investing

Leave it alone!

plug screwdriver into socket.jpg

Some things just ought to be left alone. My son and I have often disagreed on this point. "Leave it alone!" "Why are you touching that?" "Stop rolling the window up and down." "Would you please stop pushing that button?" "Don't bother your sister." "Turn the windshield wipers off." "DO NOT PLUG THAT SCREWDRIVER INTO THE POWER OUTLET!"

Many investors to share his tendencies.

Meb Faber wrote a great study on various asset models called Global Asset Allocation. The book is a detailed performance analysis of eight "reasonable" but very different allocation strategies over the most recent forty year period.

These portfolios had stock allocations as low as 25% and as high as 90% (Warren Buffet's famous 90/10 allocation). They included a bond allocation from 10% on the low end to 55% on the high end. Real assets (commodities, real estate, natural resource equities) ranged from 0% in, two of the eight portfolios, all the way up to 50%.

While the reading is admittedly a bit dry, the conclusion is remarkable. Over the forty year period, these eight very different strategies all produced annual returns within 2% of each other (8.5% to 10.4%)!

On the surface this might not seem all that amazing, after all it matches what we've all been told about investing for the long run, right? However, consider that for "shorter" periods of seven to ten years (that surely must have felt like an eternity to under-performing investors) it wasn't uncommon for a given allocation strategy to have been outperformed by up to 100% by other strategies. That brings a whole new meaning to patience, doesn't it?

But the penalty for lacking patience can be harsh. The often quoted and annually updated DALBAR study shows that actual composite mutual fund investors returns have averaged only 2-3% over a thirty year period in which stocks returned better than 11% per year and bonds returned more than 7%. The only possible explanation for this huge performance discrepancy is investors buying after period of price appreciation and selling after periods of losses.

The last few weeks have been an excellent example of the temptation to "touch things" as investors have bid up industrial stocks (e.g. the Dow Jones Industrial Average or DJIA) and sold off gold mining stocks (the Philadelphia Gold and Silver Index or XAU). As often happens when prices change, sentiment (mood) indicators are now depressed for the mining shares and ebullient for industrial stocks. Does this make sense? Thirty years from now, we can be fairly confident that industrial companies will still be doing industrial things, and miners will still be mining gold. Trees won't grow to the sky, and gold won't become worthless. On the contrary, over many years, economic expansions, and recessions, it is quite likely that both US industrial companies and gold will maintain substantial value. However if you had to take either a share of General Electric or a gold coin, and then play Rip Van Winkle for a century, I bet you'd take the coin!

Understanding all of that, why wouldn't a rationale long term investor be more inclined to buy a little bit more of what is on sale and a little bit less of what has been marked up? First of all, my son would tell you it's because sitting still is tough sometime. Secondly, our human brains have learned that doing more of what feels good is fun. But following those normal psychological instincts flat out doesn't work for investing. Prices go up and down as a normal part of markets and the best way to lock in poor long term investment performance is to change strategy when it doesn't "feel good". Fortunately, good habits can eventually be learned with enough reinforcement...my son no longer tries to plug things into power outlets!


