Every generation needs a revolution.
Every generation needs a revolution.
A few months ago a friend asked me why we write this blog. They wanted to know if we thought we were an expert or an authority on the subjects we talk about, and thus felt it appropriate to share our views. It’s a good question that I was thinking more about and had been meaning to turn into a blog post in reply. So, here’s why we write this blog.
Not experts or authorities, but popularizers
While our level of study and experience with the primary subject matter of this blog varies from quite intensive to novice, we don’t see ourselves as experts and don’t believe we have any special authority on the subject. We don’t write about things we’re interested in to try to provide an “official” analysis or to convey the idea that we ought to be listened to just because we know what we know. Instead, our goal is only to popularize the ideas that interest us and that we consider important.
We popularize for three reasons. One, it improves our lives if more people are interested in the things we are interested in. Two, we find talking about the things we’re interested in to be entertaining and thus enjoyable in and of itself. And finally, we think we’re good at popularizing.
In our experience, we are typically the “gateway drug” of various ideas in our friend network. In other words, we are the first point of contact for many of our friends, on many subjects, to first learn of the existence of a particular idea. That isn’t because we’re super smart, or super knowledgeable, or they are the opposite– it’s simply because we happen to have eclectic tastes that are often orthogonal to our friends own cultivated interests. And because we’re passionate about what we believe in and find ourselves talking about such things quite frequently, there are many opportunities for our friends and other people we know to get exposed to our ideas.
We haven’t had an original idea, ever, though we’ve synthesized a few good notions by mashing unrelated concepts together. We’re not trying to create a scientific revolution or move humanity forward with an invention. We’re content to merely spread what we think are good ideas to other people. More importantly, we think there are common logical threads woven through the core principles of our most important ideals such that there is a coherence to being interested in all of them simultaneously. We’re interested in showing more people how subjects seemingly as diverse as economics, politics, philosophy, nutrition, corporate governance, parenting and family formation can all be linked together by common ideas.
Part of our family’s inheritance
If we produce a premium product on this blog in terms of a collection of ideas, experiences and opinions which together are valuable, we can do a lot of “work” in terms of human capital for our family, including our children. We can pass this resource on to them not only in their present intellectual endeavors, but to future generations who may come to know us only by the written record we’ve left behind. This blog will serve as part of the treasure of our family and we hope it will provide compound interest all its own!
A research emporium
We read a lot. We ask a lot of questions. We spend a lot of time thinking about the things we become interested in. And we have limited memory with which to serve all of these activities and thoughts. Our blog is an extension of our accumulated memory on various subjects. What’s more, it’s searchable with an algorithm, and it is open to the public. We enjoy contributing to the collective intelligence of humanity in this small way, particularly our own! We are always amazed to look back on something we’ve written about in the past and go, “Oh, so that’s what we think about that subject!” And it makes it easier to answer people’s questions or have a deeper discussion when we can reference our previous thinking to others by linking them to a blog post.
A tool to aid in concrete thinking
The practice of writing one’s thoughts down, particularly for public consumption, focuses the mind. It requires one be more thoughtful about what is essential to the idea. It demands one hone one’s rhetorical blade. It just produces better thinking over all to go through an idea enough to try to explain it to others. Our ideas always get better when we try to write about them. Better thinking means better doing.
And a tool to aid our writing
Of course, practicing writing one’s thoughts also means practicing one’s writing. We think we make improvements in that area by writing this blog as well.
We think we’re good writers. And we like our own ideas. And we enjoy humoring ourselves with our own thinking. Even if no one else comes by to look at what we’re doing or gaze in awe at our commanding knowledge on certain subjects, we’ll be entertained by looking back on what we wrote.
by Matt Ridley, published 2011
Why, for the last 300 years, has “everything” been getting better and better in terms of just about any human outcome you can come up with? Human beings are getting better at exchanging ideas and thus generating new and better ideas. In addition, the total stock of life improving ideas humanity can build from is compounding at an increasing rate. The benefits of free exchange extend beyond the economic realm and into the philosophic, and then back again.
