Sunday, October 23, 2016

My Investment Views in 3 Periods


As part of my work in designing specific portfolio elements for our Timespan L Portfolios® , I have begun to separate my thoughts about future inputs into specific time horizons. Please let me know what you think about this approach.

Limited Term Horizon

I have little to add to the vast majority of investment chatter other than a few facts and beliefs:

1.  With the bulk of the purchasers of ETFs being investment advisors, hedge funds and other traders there is a belief the average holding period for them is two years or less as compared with between four and five years for equity mutual funds. This leads me to believe that these are more price rather than investment merit-oriented and are short-term focused. In the latest week the two ETFs that had the biggest inflows were invested in the Russell 2000 and the S&P500. My guess is that these were not sole positions, but were probably hedging concentrated short positions.

2.  Alluding to short positions at least for one stock, it is said every available security that could be loaned out has been. This could be just a prelude to a short squeeze which could spike the stock. It could also lead to a corner being declared. This translates to many transactions being cancelled. Is this an indication of our speculative times?

3.  I believe there is a major misconception that the money being redeemed from mutual funds is going into ETFs or passive funds. The two actions are in my opinion not completely related. My guess is that a large portion of mutual fund redemptions are in effect "completions." That is, they were purchased to fund a particular need and the time has come to meet that need. Many redemptions of funds are investor initiated whereas ETF purchases are coming from investment advisors or trading type organizations.

4.  There are three indicators that make me worried about high quality fixed income investing now. First, in the latest week only fixed income funds, including ETFs  saw inflows and all other asset classes saw outflows. As mentioned in last week's post, my early analytical training was at the racetrack where favorites win only about a third of the time.   

More importantly the size of the winnings for the bettor is insufficient to cover losses on other races. One of the reasons for that is the difference between mathematical probabilities and track odds.  The first is the calculated chances of winning based on lots of conditions. The second is calculated on the amount of money relative to all the money bet less payments to the tracks and state/local taxes. Probabilities are based on judgments whereas odds are based on the needs of the track and governments plus the distribution of opinions, some better than others.

There are two other interest rates concerns which are present. Short-term rates with maturities five years and under are higher now than a year ago, but not so for longer maturities, which is often a sign of instability. In addition, published money market accounts at banks have been moving up and are near the high point for the year. Banks raise deposit rates to attract new money or when they need to retain existing deposits. As usual it appears that the Fed is behind the real market.

5.  Over the next fifteen months there are a number of national elections. Some entrepreneurs and other investors will be disappointed in the results. This may lead to an increase in the number of private businesses and other assets being offered for sale. Often the buyers will be publicly owned companies. This is worrisome. The sellers appreciate the complexity of operating their assets on a daily basis. The buyers believe that they can produce better results than the prior owners because the new managers can put into place uniform principles and more complete solutions. Thus we could be entering another period where the buyers will disappoint their investors.

Intermediate Influences

1.  For years the front cover picture of a couple of magazines were wonderfully negative indicators. They were actually correct at the time the accompanying article was produced, they were just wrong as a predictive device. A Wall Street Journal article entitled “The Dying Business of Picking Stocks” could be a good example. The first line in the article went further and said, "Investors are giving up on stock picking." Other articles seem to be in support of that contention showing in the Large Cap mutual fund arena, that over ten years the percentage of actively managed funds dropped from 84% to 66%. 

I have mixed feelings about these views. As a contrarian I am delighted that there will be fewer competitors when I am trying to buy a bargain. Further, when I choose to sell a position I am pleased that a more supposedly successful stock will have more buyers at higher prices than passive funds. On the other hand fewer people adding significantly to their retirement capital means that my tax burden will go up. My guess is that when the equity market produces 2-3 times what the ten year current interest rate will, then be there will be a rush into the market and many people will become stock pickers for the ride as long as it lasts.

2.  One current market observer has commented that almost everything is going up a bit; in my mind this lack of successful selection skills will be only a temporary phenomenon.

3.  One of the current fads is factor investing where a single investment is used as a singular screen. In many ways the first factor was bonds and the second was stocks. These were combined into a balanced account for trusts. Thus the very first mutual funds in the US were Balanced funds. I have been exposed to balanced accounts and Balanced funds since the 1950s. Over time I have noticed that some performed better than others. Several managers, actually economists in training, varied the ratio of stocks to bonds. This explained a number of the differences in performance but not enough. When I looked into the portfolio at first I saw that perceived quality made a significant contribution to both the stock and bond returns. But that did not explain enough. Clearly the prices paid for the securities made a big difference. Trading competence and clout, particularly on the bond side was important. Some funds were close to frozen and others had high turnover of their portfolio. On the equity side whether they were growth, GARP (growth at a reasonable price), value or dividend-oriented also made a difference. Further, whether there was there just one portfolio manager or multiple managers eventually also produced different results. Over time Balanced funds became less attractive to investors as many wanted more distinct performance compared with a more level result when stocks and bonds were going in different directions (which was the original intent).