SVANE CAPITAL, LLC IS A REGISTERED INVESTMENT ADVISOR.  INFORMATION PRESENTED IS FOR INFORMATIONAL AND EDUCATIONAL PURPOSES ONLY AND DOES NOT INTEND TO MAKE AN OFFER OR SOLICITATION FOR THE SALE OR PURCHASE OF ANY SPECIFIC SECURITIES, INVESTMENTS, OR INVESTMENT STRATEGIES. INVESTMENTS INVOLVE RISK AND UNLESS OTHERWISE STATED, ARE NOT GUARANTEED. INTERNATIONAL INVESTING INVOLVES SPECIAL RISKS INCLUDING THE POSSIBILITY OF SUBSTANTIAL VOLATILITY DUE TO CURRENCY FLUCTUATIONS AND POLITICAL UNCERTAINTIES. AN INVESTMENT CONCENTRATED IN SECTORS AND INDUSTRIES MAY INVOLVE GREATER RISK THAN A MORE DIVERSIFIED INVESTMENT. THERE IS NO ASSURANCE THAT A DIVERSIFIED PORTFOLIO WILL PRODUCE BETTER RETURNS THAN AN UNDIVERSIFIED PORTFOLIO, NOR DOES DIVERSIFICATION ASSURE AGAINST MARKET LOSS.  ANY GRAPH PRESENTED CANNOT IN AND OF ITSELF BE USED AS THE SOLE DETERMINANT IN MAKING AN INVESTMENT DECISION. GRAPHS ARE HISTORICAL DEPICTIONS AND HAVE INHERENT LIMITATIONS IN MAKING INVESTMENT DECISIONS AND CANNOT PREDICT THE FUTURE RESULTS OF ANY INVESTMENT. PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE PERFORMANCE. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY DISCUSSED HEREIN.

Investing Superheroes: John Bogle

John Bogle has been a financial industry pioneer and respected spokesman for over fifty years. As the founder of The Vanguard Group, which specializes in low-cost index funds, he’s had tremendous impact in driving down the costs and complexities of market participation for millions of investors. Many of the standard components of sound investment advice weren’t standard before John Bogle.

Bogle’s Key Strategic Concepts:

  • Bogle starts with the importance of long-term thinking to investment success. “The historical data support one conclusion with unusual force: To invest with success, you must be a long-term investor”. This advice is so commonly heard, that it is easy to overlook the meaning. He continues this thought saying that “In the long run, investing is not about markets at all. Investing is about enjoying the returns earned by businesses.” The long-term investor should be chiefly concerned being invested and earning the cash flow and growth generated by the businesses that he or she owns. The price of this growth and cash flow (to Bogle, “the markets”) will fluctuate and these fluctuations become meaningless over a longer time-frame.
  • “Time is your friend; impulse is your enemy” Bogle urges investors to be patient and to avoid hasty decisions. His advice is similar to the old saw “measure twice, cut once”. In other words, once we’ve started on a solid long-term investment strategy, the best thing we can do as investors is to let time and compounding work for us. Getting impulsive and changing strategies (“the enemy”) can do huge damage to our returns. 
  • John Bogle began thinking about index investing back in 1951 hinting at the idea in his Princeton thesis. The basic concept of index investing is to ignore trying to sort out “good stocks” from “bad stocks” and simply buy a diversified group of stocks as inexpensively as possible. In other words, “Don’t look for the needle in the haystack. Just buy the haystack!” It often sounds promising to try to find the best stocks, and many investors do exactly that. However, this means that the best companies often have the highest stock prices, making them not necessarily the best investments. 
  • Our favorite Bogle quote gets straight to the heart of our investing philosophy at Svane Capital. “Your success in investing will depend in part on your character and guts, and in part on your ability to realize at the height of ebullience and the depth of despair alike that this too shall pass”. Of course we must understand and focus on the long term characteristics of markets and use appropriate investing strategy. But we must also understand the normal short term behavior of markets, and use this to our advantage when possible. Day to day, and even month to month price action in markets, can be thought of as mostly random with inevitable swings from extreme optimism to extreme pessimism. It is at these extremes where the greatest opportunities are found. At these points the right decisions can feel scary or even wrong. Using these times to our advantage depends mainly on our courage, discipline, and understanding that they don’t last forever.

John Bogle had been thinking about the concept of index investing since writing his thesis in 1951. But he credits support received from Nobel prize winner Paul Samuelson, Charles D. Ellis, and Princeton Professor Burton G. Malkiel in creating a business to capitalize on the idea. 

Bogle founded The Vanguard Group in 1975 launching its first index fund in 1976. In 1996 he retired as CEO, but the company he started continued to grow into one of the largest mutual fund companies in the world today.  Two of his most popular books are “Common Sense on Mutual Funds”, and “The Clash of the Cultures: Investment vs. Speculation”.