The author charts a surprising course through humanity’s shared hunter-gatherer history. He argues that it was economic trade which allowed the division of labor to develop, and the division of labor which allowed for the transition from hunter-gatherer subsistence living to agricultural subsistence, and from there to a compounding of capital and an increasing division of labor and economic specialization that allowed for mankind to finally break free of the Malthusian trap in many parts of the globe (and more every year).
In addition, he says we are never going back. The genie is out of the bottle and rather than the division of labor being fragile, it is far more robust than any social structure yet experienced and gets stronger the more specialized it becomes.
Because of this, and because when surveying history up to this point in the broadest terms possible there is evidence of things getting better and better for more and more people, not the opposite, the author concludes that the rational thing is to be an optimist and expect this trend to continue.
There are several convenient leaps of logic built off flimsy premises that would startle and upset an opponent of markets and industrialized societies, but there is such a preponderance of hard logic and even harder evidence that there isn’t enough here to tip over the apple cart. But the value of this book is less in its rhetorical force for free markets and industrial development and more in its sweeping survey of a number of seemingly unrelated historical data and economic phenomena into a coherent picture of hopefulness about humanity’s future. I found myself joyfully surprised by the idea that in the chicken-egg quandry of agriculture and trade, the author contends that trade came first and produced all the surplus we moderns have enjoyed since then.
Going “back to the land” or seeking out de-urbanized, atomized communities seem to be doomed to bring their proponents a lower standard of living overall, idealizing a past reality that never actually existed or rejecting the very thing (the division of labor) which is necessary to enjoying a desirable standard of living with modern securities and comforts.
I’m going through my personal document archive right now. I have data stretching back to 2007, though most of it clusters around 2009+ which when I started getting “serious” about hoarding data, documents and other bits of intellectual flair about myself. What started off as a simple Spring Cleaning-type exercise in tidying up my digital filing system is instead turning into a philosophical journey to a land of the past self and it’s inviting a lot of questions and thoughts I wasn’t expecting to have, such as…
I’ve got A LOT of information I collected at various times I was attempting to self-educate on topics of interest. For example, I have enough reading material to teach and supply a graduate level course on investing and financial analysis, business management and strategy and basic accounting and corporate finance. I also have collected digital copies of nearly every book and article I’ve read on economics and related sociology and historical topics. It’s essentially a download of my brain on these topics and, given that I feel comfortable with my level of knowledge in these areas, I’ve done a lot of the hard work in gathering up a comprehensive curriculum here which might be of use to a future learner, such as my child.
But will my child want to study these things? Will my Little Lion need to do the kind of painstaking scouring of primary materials, in volume, that I did? Or will my Little Lion learn a lot of the fundamentals by a kind of osmosis being around me, talking about this stuff with me, such that it won’t really be much use to have the archive for personal perusal?
Now that I am done with these materials, they have little value to me personally. It’s nice to imagine I’d dig in here and there for reference or to double-check something, but I haven’t touched this stuff since 2012 when I began collecting it. That’s 5 years! I knew I had it all this time, but I never went looking for it. What are the chances I will look back on it another 5 years from now? Or 20?
I try to live a simple life. I’m not a minimalist in practice, but the people around me would accuse me of such. I am tempted to just delete this stuff wholesale.
When I think about transmitting my book learning to my kin, and I think about the principles of selectivity and simplicity, there are few titles I would like to hand down and say “Read this if you want to be part of the family/have success in your life/grow your mind.” A book like Human Action comes to mind. That’s as close to Required Reading on each of those points as anything I can think of. But a PDF copy of “Investment Topic X”? Or “Economic Subject Y”? I don’t think it is essential to have that all lined up for the next in line.
