500 (if taken in five year cycles) for over 50 years. It is necessary to review in 5 year cycles because of the very nature of value investing, the dislocations in value-price appraisals of the markets, and the fact that value investors are almost always doing what the public at large is not. Even if viewed in individual years, Berkshire has almost always beaten the major indexes.
That's enough for now - look forward to the new questions and challenges - of course it would be much easier to do by phone.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.