Practical analysis for investment professionals
23 February 2015

Focus for Investment Victory

Often the most focused player wins the competition. (This is why, years ago, I gave up golf. Despite the occasional good shot, I couldn’t stay focused shot after shot and hole after hole.)

While I try to be a keen observer of the investment game, few if any investors with a public record can stay intensely focused on all three parts of the game. I know I can’t. These three parts are: recency (a new word for many of us that concerns the current picture), avoiding mistakes, and anticipation.

Recency

The media and, therefore, most individuals, including many professionals, spend much of their time on the headlines of the day.

Far too often they make transactions in line with this so-called news. This is somewhat understandable as they believe, like most traders, that a security is worth its current price — to which they add (or subtract) their impressions of the impact of the latest news element, be it economic, political, corporate, or, in some cases, important sports results.

While some are skilled in the art of the trader, far too many go with the direction of market prices. I find this is often a mistake as the market has already discounted the so-called “new” development. Further, normal to enlarged rates of volatility cause the quick reversal of recent transactions. As one goes with the crowd, bid and ask spreads widen, and commissions add to the cost of unwinding a trade.

Our fund data does not directly capture these actual costs. However, with mutual funds and other professional funds, transaction turnover rate data is available. As I have previously mentioned, there are a few rare individuals who manage money for others and have continuing trading skills. All other things being reasonably equal, I tend to avoid funds with high turnover rates. As each market segment and type of security is different, one should determine high turnover compared with a fairly wide sample of peers.

In our construct of four generalized time-span oriented portfolios, the Operational Portfolio (1–2 year time span) and the Replenishment Portfolio (2–5 year) need to pay attention to current prices and near-term trends and thus could tolerate some high turnover rate fund selections. There is no need for this type of talent in the Endowment Portfolio (5–15 year) and Legacy Portfolio (beyond 15 year to multi-generations).

I recently suggested that a long-term portfolio should increase its combined energy commitment from 7 to 10%. At today’s oil prices, many of the energy-related stocks have gained off of a recent bottom and some are mirroring the 20% rise in the price of oil. If this was a shorter portfolio, I might start to be prepared to capture the gain off the bottom. But since this is a long-term portfolio in which I was prepared for a 20% further loss, I would continue to hold on to these cyclical positions for a number of years into the future.

Avoiding Mistakes

This is the investment equivalent of medicine’s Hippocratic Oath and its pledge to do no harm. Today, the investment application of this line of thinking has given rise to indexing or, at a slightly higher fee level, closet indexing.

To compose a variation of the Prudent Man Rule, first proclaimed in an 1830 case that Harvard College lost, one should do what others are doing to avoid criticism and surcharge. This precept is based on the belief that the crowd is right, as demonstrated in securities indices.

The weight of wisdom is now placed on the shoulders of the publishers of securities indices to make the right selections with the right mathematical formulas and updating mechanisms. I was able to build a reasonably successful business comparing funds utilizing Judge Samuel Putnam’s rule for my clients’ investments but was more drawn to an earlier natural law put forth some 41 years before Judge Putnam had his say. Benjamin Franklin, in a 1789 letter to a French scientist, wrote, “Nothing can be said to be certain, except death and taxes.”

Thus, I have difficulty locking my clients into a mechanistic formula.

Why is that? Since we are looking at investing through an historical lens, allow me to bring up a major change to the way the investment community has evolved over the last 40 years. On 1 May 1975, the final element of the SEC-mandated end to fixed brokerage commissions came into force. A little background is useful in understanding the regulation, which produced the opposite result than what was intended and has materially changed how the stock markets work around the world.

The official reason to introduce brokerage commission competition to the market (neglecting that there already was vigorous service and capital competition) was to lower the cost for the retail public. A number of the traditional financial institutions, like trust banks and insurance companies, wanted to cut into the profits of brokerage firms that were persuading some of their best investment people to join “The Street” at higher compensation rates. I will be happy to discuss with our subscribers how things evolved, but the key is the recognition that, excluding retirement accounts, there is very little retail listed equity agency business being done today.

The traditional institutions have lost share of market to brokerage firms’ wealth and asset management arms and to the phenomenal growth in hedge and private equity funds. These newer players, through the use of technology, exchange-traded funds (ETFs), and borrowed capital, have introduced a much higher level of volatility and share price competition at the same time as the retail investor’s total investment costs have gone up. In the next major market decline, the all-invested market indices are likely to suffer a fate similar to large wartime bulk shipping at the introduction of faster, more accurate torpedoes.

Anticipation

I feel a need to look for what others are not seeing.

From history, one of the lessons I learned was that, in the Mexican-American War, Robert E. Lee found a hidden path which allowed US troops to move much closer to the fortified Mexicans than they were expecting and helped win an important battle.

Today, Steve Jobs and other entrepreneurs do this regularly. While I do not believe anyone can accurately predict the future, I do believe that if one focuses on some of the elements that could change and locates some of these change elements, it is the equivalent of finding that hidden path.

This anticipatory gene should play out in the Legacy Portfolio to produce a stream of income spanning multiple generations for the institutions and families — including my own — that I serve. To capture these results one must be patient. However, I am very conscious that to many there is no difference between being premature and being wrong. That is why the great artistic masterpieces take a long time to develop.

Question of the week: How much of your risk capital are you willing to invest in anticipation of change? (Please share privately.)

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockPhoto.com/Hong Li

About the Author(s)
A. Michael Lipper, CFA

A. Michael Lipper, CFA, is president of Lipper Advisory Services, Inc., a firm providing money management services for wealthy families, retirement plans and charitable organizations. A former president of the New York Society of Security Analysts, he created the Lipper Growth Fund Index, the first of today’s global array of Lipper Indexes, averages and performance analyses for mutual funds. After selling his company to Reuters in 1998, Lipper has focused his energy on managing the investments of his clients and his family. His first book, Money Wise: How to Create, Grow and Preserve Your Wealth, was published by St. Martin's Press. Lipper’s unique perspectives on world markets and their implications have been posted weekly on his blog since August, 2008.

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