The modern trend of Big Data promises amazing returns to collecting and analyzing comprehensive data about people’s interests, behaviors, etc. Mostly, it is a false promise in my experience and I think it’s a false promise in looking through my archive as well. Here’s some notes I took in 2010 on some subject. Here is a spreadsheet I built for something in 2011. Here is some list of experiences I wanted to have, or goals I was chasing after. It is the story of my life, the breadcrumbs along the path to whatever my final purpose and meaning is. (It’s amazing how you seem to get an idea in your head early on in your life and just iterate it over and over. I wonder where those ideas come from and why we get fascinated with them?) But what of it? Can’t rehash that part of my life and choose differently, and I am where I am, and it doesn’t offer much predictive value for where I am going unless it is to continue on the path I am on, but then it is inevitable so, again, what of it?
I think about this with my email archiving as well. I have a lot of emails stored up over the year. Conversations on all kinds of topics. Lengthy diatribes about what I think and why. A veritable mind map on a plethora of issues. It’s fun to be able to look back on it from time to time. But really, it is of more value to Google in selling my (anonymized?) data to advertisers than it will ever be to me in providing some kind of meaningful insight or prediction about myself. Mostly it is good for looking up old logins, loyalty program info, or upcoming event or itinerary data. After that, it is the past, and it doesn’t matter.
I have all these photos, too. Ever since I had a web-connected phone, they just started accumulating. A snap here, a photo there. How many have I looked back on even a week or two after I took it? The significance fades, even if the memory is still there. One day I could share with a friend who wants to know about a place I’ve been or an experience I’ve had, or with my Little Lion, to illustrate what life was like before I was a parent. Why? Why does this matter? It is gone. It can’t be gotten back to. What can it tell us? Little, I think.
So, a new habit to inculcate: create a robust, dynamic filing structure for recalling and accessing current data and records of interest, and then have the discipline to purge when these files go “inactive” in my consciousness.
This is from 2008, from the now defunct “Mencius Moldbug” blog:
In 1933, public opinion could still be positively impressed by group calisthenics displaying the face of the Leader, eagles shooting lightning bolts, etc, etc. By today’s standards, the public of 1933 (both German and American) was a seven-year-old boy. Today’s public is more of a thirteen-year-old girl (a smart, plucky, well-meaning girl), and guiding it demands a very different tone.
You are not a thirteen-year-old girl. So how did you fall for this bizarre circus? How can any mature, intelligent, and educated person put their faith in this gigantic festival of phoniness?
Think about it. You read the New York Times, or similar, on a regular basis. It tells you this, it tells you that, it reports that “scientists say” X or Y or Z. And there is always a name at the top of the article. It might be “Michael Luo” or “Celia Dugger” or “Heather Timmons” or “Marc Lacey” or… the list, is, of course, endless.
Do you know Michael or Celia or Heather or Marc? Are they your personal friends? How do you know that they aren’t pulling your chain? How do you know that the impression you get from reading their stories is the same impression that you would have if you, personally, saw everything that Michael or Celia or Heather or Marc saw? Why in God’s green earth do you see their “stories” as anything but an attempt to “manipulate procedural outcomes” by guiding you, dear citizen, to interpret the world in a certain way and deliver your vote accordingly?
The answer is that you do not trust them, personally. Bylines are not there for you. They are there for the journalists themselves. If the Times, like the Economist, lost its bylines and attributed all its stories to “a New York Times reporter,” your faith would not change one iota. You trust Michael and Celia and Heather and Marc, in other words, because they are speaking (quite literally) ex cathedra.
So you trust the institution, not the people. Very well. Let’s repeat the question: what is it about the New York Times that you find trustworthy? The old blackletter logo? The motto? Suppose that instead of being “reporters” of “the New York Times,” Michael and Celia and Heather and Marc were “cardinals” of “the One, Holy, Catholic and Apostolic Church?” Would this render them more credible, less credible, or about as credible? Suppose, instead, they were “professors” at “Stanford University?” Would this increase or decrease your trust?
For a hardened denialist such as myself, who has completely lost his faith in all these institutions, attempting to understand the world through the reports and analysis produced by the Cathedral is like trying to watch a circus through the camera on a cell phone duct-taped to the elephant’s trunk. It can be done, but it helps to have plenty of external perspective.
