Financial Jungle

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The Public Be Damned… you may quote me: Screw ‘em.

That was the remark from legendary value manager, Marty Whitman, cursing fickle investors for fleeing his Third Avenue fund in favour of the more glamorous technology stocks. The exodus shaved his Third Avenue fund’s assets under management from $50 billion to $38 billion in 1998 and 1999. But guess who’s having the last laugh as the Third Avenue fund is enjoying a 9.95% average 10-year run. Compare that to S&P 500’s 5%!

Marty Whitman has always believed in his value philosophy, which is why he invests the bulk of his wealth alongside investors’. With so much at stake, he can also afford to focus on his long-term objectives in the face of short-term adversities. For Third Avenue, giving Whitman the pink slip is never an option given his revered status. Not to mention Whitman basically runs his own show at the firm.

Other mutual fund managers? Hmm…. not so lucky. Several quarters of persistent lousy performance and you’re out!

So why are mutual fund companies so fixated on short-term returns? Don’t look around. Look at ourselves. We’re the culprits. I once had a colleague, who’s brilliant at what he does, but he said to me, “I pick my RRSP mutual funds based on last year’s performance.” This is how most of us are wired, which is why fund companies are so wildly successful at promoting products catered to our myopic views.

According to an article by Martin Gale, most managers’ interests aren’t aligned with investors’. Judging from how managers are compensated, it’s no wonder why 80% of managers fail to beat the market. They’re not paid to beat the market!

It’s simply not good enough to invest with the manager with the most morningstar stripes. In addition to a strong track record of eclipsing the market, the manager must also “eat his own cooking.” After all, if the manager refuses to eat his poison, why should you?

In 2006, Boston Business Journal surveyed 75 locally based fund filings and discovered that 37 funds had zero dollar invested by their own managers. If a manager doesn’t invest the bulk of his wealth in his own funds, then he’s simply a well-compensated employee whose paychecks depend on MER and assets under management (AUM), not investors’ return. The easiest way to grow AUM is by selling the hottest trends; the ones that made the most money last year. Think back at the height of the Internet bubble. What attracted weak money? Nortel or oil stocks? Fast forward 8 years, which one enriched investors handsomely?

I recently came across an interesting article on Reaping What They Sow. The Denver Business Journal came up with a list of US fund companies where managers were investing heavily in their own funds. The article doesn’t go into performance, so I decided to do a little digging on the top 3 firms: Marsico Capital, Jenus Capital, and Cambiar Investors.

• Marsico Capital has 6 funds under managment: Focus, Growth, 21st Century, International Opportunities, Flexible Capital, and Global. All have beaten their respective benchmarks. 2 funds have 10+ year histories. Managers invest an average of $900k in the funds.
• Jenus Capital has too many funds to list. But their 38-year-old flagship fund, Jenus Fund, has beaten S&P500 by 2.4% a year. Managers invest an average of $675k in Janus mutual funds.
• Cambiar Investors has 3 funds under management: Large-cap, Small-Cap, and International. All have beaten their respective benchmarks. Managers have an average of $559k invested.

If you don’t recognize these U.S. firms, I’m sure you have heard of Warren Buffett, Jim Rogers, Eddie Lampert and George Soros. They, too, have their skin in the game.

Robert Rodriguez was voted by CNN Money as the best manager of our time. Since the mid-1984, his FPA Capital has shattered the S&P 500 with a 3.9% winning margin. He’s a smart dude, but guess what. He’s also the largest shareholder of his fund.

You might recognize value-investing firm, Tweedy Browne. Their flagship $6.7 billion Global Value fund has beaten the MSCI EAFE index by 4.5% a year since 1993. The current managing directors, retired principals and their families, and employees have $91.6 million locked up in the Global Fund.

MorningStar International-Stock Fund Manager of the Year winner, Hakan Castegren, invests over $1 million of his money in his Habor International fund, which commands twice the EAFE index’s 20-year annualized return.

Looking north of the border, there’s Irwin Michael, whose Fundamental Value fund trashed the TSX by a whopping 6% a year since 1990. He invests his family’s savings in his funds.

Don’t forget Francis Chou, whose Chou Associates and Chou RRSP have compounded returns of 12.4% and 10.6% respectively, despite being somewhat of balanced funds.

What about Wil Wutherich? He’s a new to SteadyHand, but not new to wealth management. His Small-Cap fund annualized 17% over a short history so far. Wil Wutherich is also stuffing his money where his mouth is.

Although 80% of “professional” money managers underperform the market, keep in mind that real professionals have skin in the game. While picking a manager with a large stake in his own funds alone doesn’t guarantee extraordinarily results, at least it weeds out the uncommitteds; the ones not paid to beat the market.

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Dividends4Life recently tagged me to write a post on My Top 3 Investing Mistakes. This series, originally launched by The Dividend Guy, is blasting through the blogosphere.

As the saying goes, “when you lose, don’t lose the lesson.”

