Print-friendly version
Send this to a friend
Posted 11/11/2002
Contrarian Chronicles
About Contrarian Chronicles
Learn the Contrarian Chronicles lingo
Visit RealMoney.com
Chat with Fleck
Check our chat schedule.
Related resources
Get our take on the market
Track your investments on MSN Money
Check how StockScouter rates your stock
Whats hot, whats not
Get live news from the market
Related Sites
Jeremy Grantham's "The Bubble Deflates, Part 7" (This is a PDF file.)
Jim Rogers' "For Whom the Closing Bell Tolls"
Contrarian Chronicles
Recent articles:
• When marketing masquerades as investing, 11/1/2002
• Faceless money managers put all of us at risk, 10/28/2002
• Juggle the numbers and drop a bundle, 10/21/2002
More...
| | Contrarian Chronicles
Money Management 101: What really matters
The creation of myriad ways to claim victory only muddies the question investors should be asking, which is: 'Did I make money?' Here's how to find out.
By Bill Fleckenstein
One of the reasons it's hard for people to deal with the painful aftermath of the bubble is that the money-management industry has offered little help. I left the long side of the business in 1996 because, between what was happening in the industry and what I saw Fed Chairman Alan Greenspan doing, I knew stocks would come to a very bad end, and I didn't want any part of it.
Little did I know that it would take six years and counting before things would be sorted out. That said, I always intended to return to the long side of the business, and I still do. Hopefully some time next year, it will be safe to be a buyer again. At that time, I intend to put a fund together that will be open to everyone. But we're getting the cart way in front of the horse.
For now, I'd like explain how you can navigate the sorry state of affairs that exists in the money-management industry today. To provide perspective on how we arrived here, Id like to share an e-mail from a pension consultant whose comments about the absurdity of the "consulting industry" appeared in my Oct. 25 column on RealMoney.
Results for the one-week long run
Wrote the consultant: "Decades ago, a firm named A.G. Becker started something called 'Funds Evaluation Service.' Pension plans and managers could purchase a report which would show, relative to a universe of their peers, their performance over various time periods. They would be in either the first, second, third, or fourth quartile. As investors began to make decisions based on performance, funds began to heavily market performance."
He adds: "It continues to this day. It's common practice to present whatever timeframe puts them in the highest quartile. Want proof? Consider the following fund analysis from Morningstar.com: 'Top 10% of category for 1-week period.' One week. Note how well that fits in with the oft-repeated 'Invest for the long run.' "
So that's how the money-manager sweepstakes evolved.
Now, what clever mutual funds did was to start up sector funds or specialized funds that could climb to the top of various performance categories. As that practice evolved, the name of the game was to create whatever flavor of stocks would attract money from people. And that's how the money-manager ranking sweepstakes begat, in my opinion, sector funds and all the other slices and dices of funds.
The consulting industry, which I believe continually issues bad advice to its large clients, and the mutual fund industry (hedge funds, too), which puts a premium on cleverness at the expense of risk-avoidance, have created an industry whose sole reason to be seems to be asset-gathering. This has promulgated the widely held notion that one cannot hold cash, that one must do some variation of what one's benchmark does, and all sorts of policies that run counter to common sense.
On the subject of risk, the money-management business has been cavalier in its disregard of same. It sees risk as "missing the rally." The consultants, on the other hand, define it incorrectly: "The industry defines risk as standard deviation, said my correspondent. While necessary for academic purposes, in practice it doesnt hold water. Standard deviation measures volatility. It has no way to distinguish between upside volatility and downside volatility, and it cannot account for capital loss. Why investors espouse this as a good measure of risk is beyond me."
He continues: "There is also much talk about benchmark risk. With benchmark risk, the underlying assumption is that investors require a return premium for investing in a portfolio of stocks not identical to the benchmark, which itself implies that investing in an index is preferable and a good idea. Thats nonsense. Again, these pros insist on exposure to all major sectors in a benchmark. Having no exposure to a major sector (i.e., technology) is considered imprudent, as it implies an ability to time the market. The end result of this effort is that pros cannibalize themselves and, by extension, their investors."