And for anyone starting from a position of absolute faith in the Cathedral, there is simply no other source of information against which to test it. You are certainly not going to discredit the Times or Stanford by reading the Times or going to Stanford, any more than you will learn about the historical Jesus by attending a Latin Mass.
We are now being told that the election of Donald Trump represents a virulent strain of tyrannical fascism in American politics, which was before lying under the surface but is now unapologetically out in the open. Certain agitators and political commentators are claiming that they don’t feel safe in a world where Trump is president, implying that there may be physical threats against their life, property or lifestyle under his regime. The conclusion is that Trump is to blame for a politics of potentially open, physical violence across partisan lines.
But if this is what Trump represents, Trump is the necessary response to an earlier dynamic, not the initiator of it. You see, the Left has been successful in its quest to control politically-acceptable speech. The world of man can be controlled by arms, or by words and ideas. If certain words and ideas can not be uttered, then the people who believe in them have no choice but to take up arms in their support. What choice but violence does a person have to convince another of his views, if his views are considered unutterable in society?
We are also told that Trump is committing what amounts to treason in warring with political factions in his own country while buddying up to autocrats in other countries, such as Russia. If the right way, and the only way, to conduct a political strategy is to play by your opponent’s rules, then this criticism may have merit. But politics is war by other means, a game of domination and annihilation. If you are a globalist after global control, you might call a truce here and there with domestic factions to enhance your projection of power outside your borders.
But what if you are a “nationalist” or “patriot”, like Mr. Trump?
If your primary political concern is dominance within your own borders, it is clear who your enemies and your friends are. Your enemies are any domestic political factions which question, criticize or otherwise restrain your full use of power inside your borders. And your friends are any parties, inside or outside your borders, that can either help you defeat your domestic opponents in some way, or who can agree to some kind of truce that lets you focus on defeating your opponents at home.
Make no mistake about it– Mr. Trump is in a war for his political (and potentially even vital) life, such is the nature of politics which has no rules but that which each opponent might individually observe. And looking at the world as he claims to, it seems not only not treasonous, but completely rational, to find friends where they can be found in order to quell the domestic disturbance represented by the Democrats and the American Left. And we can sense the truth of this proposition in observing that while critics of Mr. Trump argue that he should make peace with his domestic opponents to fight external enemies, these critics are not suggesting these opponents make peace with Mr. Trump, nor are these opponents themselves voluntarily laying down arms against Mr. Trump for the time being to take them up against the Great Alien Menace. Actions speak louder than words here.
And what about the spat with the domestic spy agencies? Ignoring the fact that they were un-American and not to be trusted under the Bush regime, and were clearly un-American and autistically-focused on studying the communication patterns of those people they nominally serve under the Obama regime (and when did these people face election and change under any of the last three administrations?), they are supposed to be answerable to the Congress, which supervises them, and the President, who leads the nation they serve.
To raise the claim that Mr. Trump is playing a “dangerous game” in challenging their methods, claim and authority, is to belie the very corruption his opposition to these organizations so far engenders– this may be a hard metaphor for many to understand these days, but it would be as if the appointed chief executive of the owner of a company was playing a dangerous game in challenging the actions and attitudes of the company’s hired employees. This argument has the theoretical cause-effect relationship of American civics exactly reversed.
In case anyone needs reminding these days, why is it exactly that the American intelligence “community” (note: for their to be a community, there by definition must be some who are inside it and some who are outside, that is, citizens of the domain and barbarians at the gates…) is to be considered trustworthy?
Have they demonstrated gross competence at their appointed tasks? Anyone who has not forgotten the failures of September 11th, 2001, must puzzle at the question.
Have they any kind of record of their activities and thinking that is examinable by the public? No, only the Congress and the President have access to that information (if the intelligence agencies are honest in presenting it in the first place!) and there is a clear principal-agent problem in electoral politics presented by these defined secrets.
And what kind of people are they who join these secret cabals, whose jobs seem to consist of lying for a living, trafficking in arms and illicit substances and occasionally murdering people deemed to be strategic problems for themselves or the government they represent?