To the extent that the more modern factor funds can learn from the analysis of Balanced funds would be useful. Further the sooner they move away from analyzing only the published financials the better. This week Goldman Sachs* reported its third quarter results. Going back to my early experience of taking Securities Analysis under Professor David Dodd of Graham and Dodd fame, I reconstructed elements of the balance sheet and income statement. While the reported results were significantly better than the "street" expectation, the stock rose only slightly. In my analysis I noted the shift in the investment banking line to more advisory and a smaller amount of underwriting. In addition, I was conscious that non-compensation expenses were sharply curtailed, plus I saw a shift in the number of employees involved in investment banking and technology (investment banking was reduced, IT was increased). All of these observations added up to the conclusion that the firm is changing and the past record and ratios are of less value today than in the past. Yet many algorithms based on the pure reported results would not have picked up these changes as used by factor funds.

*Held in the private financial services fund I manage.

Longer Term Observations

The number of US publicly traded companies has declined by half over the last 20 years, but the average size of companies is now six times larger. To some degree this means there is less of a need for a large corps of analysts, particularly covering small companies. But this may well be a chicken and egg argument, for over time the level of commissions has shrunk as has spreads between the bid and asked. I suspect that many of the small company analysts that I grew up with are still delving into small companies for their own account, but are not sharing their work with clients. This could work out well for those of us who do not like crowds.

One of the reasons that there are fewer companies could be that the global development cycle has been shortened. Thus lower cost entrepreneurs with reasonable to better technology can quickly enter a market for new products and can rapidly capture market share that would not have been possible twenty years ago. So our protective umbrella has been pulled down.

Perhaps linked to this thought is that, according to recent surveys, 82% of parents in China today believe that their children will be better off in the future than the parents are now. In the US only 32% of the parents felt the same way. My guess is that these expectations will narrow, in part because the US will continue to disproportionately attract some of the best and brightest.

Question for the week: Do you separate your investment views by time periods?         
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A. Michael Lipper, C.F.A.,
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Sunday, October 16, 2016

Being Long is Worth the Bet -
Despite Consensus


Consensus turns out to be correct occasionally. As  alluded to in last week's post, published bookmakers’ odds are simply the ratio of the amount of money bet on a particular horse, issue, or perhaps someone running for election. There is often a big difference in the confidence expressed by aggregate money and the probabilities of success. Even to themselves (let alone to any third party) voters rarely say why they voted the way they did. After many political elections the people who claim that they voted for the eventual winner is significantly higher than the recorded reality. It is not my professional function to guess which way an election will turn out and history suggests it may not matter as events that take place after the election will determine the enacted policies.

As a professional investor and portfolio manager for institutional and high net worth clients, the essence of my job is to make reasonable judgments about the future course of markets; first to reduce the chances of meaningful capital losses and second to increase the opportunities to grow capital. Notice I phrase my tasks in terms of chances. In other words, I focus on the odds. Thus, one can see why I believe my early exposure to going to the racetracks was instructive. At the time the New York tracks offered the most in prize money and therefore probably had not only the best horses running but also the savviest bettors.  (This was good training for future competition in picking stocks and funds.) At the track the amount of money bet on a particular horse identified the favorite of the betting crowd's dollars. In other words the favorite was the consensus bet. There were two problems with betting on the favorite. Roughly they win only about a third of the time. More importantly the winning payoff from favorites rarely covers more than one losing bet and often not enough to bring the losing bettor to break even. As we all are driven by our own experiences and hopefully those of accepted others, I do not favor consensus bets for investments.

Reading the Consensus is Useful

One of the important investment lessons is that to be successful is to be dependent on someone else to buy your merchandise at a high price. Thus, it is critical to understand the motivation of other investors. By definition many investors are guided by the consensus. 

If one reads what most of the pundits are saying they are more concerned about the present risks than opportunities. This is understandable in view of slow growing or contracting economies with declining productivity, political uncertainties globally, and low nominal manipulated interest rates. A number of market analysts are flashing danger or at least caution signs and reminding us as to the current length of the bull markets.

Consumers are worried about their own economic future. With the mix of population growing older some people may be worried that their retirement capital is insufficient. (Long-term this could be a positive for the investment segment of the market.)