Sources: www.johncbogle.com, www.vanguard.com, www.investopedia.com

SVANE CAPITAL, LLC IS A REGISTERED INVESTMENT ADVISER. INFORMATION PRESENTED IS FOR EDUCATIONAL PURPOSES ONLY AND DOES NOT INTEND TO MAKE AN OFFER OR SOLICITATION FOR THE SALE OR PURCHASE OF ANY SPECIFIC SECURITIES, INVESTMENTS, OR INVESTMENT STRATEGIES. PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE PERFORMANCE. INVESTMENTS INVOLVE RISK AND UNLESS OTHERWISE STATED, ARE NOT GUARANTEED. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY DISCUSSED HEREIN.

Investing Superheroes: Howard Marks

Howard Marks has demonstrated the concept of consistent excellence as an investor, managing portfolios for over forty years. Marks has one of the best long-term track records over this time frame. He has led Oaktree Capital Management since founding the company with five other partners in 1995. 

Key Concepts

  • Markets are random. Investing strategies must take this into account. Howard says, “You can’t tell from an outcome whether or not it was a good decision. Even if you know what is most likely, other things can happen.” Of course this brings to mind the importance of diversification and limiting Portfolio exposure to any single factor. However, this statement also points to the difficulty of knowing whether an investor is good or just lucky. The same concept applies in determining whether an investment plan is on track in spite of initial poor performance. Marks’ answer is to focus on the decision making process rather than the results of this process.  
  • Consistency trumps outstanding individual results over the long run. Marks says, “Be a little bit better than average all of the time.” A study he did over decades of market performance showed that the top ten percent of long term investors showed up in the second quadrant decade after decade, being rarely either in the top group, or below average over those periods. He says that trying to be a top performer, rather than just being consistently better than average, usually requires taking too much risk and relying on luck. 
  • “You don’t make money by buying good stocks. You make money by buying assets for less than they are worth.” Howard is saying that even an excellent company can be a terrible investment. For example, an investor buying Cisco, Intel, or Microsoft in 2000 ended up with poor results even though those companies are still market leaders sixteen years later. Might Facebook, Amazon, or Tesla be similar today? Conversely, Marks points out that truly massive investing profits were made in the 1980’s in bonds that were more likely to default than to pay off. It’s all in the price and he encourages investors to avoid popular investments while giving those that “everyone knows are bad” a second look.   

Brief Bio

Marks started his career as an equity research analyst for Citicorp in 1969. From 1978 to 1985 he served as Vice President and senior portfolio manager focusing on convertible and high yield debt. In 1985 he joined RCW Group and again led he high yield and convertible securities group, but also started one of the first distressed debt funds in a mainstream financial institution. 

Mr. Marks periodically writes his widely read “memos to Oaktree clients” which outline his views on investing the markets and economics. Warren Buffett has remarked, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book”. In 2011, Marks published “The Most Important Thing: Uncommon Sense for the Thoughtful Investor” via Columbian Business School Press. 

Sources: www.oaktree.com, www.wikipedia.com , www.youtube.com 

SVANE CAPITAL, LLC IS A REGISTERED INVESTMENT ADVISER. INFORMATION PRESENTED IS FOR EDUCATIONAL PURPOSES ONLY AND DOES NOT INTEND TO MAKE AN OFFER OR SOLICITATION FOR THE SALE OR PURCHASE OF ANY SPECIFIC SECURITIES, INVESTMENTS, OR INVESTMENT STRATEGIES. PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE PERFORMANCE. INVESTMENTS INVOLVE RISK AND UNLESS OTHERWISE STATED, ARE NOT GUARANTEED. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY DISCUSSED HEREIN.

The Long and Short of it

Valuation matters most in the long run...