He concludes: "If ones internal research indicates that a sector is as good as dead in the short run, and ones mandate prohibits short-selling, why would one choose to underweight a sector as opposed to get out of it completely? Why is performance measured relative to an index when the index has lost money for three consecutive years? Why is it that people who have lost over half our money do not understand the fundamental tenets of accounting? Retail investors owe it to themselves to demand answers to these questions."
To sleep at night, perchance to profit
When I think of what risk means to an investor, I define it as the potential for losing money. It is not beta, standard deviation or any of these other notions. However, people must know their own risk tolerance before getting involved in any investment program, whether they are managing money for themselves or turning it over to a professional. Risk tolerance and expectations should go somewhat hand-in-hand. People need to know that certain strategies tend to be riskier than others. For example, growth-stock strategies can produce massive gains, but they can also produce massive losses, whereas, a value approach -- which is more in keeping with what I believe -- sometimes runs the risk of underperforming on the upside, or sometimes might be boring.
In any case, our consultant then goes on to talk about the subject of being fully invested: "Being long-only (fully invested at all times) is akin to wearing shorts and a T-shirt all year round. There is a time when your choice will look wise and a time when your choice will look very, very foolish. The sad part is, when the leaves started to fall off the trees, when the sky turned dark and cloudy, when a general chill came over the market and it became very apparent we were headed into the dead of winter, too many people ignored the weather. Now theyre standing around, huddling together for protection, making excuses for their lack of knowledge, for their ignorance and arrogance, and for a methodology that is clearly flawed."
Finally, he offers his solution: "What this industry needs is people who are willing to manage money with an eye on absolute return. Without a doubt, stocks are risky. Few people who manage money for a living go without a few bad years where returns are negative. However, consecutive negative years, coupled with total indifference from those who so graciously and inexplicably lost that money, is unacceptable. I would implore investors to cast aside their proxies and vote with their feet, but there is no place for them to go. Unlike accredited investors, retail investors have no refuge from mediocrity. Weve been shanghaied, and were stuck with crestfallen charlatans who are plagued by egregious greed and ignorance. Still. When will it change?"
I absolutely agree with his conclusion. I think that for the bulk of one's money, people should be absolute-return-oriented. That is, they should be asking, "Did I make money? Did I lose money?" Obviously, they need to keep their eye on some sort of a benchmark to know if reasonable expectations are being met. Obviously, if someone is only able to generate, say, 5% a year for several years, and the market goes up 20% for each of those years, that methodology may be flawed. The important thing in that example is to make the assessment over time.
Mixed-bag bucks
Almost every sound investment strategy will have periods of great and poor performance. We see multiyear periods where value-type investors do better, and other periods where growth-oriented investors do better. Value investors can often buy growth stocks, but they only get to do it when there are perceived problems (assuming the valuation is reasonable). They never buy growth stocks when everything is rosy, as the price tends to be too rich.
It is absolutely critical to know what to expect from one's money managers. A single subpar year should not be grounds for dismissal. In fact, if you really understand what your money manager is doing, and he has a bit of an off year, you might want to consider giving him more money, because whatever he is doing is out of favor. And that will likely change.
Of course, that brings up the point about how to find a good manager, and how to know how he is doing. I think the best thing to do is to ask for a copy of old portfolios. Take a look at what he owned and see if you can reverse-engineer what his thought process was. What you are looking for is a logical, consistent thought process that would have made sense in that period. The more time you take to understand how this person thinks and analyzes investments, the better your chances of finding someone you can work with. This will greatly enhance your prospects for success.
Inopportune vs. inept
But fully recognize that everyone makes mistakes. What you're looking for is, did the manager make a series of mistakes that showed a total lack of understanding (like owning Micron Technology (MU, news, msgs)), or was it just that his opinion was wrong about something, or that his timing was premature, as often happens? We're all going to be wrong in our opinions. The trick is, can you set yourself up to control the risk when you are wrong? And that's where I believe that value investors have an edge. The downside of being a value investor is often boredom, but you do not usually see hellacious losses.