Missing Opportunities from the Past

Going back to the horse racing analysis, longer races allow for temporary recoveries and tend to favor higher quality horses. The same is generally true with investments. In his recent blog,  Bill Smead of Smead Capital published the following chart:
S&P 500: 1926- 2015

Time Frame
% Positive
% Negative
1 Year
5 Years
10 Years
20 Years

Two worthwhile items to note. The first is that the table is just expressed in gains and losses and their size. The second is that historical experience supports our concept of the TIMESPAN L Portfolios ® . We assume that the shorter term portfolios will produce more cyclical performance and the longer term portfolios will show more secular growth.

One attempt size the positives and negatives is this week's Barron's Big Money Poll. Among other questions, one asked what were the chances that the S&P500 would reproduce its long-term performance of approximately 9% per year?  Of the responses, 80% felt that it would not produce this return over the next five years, but 44% of the participants felt that over ten years the index would also underperform. The implication is that the aggregate group is looking for an acceleration in growth in the second five year period.

My Guess

With so many people being worried about the outlook, particularly the near term, I believe there is not a great deal of risk in terms of the permanent loss of capital by remaining long this equity market. I am somewhat comfortable accepting that there can be intermediate price declines of up to 25%. Over the next five to twenty year periods mentioned, there are upside potentials of multiple doubles. Thus it is worth the bet.


For those that attempt to use any particular day to trade rather than a long series, be careful about intraday trading. Currently on many days the pattern of trading is similar to those that my grandfather knew. This view is reinforced when one looks at the number of floor traders working orders at trading posts on the floor of the New York Stock Exchange as shown on cable television. They are busy on the opening and closing. For periods in between, I suspect they are active in off-floor trading with institutions. The opening benefits from orders from Europe which often means more buying than selling as long as the US dollar is rising in value. (I do not expect that the trend to continue.) I have noticed that unless the market is strong at the end of the day, often the gains of the session are reduced as traders want to lessen their exposure overnight.  Investors should be conscious as to the timing and methods of placing orders as it is an important skill in this period of low returns. One of the advantages of using mutual funds as the medium of investment is that orders for fund shares are executed on a forward basis meaning that execution price will be the price of the net asset value on the close.

In Conclusion

Use consensus not as a guide but as a recipient of your investments. Relax through periodic declines. The odds favor the long-term investors.

Copyright © 2008 - 2016
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Sunday, October 9, 2016

Searching for Confidence


If we were more confident, we would commit. The lack of confidence is what prevents us to committing to another person, a political view and an investment of time, effort, or money.  Animals as well as humans over-rely on our or others' memory as a guide for our next committed actions. The difference between humans and animals is that out of bitter experience we have been disappointed that in particular cases the past was not repeated exactly as believed.

To protect ourselves from disappointment we search for systematic ways to predict the future. Often not finding the magic formula, we rely on so-called "experts."

Another Lesson from "The Track"

While at the track after I concluded either I couldn't find the next winner or in my opinion the betting odds were too low to make a sound bet, I began a life-long exercise. I listened to those around me in their conversations as to why they thought a particular choice was the correct one. In an over-simplification, these views generally fell into two camps. The first very much focused on especially current information about various horses, jockeys, trainers, times of prior winners, and track conditions. The second camp used various numerical inputs such as past speed records for the race, the weight the horse was carrying, whether horses that were favorites that day were winning at the expected rate, etc, etc. This second group was slavishly following a systematic procedure or as it was known at the track, they had a system.

The post-race reactions after members of each camp that did not win was most instructive. First both blamed various "experts" for not producing winners for them. Those in the first camp restudied the information they had before the race to see what critical insight that they missed that they should apply to future races. The second camp’s followers rechecked their data for accuracy and if their math was correct they would begin the search for a new system and a new set of "experts."

The first camp were my first exposure to the arts of analysis. They searched the very present competitive conditions. The second group were in effect statisticians who believed the future could be determined from the numbers.

Years later I recognized that these two camps exist today in guessing which way various elections will go and what is the most successful way to manage money.


As a career securities analyst I have never seen a number from which I didn't want more information and data. However, I am not a card carrying member of the statistical clan. The reason I do not claim membership is that I do not think the numbers by themselves provide the answers that I need to generate confidence.

There are two other reasons that I don't wish to fit under the statistician label. The first is historical. In the era when the Dow Jones Industrial Average was being constructed, those hard working clerks in brokerage firms who produced recommendations for investors and whose main source of corporate information were the very thin reports published by companies. These clerks were unable to visit companies or third party sources and were called statisticians. My guess is that my Grandfather's firm had one or more. It was not until the era when Benjamin Graham was going beyond the ratio analyses of annual reports that the term securities analyst evolved.

