Ideas Matter: Why Everyone Should Find Time To Argue About Things (#ideas, #philosophy)

The contents of this post are adapted from e-mail correspondence with an acquaintance.

To give some context, this e-mail was prompted by a friend who made the point that our (by then) lengthy discussion on theoretical economic and political concepts was not a productive use of time and was little more than mental masturbation. In replying to this insistence (and attempting to refute more of what I saw as fallacious arguments), I tried to plead the case for caring about stuff like economic or political theory, esoteric or otherwise.

I wanted to make the case that these ideas had real, practical validity in our everyday lives, not just in the narrow halls of academia or someplace equally arbitrary and detached from the real world of everyday issues:

On the contrary, I believe these discussions can always be a constructive use of time if they lead one or both parties closer to an understanding of the truth on a given issue. I don’t know if Mises was the first to say it, and certainly he wasn’t the only one because Ayn Rand articulated a similar philosophy, but he had a slogan, “Ideas move society.” Over time, the structure of production and the political system overarching any society will come to be informed by the prevalent ideas held by its individual members.

In a grand and very real sense, every erroneous idea we hold takes us a little bit further from a harmonious, progressing, civilized society, while every truthful idea we hold takes us a little bit closer. This is not a matter of elegant armchair theory but of cold, hard, factual reality and it is all a consequence of Mises’s famous dictim, “Man acts.”

Every man acts, this is an inescapable fact of life. But what every man acts upon, well, that is informed by the ideas he holds and the values he determines to be worth pursuing.

We live in a time of gross ignorance of many simple truths, among the bitterest of which happen to be economic laws of cause and effect. Unfortunately, we also live with the consequences of this ignorance. It is not our duty in a universal, cosmic sense, but it is our obligation in a means-end sense, that if we wish to push back this tide of ignorance and live our lives on the dry-land of reason, we must fight it with sea walls of truth, not attempt to gather it up in fishermen’s nets of half-truth, pseudo-reason and arbitrary preference. Only consistent, logically-sound ideas can replace the fallacious if hope of progress is to be made, else you simply replace one flawed system with another.

I take a personal interest in the ideas of people who fascinate me because I think it is a natural implication to be curious about the beliefs and reasons of those I respect, and because in my own quest for truth and understanding I try to be ever vigilant that I may not have all the facts and perhaps someone can respectfully cross me on something I thought was true and show me why it is not. I am not content to simply say “My mind is made up” and carry on merrily when someone claims the truth is not my own.

This is why I have made an honest and sincere attempt to engage you on this subject and others in the past. I feel if you are to be my acquaintance and in some ways my friend, and if I am to respect your judgment in things, I must test you on these matters for the good of us both.

We all act, all day, every day. The actions we choose are based upon our values and our values are informed by our understanding of truth. Our understanding of truth, by shaping our values which inform which actions we take and when, has a direct, tangible bearing on the practical manner in which we live our lives.

Video – Rahul Saraogi On Value Investing In India (#valueinvesting, #India, @manualofideas, #investing)

The Manual of Ideas presents Rahul Saraogi, managing director of Atyant Capital Advisors

Major take-aways from the interview:

  • Referring to Klarman, finding ideas and doing the analysis is a small part of investing; the two most critical factors to succes in any investment as a minority shareholder are corporate governance and capital allocation
  • Good corporate governance means a dominant shareholder who treats minority shareholders like an equal business partner: even aside from egregious fraud and legal violations, you can face situations where dominant shareholders use the company like a piggy bank or to promote personal agendas
  • Once you’ve cleared the corporate governance hurdle you must consider capital allocation: many times companies follow the same strategy that got them from 0 to a few hundred million in market cap, which will not work to get them to the next level; often by this time the dominant shareholder is sufficiently wealthy and loses interest in capital allocation to the detriment of minority shareholders
  • India’s investment universe:
    • Indian GDP close to $2T
    • Indian market cap $1.5-2T
    • 80-85% of India’s market cap is represented by the top 150 firms: mega-cap banks, steel producers, etc., that trade on ADRs and everyone knows of outside of India
    • Thousands of listed companies below this with market caps ranging from $2-3B to a couple million dollars
    • Rahul finds the next 1200-1300 companies below the top 150, with market caps ranging from $50M-$2B, to be the most interesting opportunity
  • Corporate governance is binary: either a company gets it, or it doesn’t
  • Case study: 1998, invested in a sugar manufacturer trading for $20M generating $20M in annual earnings with a 14% tax free dividend yield, virtually debt free, strong moats, dominant player in its field, grew from $20M to $900M market cap, the owners were very focused on growing capital, no grandiose desire to build empires, not trying to grow the top line at all costs or gain rankings, just allocating capital wisely
  • Every investor is looking for shortcuts and binary decisions, ie, “Should I invest in India or not invest in India?”; the reality is it’s a lot of work, it’s about turning over as many stones as you can– what Buffett has done well is finding people who can compound capital and then staying with them through market cycles
  • You can do what Buffett did in any market but you must dive into it, get your hands dirty, do the work it takes and then maintain the discipline to stick with what you’ve found
  • Home-market bias: most people are going to allocate most of their capital in their home-market, because by definition anything that is not familiar or proximate is considered risky; consequentially, “locals” will disproportionately benefit from economic and financial gains in their local markets
  • India can not and likely will not become a dominant allocation in a foreign investors portfolio; without devoting 100% of your time and energy to understanding that market, or having someone invest on your behalf who does, you will likely not understand the culture, motivation and habits of the people in that market
  • “It is imperative that in any market you go with people who understand it and are focused on it full time because investing is ultimately bottom-up”
  • Accounting, financial reporting and investor relations practices are modeled off the US and UK so they’re similar; however, many businesses are run by one or two entrepreneurs and they’re often too busy to be available to speak with outside investors, but persistence pays off when they realize you’re interested in learning about their business
  • Access to capital in Indian markets has improved, meaning it has become easier for Indian companies to scale
  • Why does India have high rates of capital compounding? India is a 5,000 year old civilization and has had borrowing, lending and private markets for capital that entire time meaning people are aware of capital compounding; that being said, India has companies and management that understand ROC, those that don’t, and those that are essentially professional Ponzi-schemes, issuing capital at every market peak and then trading for less than the issued capital at the trough because they’re constantly destroying wealth
  • Rahul sees the government as incapable of providing the public infrastructure needed by the growing economy; he sees the economy turning toward a “private-public partnership” model that is more private than public– enlightened fascism?
  • As companies rushed into this private-public space, a lot of conglomeration and corporate mission-creep occurred, resulting in systemically low ROC for companies in the infrastructure space as most as poorly run; failure of top-down investing thesis
  • “I’m looking for confirmation in facts, not in other investors’ opinions”
  • I can comment on whether valuations for individual companies make sense, but I can’t make a judgment on the value of a broad market index, I just don’t think that number means anything
  • Risk management: develop assumptions about the company’s business and then periodically analyze what the company is doing relative to original investment hypothesis; if your assumptions prove to be wrong or something changes drastically with the company, that is when you hit a “fundamental stop-loss” and corrective action needs to be taken immediately, even if the stock has done well and the price has risen

Video – Hugh Hendry Visits The Milken Institute (#macro)

Hugh Hendry interviewed in a panel discussion at the 2012 Milken Institute Global Conference

Major take-aways from the interview:

  • Global economy is “grossly distorted” by two fixed exchange regimes: the Euro (similar to the gold standard of the 1920s) and the Dollar-Renminbi
  • China is attempting to play the role of the “bridge”, just as Germany did in the 1920s, to help the global economy spend its way into recovery
  • Two types of leverage: operational and financial; Germany is a country w/ operational leverage; Golden Rule of Operational Leverage, “Never, never countenance having financial leverage”, this explains Germany’s financial prudence and why they’ll reject a transfer union
  • Transfer of economic rent in Europe; redistribution of rents within Europe, the trade is short the financial sector, long the export sector
  • Heading toward Euro parity w/ the dollar, if not lower; results in profound economic advantage especially for businesses with operational leverage
  • “The thing I fear” is confiscation: of client’s assets, my assets; we are 1 year away from true nationalization of French banks
  • Theme of US being supplanted as global leader, especially by Chinese, is overwrought
  • Why US will not be easily overtaken: when US had its “China moment”, it was on a gold standard…
    • implication, as an entrepreneur, you had one chance– get it right or you’re finished
    • today is a world of mercantilism, money-printing, the  entrepreneur has been devalued because you get a 2nd, 3rd, 4th chance
    • when the US had its emergence on a hard money system, it built foundations which are “rock solid”
    • today, this robust society has restructured debt, restructured the cost of labor, has cleared property at market levels
    • additionally, “God has intervened”, w/ progress in shale oil extraction technology; US paying $2, Europe $10, Asians $14-18
  • Dollar is only going to go one way, higher; this is like early 1980/82
  • “I haven’t finished Atlas Shrugged, I can’t finish it”: it’s too depressing; it reads like non-fiction, she’s describing the world of today
  • The short sale ban was an attack on free thought; people have died in wars for the privilege to stand up and say “The Emperor has no clothes”; banned short selling because truth is unpalatable to political class; the scale and magnitude of the problem is greater than their ability to respond
  • We are single digit years away from a most profound market-clearing moment, on the order of 1932 or 1982, where you don’t need smarts, you just need to be long
  • Hard-landing scenario in Asia combined w/ recession in Europe would result in “bottoming” process, at which point all you need is courage to go long

Video – Joel Greenblatt On Forbes (#valueinvesting)

Intelligent Investing with Steve Forbes presents Joel Greenblatt, adjunct faculty member at Columbia University, co-CIO of Formula Investing

Major take-aways from the interview:

  • 70% of active managers can not be passive index funds like the S&P500 due to high costs, high fees
  • Unfortunately, for the 30% who beat the index over the last 3, 5 and 10-year periods, there is no correlation with how they do over the next 3, 5 and 10-yr periods
  • A disadvantage to standard index investments is that they are market-cap weighted; the more overpriced something is, the more of the index it represents, the more underpriced something is, the less of the index it represents
  • A superior alternative is equal-weight indexes, for example, in the S&P500, Stock #1 is allocated the same amount of capital as Stock #500; errors are therefore random rather than systematic
  • Greenblatt’s firm created a “value-weighted index”: the cheaper something is, the more weight it gets in the index
  • Key metrics for analyzing a business
    • High adjusted FCF
    • Returns on tangible assets
  • Why do good companies sell cheaply? People are worried that earnings power over the next few years will not be as good as the past so they’re willing to sell at a discount; institutional investors will systematically avoid uncertainty and provide you opportunity to buy cheap
  • Most business schools are teaching Efficient Markets theory, not Benjamin Graham; good news for value investors because it means you have less competition

 

The Infinite Regression Investment Philosophy ($FRMO, $DNB, $SPY, @GeoffGannon)

Courtesy of the 2012 FRMO Letter to Shareholders [PDF]:

If one were to look at the 100 US public companies with the largest defined benefit pension plans, one would find the likes of Exxon Mobil, General Electric, Pepsi, Verizon and UPS. As of the end of 2011, using these largest 100 as a proxy, American companies recorded perhaps the largest underfunded status ever, certainly within the past dozen years, both in dollar and percentage terms. And this follows a helpful three years of double-digit annualized returns on their plan assets.

Moreover, there is much reason to expect this position to worsen. The discount rates they use to determine the present value of all their future estimated pension obligations is about 3 times higher, at an average 4.8%, than it should be, since we know the average investment grade bond yield today to be about 1.3%. This means that the obligations are actually far larger than currently presented in these companies’ financial statements. Moreover, these pension plans, on average, still presume to earn almost 8% on their plan assets. Yet, over 40% of the plan assets are invested in bonds. Assuming, as one must, that 40% of these pension plan assets will earn 1.3% at best, then those bond portfolios, all else equal, can contribute only 0.5% to the return of the entire plan assets. This leaves the remaining 60%, most of which is invested in equities, to produce the balance of the 8% expected return, which means the balance must produce about a 13% return every year.