In any case, one should be leery of a manager who continually changes his style or his philosophy. And that brings up the most important consideration: You need to understand what the philosophy and approach is of whoever manages your money. It has to be something that you tend to agree with. I think the bulk of one's assets should go to people who think like you do. That way, when the inevitable bad periods come, you'll understand why, and you won't be tempted to cut and run at the most inopportune time.
That is not to say that other styles might not be good for a small portion of one's assets, when one thinks the time is right. Even sector funds and ETFs (exchange-traded funds) have their place. But my belief is that those are probably better ideas for a six-month or two-year trade, rather than someplace to park the bulk of one's assets.
Of course, some people are capable of managing their own money, but most people don't have the time. It takes a tremendous amount of time and effort to try to be a successful investor. For most people, probably a combination of some money invested by a competent professional, and some money managed on their own makes sense, because everyone is capable of generating their own good ideas, assuming that they have some experience.
A pension for pulling no punches
So why hasnt my correspondent started his own consulting firm? He explained that because he was only 26, he would have great difficulty attracting clients, since people tend not to listen to youngsters. (I have often found that younger people with a great deal of common sense can cut through a lot of the bull, and that is the case with this gentleman.) Otherwise, he made it very plain that he wanted nothing to do with the pension-fund business, and can't wait to escape.
He told me, "What I want is to start a mutual fund that focuses on absolute return. My sole goal is to give the little guy a viable option to all the crap that's out there. I figure I am 10 years away, at a minimum, from having that happen. I am also convinced that the industry won't get its act together any time between now and then."
Lone Wolf Asset Management
For people going it alone, I think common sense and some helpful research services will put them in good stead. I'll list some of my favorites that are not too expensive. Obviously, regular readers of RealMoney, where my daily "Market Rap" column appears, know of the many good, thought-provoking ideas available there, even from columnists whose conclusions they might not necessarily agree with.
Other services include The High-Tech Strategist, written by the best analyst on the planet, Fred Hickey; The Gloom, Doom and Boom Report, by Marc Faber; Grant's Interest Rate Observer, written by Jim Grant; Dow Theory Letters by Richard Russell; Vickers Weekly Insider Report; Value Line, which should be used for background information, not for stock-picking or future projections; and Yahoo! Finance and MSN Money, which offer lots of free, helpful information. (There are also many other useful services out there, but the ones I have just listed, except for Value Line, are a must.) They can be had for less than a couple of thousand dollars, which is a small amount to pay to be sure that your investment ideas are well grounded.
After you have read these services to give your ideas a framework, you should follow the insiders (which the aforementioned Vickers does). Insider buying is always a good place to start. Following insiders, applying common sense, and being alert to what other smart people do should put you way ahead of the pack, in terms of trying to come up with winning ideas on your own.
One other extremely critical point I must share with everyone with is this: In my opinion, the difference between a great company and a great investment is the price you pay. Price (a shorthand way of saying an attractive valuation) is a huge determinate of your potential rate of return. That is my big complaint with Bubblevision and other services that just spew noise. They never attempt to relate the stock price and its implied value of a business to the fundamentals of the business. All they talk about is price action and goofy things like beating the number. None of that has anything to do with investing.
Finally, in terms of current asset allocation, I would have a minimum exposure to equities. As for fixed income, I would keep the maturity short, because I think the absolute rate of return being offered is not very appealing in longer-dated Treasurys. Also, I think we have dollar risk, which is why I continually advocate having an insurance policy in gold. People can have a core position in gold, and then trade around it if they want. But to repeat, I think having a defensive gold position will be very important going forward. So I hope that answers most of the questions that people have. We'll continue this dialogue in the future, and I will offer some ideas about what readers can do.
William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At time of publication, William Fleckenstein owned none of the equities mentioned in this column. Positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
|