Well, just that– liars, murderers, professional criminals and reckless thrill-seekers.
A better question than “Why should they be trusted?” is “Why should they be tolerated in a society that claims to have an open government?” Speaking of tyranny and autocratic rule, is there any model more noble in form than the modern spook cartels?
Isn’t it interesting how people develop a sense of entitlement over things that, until only a few years ago, did not exist?
And isn’t even more curious that people will become defensive about protecting outmoded jobs they hate?
I read an article about NYC taxi and limo drivers seeking to ban the implementation of autonomous vehicles in NYC to protect their jobs. But how many taxi and limo drivers even like their jobs, or love them? Do these people wake up every morning, breathe deeply and say to themselves, “I am so grateful to get to drive people around again today!”
Technology marches on, and soon it will provide new things and new jobs for people to feel entitled about.
by Bill Bonner, Will Bonner, published 2012
What kind of habits and modes of thought separate Old Money families from everyone else? How do you build a family fortune? How do you get a family to work together toward a single purpose as the “core” is continually invaded by new spouses and children? How do you invest your prodigious wealth at high rates of return? How do you hold on to your family fortune for 100 years? Why does 100 years seem like a long time when it’s really only 3-4 generations of people?
Frustratingly (maddeningly?), the answer most often given in this book to questions like these is, “We don’t know, but here’s our guess.”
What I didn’t get from this book, then, were many specific, useful ideas for implementing with my own family enterprise– or family-as-enterprise. What I did get, and what will be the focus of this review, are a lot of questions, principles to ponder, and general strategic problems in need of robust solutions. This is not a how-to manual for putting together the essential structure of long-lived family institutions such as tax and estate planning, family organization and branding, household management.
Most people will not have a family fortune to contend with. It is not something that can be acquired through a known formula, but rather it is the outcome of an entrepreneurial process that is, epistemologically speaking, random. Just as one can not predictably create a family fortune, one can not predictably control the size or scope of the family fortune, within certain bounds. In other words, your family may have the good fortune to stumble upon a business opportunity with a significant market capitalization. That’s the first hurdle, and there’s no formula for getting there. Then, that fortune might turn out to be worth $50M, $100M, or $5B. That’s another hurdle, and there’s no formula. Failing to seize every opportunity you are presented with might limit your total fortune, and being eager and observant for those opportunities might extend the limit. But there is no recipe for turning something that is worth $50M into $5B unless it was the kind of opportunity that can scale that big in the first place.
Some market opportunities are worth a lot to one person who owns them (“he made a fortune!”), but they’re still not worth a lot to the market or economy as a whole (limited scale). This is an important point because of the gilded cage nature of family fortunes– once you have one, you’re kind of stuck with it, but it’s really tempting to think you have a lot more control over it than you do, or that it’s a lot more durable than it might be.
Imagine you’re the guy with the $50M fortune. You’re pretty happy with your luck, assuming everything else is right in your life, but you’re aware of people with $5B fortunes. If you can generate a $50M fortune, why can’t you generate a $5B fortune? Are those people smarter? Better connected? More productive? What’s the difference?
Luck, and leverage, but using leverage without blowing up is really just a residue of luck.
So you’ve got this $50M fortune. What can you do with it? If you have it invested in the business that created it, you enjoy a nice income stream from it each year (maybe that’s worth $2.5M, maybe it’s worth $5M if you’re really lucky) and you reinvest where and when you can. If your business doesn’t scale easily though, you can’t put it back in and make more. You’re stuck at $50M. What if you take the $50M out by selling the business? Now you have $50M in cash with no annual return and an investment problem. Where are you going to put $50M to work such that you can, say, spend $5M per year and still have $50M left over to do it again next year? Know any hot stocks? You didn’t make your fortune in investing the first time around, what makes you think you’re going to make it there the second time around just because you have $50M now? (Note: you are statistically and logically unlikely to achieve this outcome if you so desire it.) Know any good businesses for sale? Oh, that’s right, you just sold one!