First, one is hard pressed to suggest that this reality will come to pass, so that one should expect much larger funding deficits in the coming years and, it follows, much larger contributions to those pension plans, which in turn must detract from shareholder earnings and earnings growth. That pending reality, though, is less interesting than this one: that these companies, by dint of their investment philosophy and practice, place the major portion of their equity assets in the S&P 500 (and other indices representing essentially the same, largest companies in the US), in order to attempt to earn the highest risk-adjusted expected returns. Yet the S&P 500 to a significant degree is composed of the set of companies with the largest pension plans, which are problematic as described above– these companies are investing in themselves for future returns to restore their pension plans, even as they themselves are problematic because of these pension plans. But this is their formulaic process, and the tools by which this process is measured and implemented are these self-same indices.

This is Free Lunch-thinking.

By the way, value investor Geoff Gannon (much beloved on this site) has written a lot about Dun & Bradstreet, a company with an underfunded pension liability sword hanging over its neck. He makes the case for why this is not something to worry about with DNB but I have to say it’s the one thing making me hesitate about jumping in to an otherwise compelling franchise opportunity.

In general, I try to avoid companies with employee pension plans, at least the defined benefit variety. They may be “private” and “voluntary” but to me they smack of socialism-lite. They’re uneconomic and based upon absurd assumptions and unrealistic expectations. They are, like Social Security, promises that can’t be kept and must eventually be broken.

The trouble is, shareholders will almost always be sacrificed first because we exist in a culture today that penalizes capital and sees the equity holder as a villain and cheat.

Interview With David Baran Of Tokyo-Based LBO Fund Symphony (#JNets, #valueinvesting)

This is worth watching if you’re a value-investor interested in the Japanese equity market.

Description of the video from YouTube:

David Baran, Co-Founder of Symphony Financial Partners, has over 20 years of experience investing in Asia. He has lived in Asia and Japan for nearly 3 decades and is fluent in Japanese.

Baran’s SFP Value Realization Fund was launched in September 2003 when Nikkei was about 9,500. The index has fallen since then, yet his fund is still up 56% after fees.

The secret to achieving returns in Japan is that you’ll have to do more than just long-only investing. The unloved, under-covered nature of the Japanese market creates opportunities that ordinary fund managers are not capable of pursuing because it’s too hard to extract the value. Many Japanese firms, particularly the smaller ones, can boast about 40+% operating profits and 30+% EBITDA margins. They can have net cash positions and trade at 50+% net cash to market cap. Hundreds actually trade at over 100% net cash to market — which means the market is valuing these viable businesses at zero.

“Investors in the U.S. equity markets would be falling over themselves to invest in a company like these – net cash, strong business moat and growth prospects,” says Baran. But being “cheap” isn’t enough — you need catalysts to unlock the value.

M&A activity flourishing in Japan

Corporate activity is such a catalyst. MBOs have an average premium of 50% (!) and sometimes reach triple digit numbers. Many of the large Japanese conglomerates started to buy back listed subsidiaries. Baran also advises on the Sinfonietta Asia Macro hedge fund, one of the best performing Asian hedge funds in 2001.

Hear David speak about:

* The 8 reasons why management buyouts are gaining popularity

* Why you need catalysts to unlock value in Japan equities

* What investors are missing by considering Japan as an “asset class”

* How to avoid “value traps”

* Considering tail risk: Why Baran’s Sinfonietta hedge fund is “geared towards a disorderly market”

What Would Happen If We All Quit Voting? Frank Chodorov Imagines (#democracy, #revolution, #voting)

Note: I found this in my old accumulated notes and had it labeled as “abridged”. I am not sure if it is abridged or not, and if I did the abridging or someone else. A link to the full, original article can be found at LewRockwell.com, which is probably where I originally found it.

If We Quit Voting by Frank Chodorov, July 1945, abridged

The theory of government by elected representatives is that these fellows are hired by the voting citizenry to take care of all matters relating to their common interests. However, it is different from ordinary employment in that the representative is not under specific orders, but is given blanket authority to do what he believes desirable for the public welfare in any and all circumstances, subject to constitutional limitations. In all matters relating to public affairs the will of the individual is transferred to the elected agent, whose responsibility is commensurate with the power thus invested in him.

