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Munger, markets, and a day at the track

|Includes: Berkshire Hathaway inc. (BRK.B)

Really nice article at Can Turtles Fly? entitled, “Charlie Munger: Stock market as a pari-mutuel betting system“.  The ultimate market commentator/psychologist, the post quotes Berkshire’s Munger and his core tenets on investing, culled mostly from an undated speech, “The Art of Stock Picking.”  Beyond being a really interesting read, the speech details Munger’s proposition that the stock market is a pari-mutuel betting system.

From Munger’s speech:

Everybody goes there [horse track using pari-mutuel betting system] and bets and the odds change based o­n what’s bet. That’s what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so o­n and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system.

And then the track is taking 17% off the top. So not only do you have to outwit all the other betters, but you’ve got to outwit them by such a big margin that on average, you can afford to take 17% of your gross bets off the top and give it to the house before the rest of your money can be put to work.

Can Turtles Fly? then breaks down Munger’s ideas into two insights: odds always are changing and it’s hard to determine the best bet, and investors have to win in spite of the house always taking a cut.

It’s a good read.  I definitely recommend perusing the article on  a lazy, last Sunday of summer, like today.

Good investors can and do win by taking these rules into account and taking things very seriously.  Can Turtles Fly? found these ideas very influential and has concentrated his investing into infrequent, larger bets when he feels the odds are more in his favor.

These same inefficiencies in the market also lend opportunities to new firms or types of investors willing to do the hard, sweat-equity type of work, like SecondMarket does.  The firm, profiled in today’s WSJ, “brings together buyers and sellers in the largest centralized, independent marketplace and auction platform for illiquid assets.”

As the market for adjustable-rate securities basically just got-up-and-went (witness the current Cuomo-led suit vs. Schwab), sellers were having a hard time pricing what they were left holding, let alone selling them.  There’s always a price where a transaction gets done but given what happened over the past year, buyers and sellers couldn’t connect to find out which price provided liquidity to the seller and a good bet for the buyer.  So, along came SecondMarket and a slew of other companies to play matchmaker for this market.

In a recent discussion with Benchmark Capital’s Michael Eisenberg, Eisenberg related to me that he expected to see technology-led new markets arise over the next few years providing transaction liquidity in things we’ve never even heard of.  What’s interesting with SecondMarket is that it’s start was nothing more than five guys and an Excel spreadsheet.

According to the WSJ article:

The company started out, as Mr. Silbert puts it, with just “five guys, five phones and an Excel spreadsheet” in his apartment, then in a succession of funky office buildings.

SecondMarket has cobbled together a database that allows its approved members to search for possible purchases and make bids. Still, sellers can’t always peddle investments to whomever they want. Hedge and private-equity funds and private companies can veto a buyer if they don’t like him. They also can bar a buyer from bidding and can control the amount of information about them listed on SecondMarket’s site. Seller identities are kept secret at the outset, so as not to anger the managers of funds or private companies.

The bidding system isn’t totally electronic. SecondMarket’s specialists will leap in verbally to bring buyer and seller closer together. For instance, the seller may want 100% of what he paid for a security and the buyer may bid just half that.

It’s clear that once buyer and seller are matched, SecondMarket’s job is not done.  In order to clear the house’s 2-4% transaction fee to getting a deal done, the firm needs sell both buyer and seller on the merits of a transaction.

Inefficiencies abound and it’s likely that secondary, secondary markets may see less business as the overall stock market makes its rebound.  But it’s interesting to see why and how investors can make money off of the market’s ever-present, ongoing inefficiencies.