That’s the gilded cage. You’re stuck with a $50M fortune. It’s a nice problem to have, but it’s still a problem. And nothing changes at scale besides the difficulty of the problem. It isn’t easier but actually harder to achieve yield at higher increments of invested capital due to the economic phenomenon of diminishing marginal returns (if this were not the case, you could infinitely scale things by always adding more resources to every project; DMR ensures that the more you add over time, the less incremental gain you get to the point that you get no return or a negative return, ie, waste). If you had $5B, you’d have even fewer places to put it and you’d have given up an even rarer business opportunity in selling.
Unless your business value is about to become permanently impaired and you can see the writing on the wall when no one else can — technological change, regulatory change, some kind of disastrous political or economic event — your business will never be as valuable to you on the market as it is under your ownership, assuming you’re a competent operator. I’m not going to explore what you do if you’re incompetent because that’s a special case, although it follows the same general logic and leads to the same general investment problems.
I think what this means is that the primary challenge for a family with a fortune in terms of managing their business is to be sensitive to the innovation required over time to maintain the economic value of the assets, to manage the capital structure of their business intelligently (ie, not too much debt) so they don’t lose control because of the volatility of the business cycle, and to build cash up and keep their eyes peeled for a truly unique investment opportunity, the kind that made the first family fortune possible. That means it’s more important to avoid doing the wrong things than it is to try to be finding the right things to do. It also means it requires great patience. If we’re talking about building multi-generational wealth, patience is implied in the premise, but it’s still worth repeating. Bonner emphasizes this frequently– find ways to let time work for you, not against you. He believes luck, advantages and businesses all tend to grow over time so the idea is to set things up so those advantages will accumulate in your favor.
Smart investing is not the way to build a fortune. Some people will build a fortune building an investment business (ie, a wealth manager), but it will not be the investing itself that makes them rich but the operational leverage they gain through their fee structure. Because Bonner is a skeptic of “investing” as a tool for wealth building, he would land squarely on my side of the skeptic’s divide about the value public capital markets play in economic growth. Why should a person find it necessary or valuable to contribute capital to a company building things in other people’s towns instead of investing in opportunities in their own town, right “down the street”? Profit signals and differing equity returns will attract capital from disparate areas and thereby indicate relative value across an economy, but I am skeptical that this process and the capital markets in general would be as big a part of the economy overall as they are presently if we were in anything more closely approximating free market conditions without crony capitalist interventions.
So, you may get lucky and find yourself with a fortune, small or large, from a family business. If you do, hold on to it, appreciate it, care for it, tend to it responsibly and hope you or one of your descendants has an opportunity to take another swing at an uncertain point in the future. But don’t try to force it, and don’t think there’s anything you can do to greatly enhance your opportunity beyond what it is. And understand that it will never be as valuable to you as a pile of cash as it is invested in your business.
The other big topic in the book is building the institutional framework of a long-lived family that can participate in this family business over the generations and can also be “true” to the family culture and values. Family planning is an idea that attracts me, and I have spent considerable time on my own with the concept of creating a family brand (what the ancients’ termed a coat of arms) to identify the family and its enterprises.
The trouble I have with family planning is the same trouble I have with all planning, particularly that of the central variety– what if the individual members of your family don’t really find value in your plan? Obviously, raising them with certain values and viewpoints creates a better chance for a kind of coalescing around this identity and direction. But is that how I want to raise my children, by telling them what is important? I think they can figure that kind of stuff out on their own, just as I did. Hopefully I can lead by example, and provide a demonstration of the virtue of the family virtue. But I think a potentially frustrating consequence of putting this emphasis on building multi-generational institutions together is you might find out your family just doesn’t see the use in them. That’s kind of worse case, though, and doesn’t necessarily argue against the project in general.