...but other stuff happens in the meantime

Benjamin Graham famously said “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” A voting machine counts votes. Votes are based on sentiment of people at a given time. Sentiment can change as narratives come and go and is difficult to measure accurately. A weighing machine is much more precise and accurate. The metaphor suggests that in the short term prices are driven by sentiment and the “story of the day”, while in the long term, trends are driven by something you can measure more concretely, valuation.

The overlapping wave graphic above is a simplified picture conceptualizing the interaction between the long term valuation (weighing machine) reversion cycle, and the shorter term narrative (voting machine) cycle. Obviously, this is an over-simplification as the cycles are anything but regular and perfectly predictable, but it demonstrates graphically some important concepts. A few comments:

  • The valuation reversion, or full market cycle is long. Typical equity market cycles follow the business cycle and are 7-11 years. Interest rate cycles tend to follow an even longer generational cycle at 60-70 years. The sentiment or narrative cycle is shorter, typically with a duration less than three years. 
  • It is the longer cycles that “matter more”. Valuation cycles tend to be bigger from bottom to top than sentiment cycles. They are also easier to quantify. Both of these factors are important to us. Buying relatively undervalued asset classes, and then holding them until they are overvalued is a major component of our strategy.
  • “Stacking” of sentiment and value cycles generates the highest highs and the lowest lows. Major buying opportunities always show both demonstrably low historically valuations and terrible investor sentiment. Market tops always show the opposite. Both high prices relative to historical ranges, and also investor optimism that more gains are just ahead.
  • Superimposed on top of the cycles is the constant injection of new information with a large degree of randomness. In the very short term (day-to-day, week-to-week, and sometimes month-to-month), markets routinely do “interesting” things. After the fact, some can be explained, and some can’t. Financial media frequently user the terms overbought and oversold to mean nothing more many days or weeks in a row with prices trending in the same direction.
  • The long term upward bias (due to the market internal return) is not shown in this simplified cycle model. Keep in mind that stocks represent companies that generate profit and bonds generate yield. This return is independent of the cyclical price variation on top of the return. Therefore, these lines should be visualized as sloping upward to the right. This is the feature leading to likely gains for patient buy and hold long-term investors from any starting point, given enough time.
SVANE CAPITAL, LLC IS A REGISTERED INVESTMENT ADVISER. INFORMATION PRESENTED IS FOR EDUCATIONAL PURPOSES ONLY AND DOES NOT INTEND TO MAKE AN OFFER OR SOLICITATION FOR THE SALE OR PURCHASE OF ANY SPECIFIC SECURITIES, INVESTMENTS, OR INVESTMENT STRATEGIES. PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE PERFORMANCE. INVESTMENTS INVOLVE RISK AND UNLESS OTHERWISE STATED, ARE NOT GUARANTEED. ALTHOUGH BOND FUNDS MAY PAY HIGHER YIELDS THAN OTHER FIXED INCOME INVESTMENTS IT DOES NOT NEGATE THE FACT THAT THE MARKET VALUE OF ALL BONDS FLUCTUATE DUE TO INTEREST RATE MOVEMENTS AND OTHER FACTORS. INTERNATIONAL INVESTING INVOLVES SPECIAL RISKS INCLUDING THE POSSIBILITY OF SUBSTANTIAL VOLATILITY DUE TO CURRENCY FLUCTUATIONS AND POLITICAL UNCERTAINTIES. IN INVESTMENT CONCENTRATED IN SECTORS AND INDUSTRIES MAY INVOLVE GRATER RISK THAN A MORE DIVERSIFIED INVESTMENT. THERE IS NO ASSURANCE THAT A DIVERSIFIED PORTFOLIO WILL PRODUCE BETTER RETURNS THAN AN UNDIVERSIFIED PORTFOLIO, NOR DOES DIVERSIFICATION ASSURE AGAINST MARKET LOSS. ANY GRAPH PRESENTED CANNOT IN AND OF ITSELF BE USED AS THE SOLE DETERMINANT IN MAKING AN INVESTMENT DECISION. GRAPHS ARE HISTORICAL DEPICTIONS AND HAVE INHERENT LIMITATIONS IN MAKING INVESTMENT DECISIONS AND CANNOT PREDICT THE FUTURE RESULTS OF ANY INVESTMENT. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY DISCUSSED HEREIN.

