Opportunities Gained Through Losses for Some
This past week, a number of things have occurred that will intrude on my work in the next several weeks.
Regular readers of these posts have learned that there are two related themes in my investment thinking. I am very wary of a future peak leading to a major stock price decline, and I am impressed with the value of time-horizon portfolios.
One rarely appreciates the advantages or disadvantages that accrue to individuals based on the time they enter their first professional jobs. I began my first professional investment job in 1960 as a junior analyst/trainee. I was part of the second wave of young people to enter the business in a long time. Some others entered Wall Street around 1955. Each of the phalanxes moved up the ladders very quickly to replace the managers who were scarred by the tales of the Great Depression. Many of these managers (and more importantly, their clients) were extremely afraid that the post–World War II boom was about to end, and they were therefore reluctant to buy stocks in the early 1960s.
Their clients found them to be wrong by 1968, if not earlier, and allowed us relatively unseasoned analysts and portfolio managers an opportunity to make important investment decisions. Out of these experiences I became conscious that the larger losses suffered because of the collapse of stock prices in the 1929–32 market were not the dollar losses sustained. A much larger loss that many investors and their heirs suffered was caused by former investors or their friends and relatives neglecting to reinvest into the stock market. They lost huge opportunities to make a great deal of money.
Ever since that recognition, I have been focused on not making that mistake for myself and clients. This is exactly why I believe in creating investment portfolios structured to meet needs for different times. I have little confidence in my (and most others’) ability to make correct risk on/risk off decisions.
The #1 401(k) — Our Client
For many Americans, a large part of retirement savings is in 401(k) salary savings plans sponsored by their employers. From my point of view as a manager and consultant to a number of these plans, they should be invested for the long-term, utilizing my time-horizon approach.
Each year BrightScope creates a list of the best 401(k) plans. This year they named the Second Career Savings Plan of the National Football League (and the NFL Players Association) as the best in the country. Numerous factors were considered, including total fees charged. Because of participant choice, they did not measure aggregate performance.
I can definitively state that investment performance was good, as can the plan sponsor. This has been satisfying to all who have been involved. I wish them well in the future. After twenty years of working with the plan, I have elected to pursue other opportunities utilizing our expertise and efforts. They should do well as a result of the generous employer contribution and the structure and administration of the plan.
Seth Klarman’s Warnings and Permanent Losses
Seth Klarman is a well-known hedge fund manager who is used by some of the non-profits upon whose investment committees I sit. He has sent back cash to investors (rather than investing it), so his latest letter as published by John Mauldin is not a complete surprise. Let me summarize his points as follows:
- Most investors are downplaying risk, and this never turns out well.
- Maybe not today or tomorrow, but someday a collapse may occur.
- The pain of investment loss is considerably more unpleasant than the pleasure from any gain.
- Correlations will be extremely high.
- Investors in bear markets are always tested and retested.
Analytically, I agree with Mr. Klarman’s cautions, but I do want to put them into perspective. For those accounts that have needs beyond ten years, I would be reluctant to place less than 50% of the value of the portfolio in risk-assuming investments. I do recognize that in periodic down markets the major stock market indices can decline 50%. The decline from the peak in 2007 to the bottom in 2009 was 57%, with many good managers losing more. The recovery since the bottom has more than made up from the loss and then some additional gains, often more than 50%, above the former peak.
What to Do?
Along with most professional investors, I do not posses the market timing skills of Mr. Klarman and a handful of others. Nevertheless, I am conscious of his warnings.
Thus, recently I cut back on two of the largest (and quite profitable) stocks in my private financial services fund. I am also reducing some of the positions in small-cap funds in our managed fund account portfolios after they have performed very well and have no or little cash reserves. These moves will not be sufficient if I am totally surprised when the next major decline happens. I am, perhaps foolishly, expecting a more speculative rise before the peak is reached. There are two clear parameters to my thinking. The first is to get prepared for a decline, and the second is not to get too long-term bearish as to flee from taking risks for long-term gains opportunities.
ISEEE White Paper and Emerging Companies
There is a very healthy tendency for people in the global financial community to meet and discuss, often heatedly, their views as to the investment future.
I belong to a couple of these meetings, and I’ve learned to appreciate other professionals’ experiences. One of the groups I recently joined is the International Stock Exchange Executives Emeriti (ISEEE). This is a group of present and former senior stock exchange officials from around the world who meet periodically. Evidently, my term of office as the chair of one of the advisory committees to the board of the New York Stock Exchange qualifies me for membership. For a number of years, the group has been concerned about the general inability of emerging companies to get adequate financing in most of the world’s markets.
Next month at the ISEEE conference at the Museum of American Finance* in New York (one of their conferences around the world) the topic will again be discussed. I have been asked to prepare a brief white paper on my concerns for losses while investing in emerging companies. There is no doubt that there will be some outstanding successes where capital will be multiplied numerous times. On the other hand, it is almost axiomatic that there will be loses sustained by inexperienced investors.
I don’t know that large losses can be prevented, but there are two concepts I am going to try and develop. The first is that various restrictions caused by the regulators and case law should be modified to present more information about future plans and greater discussions as to the specific market opportunities and threats the company is likely to be exposed. The UK polices are more helpful than those in the United States. A second proposal that also surfaced (to the best of my knowledge in some UK reports) is that each emerging company offering needs to require at least one or more institutional investors, with perhaps a required carve-out of 10% of the offering. I have some other ideas that I might include.
I find it a bit ironic that for this conference I will be sitting in the old banking halls at 48 Wall Street, the former home of the Bank of New York, my first professional job after leaving the US Marine Corps.
I solicit the readers of this post to share their thoughts as to how we can protect investors from losses but still encourage them to be lifelong investors.
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* I am a trustee of the Museum of American Finance.
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