Yet, what if you’re successful at this? Building a business and building wealth is a coordination problem resolved by growing trust. Who can you trust more than members of your own family? Creating a family organization based on shared values and common identity and linking that organization to a business entity could allow for a uniquely successful competitive strategy and management continuity over a significantly longer timeline than the average public or private competitor– in other words, huge competitive advantages over time. Simultaneously, this arrangement could solve one of the common problems of families and their constituent members, that being how each as an individual and the family as a whole can achieve security, success and satisfaction with one’s productive efforts and life. As I’ve argued in the past, I believe the family is the best institution for accomplishing this task and it is certainly far superior to the currently dominant model of public corporations (for-profit and nation-states/institutional gangsterism).
From Is Value Investing Broken? by Geoff Gannon:
There’s a tendency for people – people of any time – to see the time they live in as unique, dangerous, different, unlike any other age. In some ways, they are always right. Some things really are different this time from all other times. But, mostly, they’re wrong. And what they are wrong about is reading a golden age of stability into the past. I was talking with a value investor once and this value investor said that sure Ben Graham’s ideas worked in Ben Graham’s times. But Ben Graham invested in simpler times.
Here are the times Ben Graham invested in: the 1910s through the 1950s. He invested during Two World Wars, the start of the Cold War, the atomic bombings of Nagasaki and Hiroshima by the U.S. and then the testing of nuclear weapons by other countries, The Great Depression, a big explosion (reportedly a terrorist bombing) on Wall Street, and the longest shut down of trading in Wall Street history that I can remember at least (right as World War One started). People talk about political risk today. Political risk in Ben Graham’s time meant Marxists and Fascists. Investors saw hyperinflation in Germany after the war and then they saw deflation after the 1929 crash. These were not simple times. If you go back and read the newspapers from the time – you can see how not simple they were.
Now, yes, they were different from today in some ways. Much of the period investors and economists in the U.S. study were more regulated than today. So, you either had the Gold Standard or Bretton Woods. You had much greater belief in planned and insular economies in a lot of countries. With the benefit of hindsight – and seeing the entire sweep of history – many of these decades seem simple to us. They rarely were. Try to find a decade without too much inflation, too much deflation, too much war, the mania of some bubble, or the bursting of that bubble. At any point in that past, people could have believed value investing was dead. And yet, buy and hold investors – business owners and the like – have been compounding fortunes in the U.S. from the 1800s through today. If there are companies that can make founders and their families billionaires – there are companies that can make shareholders very rich if they buy and hold.
For the last two years, Murray Stahl and Steve Bregman of Horizon Kinetics have published a “Compendium Compilation” of their various research pieces and market commentariesthroughout the year. I recently requested copies of the 2014 and 2015 compendiums and just completed reading through the 2015 compendium. What follows are “stitched together” quotes from several of the essays.
The Indexation Experience
An active manager always can be found to be deficient if underperformance relative to an appropriate index is discovered. In fact, a manager can be found to be deficient if a return generated is equivalent to the appropriate index… one could always purchase the index as the less expensive investment alternative.
How does one judge an index to be deficient?
Since short-term interest rates approach zero in most regions of the world, the valuation environment is very benign… most governments during this period have embarked upon grand fiscal stimulus efforts that are now becoming unsustainable.
When one measures a manager relative to an index, is one measuring investment acumen or marketing ability?
The manager… will purchase a security until the expected excess rate of return is zero. The index… is marketed until the marginal revenue from a product is zero, which is an entirely different concept.
The index is not constrained by valuation.
Most indexes, in the fullness of time, do not earn impressive rates of return.
Problems With Indexation
When indexation excludes the so-called marginal securities, two things happen. The marginal securities are the stocks where the volatility really resides, which means the index is going to lose its volatility. Second, the marginal securities are an important contributor to what would have been the return… their negative impact gets captured on the way down– but the positive return impact does not get captured on the way up.
It is the nature of a market capitalization weighted index that it is always un-diversifying.
The problem with such an approach [wide diversification] is that it is quite impossible for any individual, or even a team of individuals, to have a good working knowledge of the individual investments at a security level. The portfolio can only be understood in terms of its statistical attributes… CalPERS… has about 20,349 individual investments.