Time Is On Our Side

And time goes by so slowly
And time can do so much
— The Righteous Brothers (Unchained Melody)

FV=PV*(1+r)^t is the formula for what Einstein called the Eighth Wonder of the World, namely the power of compound interest. Time is the most important driver of this wealth building equation, but it can also be the most difficult part for real investors to harness because of the fact that we are ourselves bounded by its constraints. As seemingly important information (news headlines or price changes in our portfolios) is constantly arriving, there can be a strong urge to periodically change course, and therefore possibly press reset on the all-important time variable.

We’re fairly certain Tom Petty wasn’t thinking about investing while he sang “The Waiting”, but he could have been. In fact, rather than “seeing a card” every day, as investors, we may only “see a card” that actually matters every few months. Because if this, it is critically important that we have confidence in our strategy can therefore wait patiently, and without undue concern. If we aren’t able to stick with our plan through down periods, we simply can’t expect to achieve our long term investment goals.

The waiting is the hardest part
Every day you see one more card
— Tom Petty & The Heartbreakers (The Waiting)

Research shows that the returns actually achieved by many investors fail to measure up what might have been expected given the options available to them (and the known ex-post-facto returns of those investment options). Perhaps the best known study is done by DALBAR, Inc. and updated each year. Some noteworthy findings from the 2015 summary:


•    The 20-year annualized broad market equity return exceeded the 20-year annualized return earned by the average equity investor by almost a 2:1 margin (9.85% vs 4.66%)


•    In 2014 both the broader stock and bond markets outperformed the average stock and average bond investor by factors exceeding 2:1


•    This under-performance of the average investor occurred in spite of him/her “guessing right” 8 of 12 months (as judged by subsequent months’ performance)


These performance discrepancies are mostly due to asset class selection and the timing of the buys and sells of the asset classes. Many investors inadvertently end up with a start-stop-start-stop approach. Even if this is unintended, and even if the starts and stops only happen on just a very few occasions, the damage done to overall returns can be substantial.

Despite being generally “right” about immediate market direction, investors as a whole under-perform the broad market indexes because being out of the market earns nothing, and also because by the time a move feels right, it is often almost over.  The magnitude of market impact for unexpected events exceeds the magnitude of market impact for expected events by a substantial margin. Many investors fail to account for these surprises (which we know are bound to happen, but for which we don’t know the timing) in their investment plan. 


Given the meager actual performance of intelligent and motivated people, what should we do to place the odds back in our favor? In the simplest possible terms, what matters most is sticking with a reasonable investing strategy for an extended period of time. Three questions:

Question: What is a reasonable investing strategy?
Answer: A reasonable investing strategy holds different types of investments (diversification) and doesn’t try to time the market by repeatedly jumping in and out of investments. A reasonable strategy can also be biased toward more attractive values. 

Question: How can we make sure we stick with the strategy?
Answer: We should our portfolio risk constraints to a level appropriate with our individual situations and personalities. (This is why the risk profile we cover at the beginning of the process is so important, it directly influences the likelihood that we “hang in there” without too much teeth gnashing.) 

Question: How long do we have to wait?
Answer: That is a question that requires a statistical answer. One way is to note that many market cycles occur over 7-10 year periods (or less), so it is likely that within that period of time, our strategy and discipline will be rewarded. A longer answer is that it depends on the stochastic nature of the market process and the degree of certainty we require in our test. For example, how many times would we need to toss a coin before we can be sure we will have 50% heads and 50% tails?

In summary, as investors, we can maximize our probability of achieving good long-term returns by picking a good plan, and then by sticking to the plan, and allowing compound interest to work in our favor. While we can’t be certain about the exact future outcomes, due to the nature of risk, we can be confident about process and the overall probability of a positive outcome.