It is this transference of power from voter to elected agents that is the crux of republicanism. The transference is well-nigh absolute. Even the constitutional limitations are not so in fact, since they can be circumvented by legal devices in the hands of the agents. Except for the tenuous process of impeachment, the mandate is irrevocable. For the abuse or misuse of the mandate the only recourse left to the principals, the people, is to oust the agents at the next election. But when we oust the rascals, do we not, as a matter of course, invite a new crowd? It all adds up to the fact that by voting them out of power, the people put the running of their community life into the hands of a separate group, upon whose wisdom and integrity the fate of the community rests.

All this would change if we quit voting. Such abstinence would be tantamount to this notice to politicians: since we as individuals have decided to look after our affairs, your services are no longer needed.

There is some warrant for the belief that a better social order would ensue when the individual is responsible for it and, therefore, responsive to its needs. He no longer has the law or the lawmakers to cover his sins of omission; need of the neighbors’ good opinion will be sufficient compulsion for jury duty and no loopholes in a draft law, no recourse to “political pull” will be possible when danger to his community calls him to arms. In his private affairs, the now-sovereign individual will have to meet the dictum of the marketplace: produce or you do not eat; no law will help you. In his public behavior he must be decent or suffer the sentence of social ostracism, with no recourse to legal exoneration. From a law-abiding citizen he will be transmuted into a self-respecting man.

Would chaos result? No, there would be order, without law to disturb it.

But, let us define chaos. Is it not disharmony resulting from social friction? When we trace social friction to its source do we not find that it seminates in a feeling of unwarranted hurt, or injustice? Then chaos is a social condition in which injustice obtains. Now, when one man may take, by law, what another man has put his labor into, we have injustice of the keenest kind, for the denial of a man’s right to possess and enjoy what he produces is akin to a denial of life. Yet the power to confiscate property is the first business of politics. We see how this is so in the matter of taxation; but greater by far is the amount of property confiscated by monopolies, all of which are founded in law.

While this economic basis of injustice has been lost in our adjustment to it, the resulting friction is quite evident. Most of us are poor in spite of our constant effort and known ability to produce an abundance; the incongruity is aggravated by a feeling of hopelessness. But the keenest hurt arises from the thought that the wealth we see about us is somehow ours by right of labor, but is not ours by right of law. Resentment, intensified by bewilderment, stirs up a reckless urge to do something about it. We demand justice; we have friction. We have strikes and crimes and bankruptcy and mental unbalances. And we cheat our neighbors, and each seeks for himself a legal privilege to live by another’s labor. And we have war. Is this a condition of harmony or of chaos?

So, if we should quit voting for parties and candidates, we would individually reassume responsibility for our acts and, therefore, responsibility for the common good. There would be no way of dodging the verdict of the marketplace; we would take back only in proportion to our contribution. Any attempt to profit at the expense of a neighbor or the community would be quickly spotted and as quickly squelched, for everybody would recognize a threat to himself in the slightest indulgence of injustice. Since nobody would have the power to enforce monopoly conditions, none would obtain. Order would be maintained by the rules of existence, the natural laws of economics.

That is, if the politicians would permit themselves to be thus ousted from their positions of power and privilege.

I doubt it.

Remember that the proposal to quit voting is basically revolutionary; it amounts to a shifting of power from one group to another, which is the essence of revolution. As soon as the nonvoting movement got up steam, the politicians would most assuredly start a counterrevolution. Measures to enforce voting would be instituted; fines would be imposed for violations, and prison sentences would be meted out to repeaters.

It is a necessity for political power, no matter how gained, to have the moral support of public approval, and suffrage is the most efficient scheme for registering it; notice how Hitler, Mussolini, and Stalin insisted on having ballots cast. In any republican government, even ours, only a fraction of the populace votes for the successful candidate, but that fraction is quantitatively impressive; it is this appearance of overwhelming sanction that supports him in the exercise of political power. Without it he would be lost.