If a team of 10 analysts were to work eight hours a day for three months, which is 22 business days per month, with no interruptions, the team would have at its disposal 10 x 8 x 3 x 22 man-hours to read 20,349 quarterly reports. This amounts to 5,280 man-hours available to read 20,349 quarterly reports, which equates to slightly more than 15 minutes per quarterly report… It should be obvious that success or failure in this endeavor must depend upon whether the statistical attributes of the portfolio provide the data necessary to make intelligent asset allocation decisions… it is impossible to devise a simple list of fundamental statistics to be used to comprehend a portfolio… because of differences in corporate expenditure practices, depreciation policies, tax laws in various jurisdictions, and GAAP vs. IFRS accounting.
The many diversified funds that purchase the most liquid securities must by definition generally own the same securities, since there is only one set of liquid securities. If the diversified institutions, therefore, own the same securities, when studying the price behavior of those securities, those institutions are, in reality, studying themselves.
If one believes in the Efficient Markets Hypothesis, then securities prices must reflect the beliefs of the holders of the securities. Yet, as shown above, the holders of securities do not study the securities. In fact, given diversification practices, it is not possible to study the securities. It is only possible that the investors study one another. Thus, one is confronted with a feedback loop or a huge self-reference paradox, as one may see in the paintings of M.C. Escher, such as Waterfall or Drawing Hands.
Another interesting case is the Singapore Index… returned 3.2% per annum. The mere fact that the economy of Singapore grew at over 6% per annum for more than 18 years does not correlate well with the stock market reutnr for the simple reason that the Singaporean companies in the index are global companies. These results reflect many factors apart from the economy of Singapore.
Similarly, the Swedish index does not necessarily reflect the economy of Sweden. And the UK index does not necessarily reflect the economy of the UK.
The thrust of these facts is to question, if not actually reject, the geographical form of classification as an asset allocation building block. That calls into question the entire international method of investing. The characteristics of equities have little to do with the legal place of domicile of a given firm. However, on a weekly basis the Investment Company Institute records $3 billion to $4 billion withdrawn from domestic equity funds and deposited into internaitonal equity funds in search of diversification and risk control atrributes that simply do not exist. As has been the case with many widely held investment beliefs without foundation, this will not have a good outcome.
[Fischer Black] said that there are people who are highly knowledgeable about certain companies– the information traders– and when they trade, they are very well informed. Most others, however, are not so well informed; they are the noise traders.
[Fischer Black’s concept of] efficient markets was that if the bulk of investors were in an index that, as he defined it, would include every stock out there– everything– the noise traders would go there. That would eliminate the bulk of the noise traders from the active marketplace, so only the information traders would be trading. They would not go into the index, becuase they are highly informed, and the market would be much more efficient in the sense that it would reflect the judgments of informed participants.
If one reflects upon this matter [Carl Icahn’s letter to Apple], one will see that Mr. Icahn has posed an exceedingly profound question to all investors, and especially academics. Apple is the largest company in the world. It is arguably the most ubiquitous company in the world. Billions of people use Apple products daily and are very familiar with those products. If there is any equity in the world that should be priced efficiently, it should be Apple.
Yet, Apple has a lower P/E than companies such as Exxon, Coca-cola, and even Philip Morris International. One might debate the future prospects for Apple, but surely these are more robust than those of Philip Morris International. Does anyone assert that demand for cigarettes will increase?
The money manager industry is not populated by Homo Economicus, carefully and rationally evaluating different investment opportunities. The money manager can only survive by attracting assets to manage for a fee.
Modern financial theory cannot explain momentum because, if the stock market is efficient, there should be no serial correlation observed in securities… momentum investing is not a new innovation. It is a concept virtually as old as the idea of a stock market, although it has not always been called “momentum.” Technical analysis is essentially a search for securities with momentum.
It is now possible to raise substantial sums for almost any index if the rate of return is sufficiently high. It is nearly impossible to raise money for any index if the rate of return is insufficiently high, let alone if that return happens to be negative. This is not the asset allocation process. This is the momentum process. The industry makes use of a substantial marketing budget, It clearly influences the valuations not only of individual securities but of entire sectors, and it dominates, for the time being, the investment process.