The second reason I do not want to march under the statistician banner goes further back in history, but is equally important today. Another Benjamin, Benjamin Disraeli the Prime Minister of the United Kingdom in the 19th century is quoted (most often in the US by Mark Twain) as saying "Liars, Damn Liars, and Statisticians" were  the source of bad information and conclusions. I am afraid, particularly this remains true in the political world today. Part of this tarnished label attached to statisticians has to do with polling. Not only did the Brexit polling not capture the true intentions of those in Northern England but that it was followed in Colombia. There were three pre-referendum polls that showed that the no vote in Colombia was between 34 and 38%. The final vote was the "No" vote carried 50.2%. Again the issue has a geographic focus. Most of the No vote was largely rural, which is more difficult and expensive to gather. I am guessing many of the current US polls are similarly flawed.

One of the mistakes some British made is crediting the bookies with analytical inputs. A similar mistake, I believe, is being made on this side of the pond. The believers in the efficacy of these inputs, do not understand that both measures are similar to the pari-mutuel system at the racetracks where the odds are not judged mentally but are calculated by the amount of money bet. Further, my guess is that the northern English farmers and most Republicans in the US are not by nature gamblers, so the weight of money is not representative of the voters.

Turning to our investment world, those that believe in factor investing or other asset allocation dictates are essentially statisticians looking for their "system" as some of their brethren did at the track. Recently JP Morgan Asset Management published a 72 page   "Guide to the Markets®". An analysis of some of its data is as follows:

It has identified seven  major factors; including High Dividend Yield, Small Cap, Minimum Volatility, Cyclical Sectors, and  Momentum. The two best factor portfolios in 2015 were the last and next to last in the first nine months of this year.

Asset allocation funds may have many adherents, however since 2006 in a performance array of ten different types of Fixed Income funds on average they ranked fifth out of ten with two years in fourth place and three in sixth place.

In a similar selection of ten major asset classes from 2000, asset allocation returns were again in the middle on average, with the best in one year getting up to third place and five times in seventh place.

There is a problem with the statistical-only approach. When will the creators of the factors or asset classes recognize the changes in our dynamic markets? If those changes are perceived too late, much of the growth in value will not be achieved. For example, when the four largest global companies in terms of current market cap are recognized with appropriate weights they are all relatively young companies that are still in their first to third  generation of management.  The four are Apple, Alphabet (Google), Microsoft, and Amazon.

Analytical Approaches

A good analyst examines the past statistics to see what items are likely to be absent going forward and/or deserve a different weighting going forward because of a change of conditions. In projecting the future it is also wise to assume some level of intellectual or financial fraud as well as less than perfect executions of plans. In addition one should expect that technology will both help and hurt people's efforts. At one point, it was good analytical practice to calculate eventual scrap value from written off plant and equipment. Today it may actually cost a company to close down and get rid of plant and equipment without a tangible scrap value. In today's fast moving world useful lives may be shorter than the depreciation schedules.

Beyond the analysis of the past what can the analyst use to project the future? To an important extent demographics is destiny. However, the raw numbers have to be modified by changes in social structure and education. The answers may be quite different from work force and consumer market applications. These trends are not just national but global in implications. In turn this suggests that any US investor that does not have approximately half of his or her earnings coming from beyond our borders is not appropriately hedged. However, we already live in a global world where almost every company large or small is benefiting or suffering from multi-national influences. Thus no matter where you pay your taxes, locally based multi-nationals are diversifying the national sources of your investment income without your instruction.

Investment Implications

One of the lessons from the racetrack is that short races are more difficult to get right. The first one out of the gate has a tremendous advantage over the slightly slower. In investing I have noted a similar phenomenon. Catching up is difficult. Thus, at the track and in terms of portfolio management I prefer the longer races where there is time to recover. Therefore, at this point in our history I would like to focus a couple years after the next series of US elections which may not end until 2019. At that point demographics from today's level and mix will be playing out. There will be some major technological changes, hopefully positive.

I am more confident in the run up to my preferred investment horizon, I will rely on the past pattern of periodic and relatively painful declines followed by much longer periods of gains which in total produce a reasonable rate of return for those who are in for the long-term. This philosophy will work until it becomes dangerous because of “fellow travelers’ enthusiasm.”   

Question of the Week: Are you more a Statistician or an Analyst?
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Copyright © 2008 - 2016
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.