Propaganda, too, would bombard this passive resistance to statism; not only that put out by the politicians of all parties — the coalition would be as complete as it would be spontaneous — but also the more effective kind emanating from seemingly disinterested sources. All the monopolists, all the coupon-clipping foundations, all the tax-exempt eleemosynary institutions — in short, all the “respectables” — would join in a howling defense of the status quo.

We would be told most emphatically that unless we keep on voting away our power to responsible persons, it would be grabbed by irresponsible ones; tyranny would result.

But the argument is rather specious in the light of the fact that every election is a seizure of power. The balloting system has been defined as a battle between opposing forces, each armed with proposals for the public good, for a grant of power to put these proposals into practice. As far as it goes, this definition is correct; but when the successful contestant acquires the grant of power toward what end does he use it — not theoretically but practically? Does he not, with an eye to the next campaign, and with the citizens’ money, go in for purchasing support from pressure groups? Whether it is by catering to a monopoly interest whose campaign contribution is necessary to his purpose, or to a privilege-seeking labor group, or to a hungry army of unemployed or of veterans, the over-the-barrel method of seizing and maintaining political power is standard practice.

This is not, however, an indictment of our election system. It is rather a description of our adjustment to conquest. Going back to beginnings — although the process is still in vogue, as in Manchuria, or more recently in the Baltic states — when a band of freebooters developed an appetite for other people’s property they went after it with vim and vigor. Repeated visitations of this nature left the victims breathless, if not lifeless, and propertyless to boot. So, as men do when they have no other choice, they made a compromise. They hired one gang of thieves to protect them from other gangs, and in time the price paid for such protection came to be known as taxation. The tax gatherers settled down in the conquered communities, possibly to make collections certain and regular, and as the years rolled on a blend of cultures and of bloods made of the two classes one nation. But the system of taxation remained after it had lost its original significance; lawyers and professors of economics, by deft circumlocution, turned tribute into “fiscal policy” and clothed it with social good.

Nevertheless, the social effect of the system was to keep the citizenry divided into two economic groups: payers and receivers. Those who lived without producing became traditionalized as “servants of the people,” and thus gained ideological support. They further entrenched themselves by acquiring sub-tax-collecting allies; that is, some of their group became landowners, whose collection of rent rested on the law-enforcement powers of the ruling clique, and others were granted subsidies, tariffs, franchises, patent rights, monopoly privileges of one sort or another. This division of spoils between those who wield power and those whose privileges depend on it is succinctly described in the expression, “the state within the state.”

Thus, when we trace our political system to its origin, we come to conquest. Tradition, law, and custom have obscured its true nature, but no metamorphosis has taken place; its claws and fangs are still sharp, its appetite as voracious as ever. In the light of history it is not a figure of speech to define politics as the art of seizing power; and its present purpose, as of old, is economic.

There is no doubt that men of high purpose will always give of their talents for the common welfare, with no thought of recompense other than the goodwill of the community. But so long as our taxation system remains, so long as the political means for acquiring economic goods is available, just so long will the spirit of conquest assert itself; for men always seek to satisfy their desires with the least effort. It is interesting to speculate on the kind of campaigns and the type of candidates we would have if taxation were abolished and if, also, the power to dispense privilege vanished. Who would run for office if there were “nothing in it”?

Why should a self-respecting citizen endorse an institution grounded in thievery? For that is what one does when one votes. If it be argued that we must let bygones be bygones, see what we can do toward cleaning up the institution so that it can be used for the maintenance of an orderly existence, the answer is that it cannot be done; we have been voting for one “good government” after another, and what have we got? Perhaps the silliest argument, and yet the one invariably advanced when this succession of failures is pointed out, is that “we must choose the lesser of two evils.” Under what compulsion are we to make such a choice? Why not pass up both of them?

To effectuate the suggested revolution all that is necessary is to stay away from the polls. Unlike other revolutions, it calls for no organization, no violence, no war fund, no leader to sell it out. In the quiet of his conscience each citizen pledges himself, to himself, not to give moral support to an unmoral institution, and on election day he remains at home. That’s all. I started my revolution 25 years ago and the country is none the worse for it.