1. Over Trading - After graduating from university in 1998, I found myself in a position to day trade $5,000 in a Royal Bank Action Direct account. I split my money 5 ways to buy high-tech stocks, and paid $29 per transaction; that’s $58 squandered away to buy and sell a stock. So, it didn’t take me long to realize that gluing my nose to the screen all day long was a high stress, zero-sum and money-losing game after fees. Which is why I’ve adopted dividend-investing as my preferred approach. It’s not intense. It’s positive-sum. It’s cheap since you buy and hold.
2. Allowing Emotions To Cripple My Judgment - One of my friends accused me of being too logical, and I agreed with him. But, I was kind of proud of it at the same time. I figured I was pretty good with numbers, and my pointy Vulcan ears would always keep my mind cool during financial upheavals. Of course, all bets were off when I started losing thousands in my trading portfolio. The story isn’t unique. I know this teenager from an investment forum who claimed to have been investing in stocks since 9 year-old — using fantasy money. Little did he know, the little pinch in losing monopoly money pales in comparison to losing real money that he may have saved for months or years. Obviously, I don’t have a heart of steel, but at least now, I understand what investment strategy works best for my psychology. At the end of the day, it doesn’t matter if you a dividend-investor, an ETF investor, a mutual fund investor, a real estate investor or a combination everything; the way to prosper in the market is to stay in the market in good and bad times.
3. Not Thinking Independently - I used to think scouring investment magazines, forums, blogs, and newsletters looking for top stock picks was considered doing my due diligence. But time and time again, I found myself drowning in a myriad of contradicting and unfounded investment advice. Many investment articles are written with inherit conflicts of interests. For example, hooking investors into buying stock-picking subscriptions, or favouring certain stocks in order to attract investment banking businesses. Even well intentioned wisdom by revered investors like Warren Buffett can be dangerous if not interpreted in the right contexts. But that’s another story. Ultimately, nothing beats absorbing investment literatures with a pair of unbiased eyes. Echoing sentiments of others is a recipe for long-term disasters.

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One of the greatest investing dilemmas I reckon with is ethical investing. Loading up on sin stocks doesn’t exactly align with my moral conscious. After all, most people like me have issues buying controversial companies like Lockheed Martin that thrive in times of war. But giving up these little devils doesn’t bode well with generally accepted investment principles such as diversification and return. Pull up a chart of S&P 500 and Lockheed Martin, and you’ll be surprised at Lockheed Martin’s low correction with the index, as well as its marvelous long-term out performance.

In his My Stocks Must Pass The Goodnight Test article, John Heinzl “vowed never to invest in such a vile product again.” The offending product he’s hissing at was tobacco. He recounted an accident where a driver was pronounced dead from a heart-attack that was possibly induced by cigarette consumption. A few weeks after the incident, John sold all his shares of Altria, the largest tobacco company in the United States, with approximately half of the U.S. cigarette market.

I personally don’t own any cigarette stocks, but I must confess; it’d be very tempting to wake up tomorrow and find all cigarette stocks on a fire sale. Not to mention, cigarette stocks have historically been most generous at puffing dividends at shareholders.

How do we measure the sin scale of a stock? Where do we draw the line to discern evil stocks from the ethical ones?

It’s interesting to note that prior to John Heinzl’s horrific car crash experience, he was content to hold Altria for their lucrative dividends. Tom Connolly of the Connolly Report also refuses to buy tobacco stocks because his sister died of lung cancer. That begs the question what if you own a stock that’s hurting everyone else except the people you know. Does that justify investing in a tobacco stock? Should it take a dramatic life experience before we evaluate the morality of a stock?

I also ponder how much of our perceptions are influenced by the media. We often don’t hear enough of the other evils that don’t illuminate as brightly on the radar screen. If you think tobacco stinks, how about oil? Last I heard, our energy consumption is punching holes in our ozone layer leaving irreversible damages to our precious environment. While the Earth is being worn down, the real causalities are the wildlife habitats and our future generations. Too bad for them, their mourning doesn’t garner nearly the same attention as tobacco. If we can somehow systematically measure sins in concrete and quantifiable units, I’m sure you’ll agree that cigarette, booze and gaming stocks are like little baby angels when standing next to these oil devils.

As Canadians, our love affair with energy stocks is best exemplified by the whopping 29.1% sector weighing on the TSX, beating financials to the top spot. Chances are, if you’re an equity investor, you’re probably heavily vested in energy stocks. To make matters worse, even if you’re not investors, the unconscionable is foisted upon you. An interesting fact is that in 2005, the Federal and Provincial governments collectively inhaled $7 billion in tobacco taxes. So much for trying to remain pure in our virtues. See the pavement you drive your car on? It’s built with cigarette money.

Although it’s virtually impossible to construct a completely ethical portfolio, looking at my core holdings, I’m relieved to say that my portfolio is relatively light on the sin scale.

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Always be nice to the people who play Lotto 6/49. You never know.

Although I’m not a frequent lottery player myself, the story is always the same. Like a regular Joe, I put off my will planning, tax filing, oil change, dentist visits, and etcetera. You name it. Yet, whenever I buy lottery tickets, I immediately kick off a fresh spreadsheet in my head planning how much to spend, how much to invest, how much goes to my parents, in-laws, siblings, relatives and friends. That’s right, my friends. You know the jackpot that I didn’t win? I was going to share it with you. How about that poker game, eh?

Not all investments must return tangible dollar figures. The odds of holding a winning ticket is 1 in 13,983,816, or 0.000007%. Why do people keep buying them when the odds are enormously low? Because it’s fun to dream, it creates excitement around the office, and it promotes positive thinking:

Ahhh, I stepped on dog poop! It must be my lucky day. I must buy Lotto 6/49.

Who says money can’t buy you (short-term) happiness? Don’t get me wrong, as I’m not a compulsive gambler. There is a propeller hat on my rationales. I usually wait for the big jackpots with these two theories in mind.

Theory One: Better Odds Without Paying More

Assuming a two-dollar ticket has a 1 in 13,983,816 chance of winning an initial jackpot of, say, $4 millions. If I wait for the jackpot to reach $28 millions, I can pool $14 with 7 friends to buy 7 tickets. Now I have a 7 in 13,983,816 chance of winning the same $4 millions for the same price.

Theory Two: Better Expected Return On The Dollar

7 in 13,983,816 is the same as 1 in 1,997,688. If you divide $28 million by 1,997,688, your expected return on a ticket is $14. Since each ticket costs $2, your expected return on a dollar is $14/2 = $7, or a little less if someone else holds the same numbers as you.

Boy. I’m such a nerd.

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