Wednesday, March 25, 2015

Charlie Munger on Lee Kuan Yew

Over this past weekend news came that Lee Kuan Yew had died at the age of 91.

During his three decades as Singapore's founding prime minister, GDP per capita increased dramatically. In fact, GDP per capita grew from roughly $ 500 in the mid-1960s to recently among the highest in the world.

Back in 2010 Charlie Munger said the following things about Singapore's founding father:

"My favorite political system in terms of being adapted to its particular circumstances, successfully, is Singapore. I think Singapore is the single most successful governmental system that exists in the world."

"If you will make a study of the life and the work of Lee Kuan Yew, you will find one of the most interesting and instructive political stories written in the history of mankind. This is better than Athens...and you will learn a lot that will be useful in your whole life."

"...study the life and work of Lee Kuan Yew, you're going to be flabbergasted."

Munger praises Singapore and Lee Kuan Yew

This parable written by Munger back in 2010 is another indication of the respect that he had for Yew (and some others).

In the parable, the politicians, facing a "brutal new reality...asked for advice from Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous and wise that he was often called the 'Good Father.' Such consultations were rare. Politicians usually ignored the Good Father because he made no campaign contributions."

Who Munger considers "virtuous and wise" obviously isn't exactly a mystery.

Vast experience and a high IQ doesn't necessarily go hand in hand with great virtue, wisdom, and other critical talents. Still, I don't think it's all that difficult with a little effort to separate the Charlie Mungers or Lee Kuan Yews of the world from those who think they've got it all figured out but, well, really just do not.

James Grant wrote in his book Money of the Mind that "Progress is cumulative in science and engineering, but cyclical in finance."

This cyclicality doesn't just apply to finance.

Put another way, the world may continue to become more technically sophisticated, but the aspects of human nature that cause even very smart individuals to make big and costly* -- though often largely unnecessary -- mistakes don't fundamentally change all that much.

"Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose..." - Charlie Munger speaking to the Foundation Financial Officers Group in 1998

Overconfidence is just one example among many.

Naturally, there are lots of smart people in business, finance, and politics. Unfortunately, this offers no guarantee they'll act with as much virtue and wisdom that one might like and end up doing great things for the world.

So that means, at least for me, when someone like Lee Kuan Yew comes along some appreciation is warranted and deserved. Perfection doesn't exist in the real world but, overall, his accomplishments seem rather astounding by almost any standard.

Much can be learned.

Few would seem to possess the combination of characteristics required to achieve what he did during his lifetime.

Here's a recent article that has a short collection of Lee Kuan Yew quotes.

Adam

* The costs, of course, aren't necessarily only measured in financial terms.

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, March 18, 2015

Forecasting Folly Revisited

In the bookOne Up on Wall Street, Peter Lynch wrote that many economists are "employed full-time trying to forecast recessions and interest rates, and if they could do it successfully twice in a row, they'd all be millionaires by now."

Lynch then adds:

"...as far as I know, most of them are still gainfully employed, which ought to tell us something."

Charlie Munger said the following in an interview with Susie Gharib back in 2009:

GHARIB: "When do you see the recovery coming?"

MUNGER: "We don't have any special ability to make that kind of macro economic prediction."


The good news is that successfully predicting macroeconomic outcomes isn't required for investors.

In fact, trying to do so is a distraction.

There's also the following dynamic to consider:

"Because there is no way to hold financial forecasters accountable for their incorrect predictions, they get more out of making wild ones. Wild predictions pay because the downside of being wrong is zilch, but the upside is lifelong fame."

So some in the business of making predictions are, in some ways, simply doing what's necessary for marketing purposes.

Prognosticators would argue otherwise but, given the complexity of the system they're attempting to understand, to me it seems effectively impossible to reliably make useful predictions.

Figuring out what a good business is worth and what to pay for it isn't an easy task, but at least it's not effectively an impossible task.

In 2003, Charlie Munger said the following at a speech to the University of California, Santa Babara Economics Department:

"...there's too much emphasis on macroeconomics and not enough on microeconomics. I think this is wrong. It's like trying to master medicine without knowing anatomy and chemistry. Also, the discipline of microeconomics is a lot of fun. It helps you correctly understand macroeconomics. And it's a perfect circus to do. In contrast, I don't think macroeconomics people have all that much fun. For one thing they are often wrong because of extreme complexity in the system they wish to understand."

Consider the findings of professor Philip Tetlock.

A study by professor Tetlock found that those "who earn their livings by holding forth confidently on the basis of limited information...make worse predictions about political and economic trends than they would by random chance." In fact, "the most famous and the most confident" are generally the worst at making predictions.*

According to Tetlock, the best forecasters tend to be more like foxes than hedgehogs.**

So ,while economic forecasting has certainly become more sophisticated, that doesn't mean they're becoming more useful.

"We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen." - Warren Buffett in the 1994 Berkshire (BRKa) Hathaway Shareholder Letter

Practically speaking, at least to me, it's mostly a waste of energy trying to makes guesses -- even very well informed guesses -- about what might happen in an uncertain world.

The focus should be on figuring out what's likely to do well over a longer time horizon even as the inevitably unpredictable world will bring many surprises and challenges. Will a good business be able maintain all or most of their competitive advantages for a very long time? Better yet, does the business have characteristics that make it likely those advantages will even be strengthened over time?

"If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results." - Warren Buffett in the 1994 Berkshire Hathaway Shareholder Letter

The stock market did just fine over the past century or so despite what almost certainly be a whole host of major economic and political shocks. Stock prices, will no doubt respond to these events. That a crisis of some kind -- or maybe even several -- will undoubtedly emerge in the coming decades hardly makes it impossible to invest. The risks of attempting to time the market are not small. In fact, attempts at timing will likely do more harm than good.

"The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions." - Warren Buffett in the 2012 Berkshire Hathaway shareholder letter

Keep in mind that 17,320% doesn't include a century of dividends.

Time in the market generally beats timing the market in the long run.

Stick to what can be understood then pay a price that reflects uncertainties. That there'll be challenging economic environments and upheavals is almost a given. There will never be any guarantees. Future difficulties may exceed all from the past century or so.

Being frozen by this reality is no investment strategy.

Expect market fluctuations. Forget about reliably predicting when and by how much. Ignore those who try to do so.***

John Kenneth Galbraith once said: "There are two kinds of forecasters: those who don't know, and those who don't know they don't know."

Munger and Buffett haven't needed to be brilliant forecasters to get investment results.

Adam

Long position in BRKb established at much lower than recent market prices

Other related posts:
Forecasting Folly
Henry Singleton: Why Flexibility Beats Long-Range Planning
Forecasters & Fortune Tellers
Charlie Munger: Snare and a Delusion
On Forecasting
James Grant on Economic Forecasting

* An excerpt from Susan Cain's book Quiet.
** Professor Tetlock puts it this way: "Hedgehogs are big-idea thinkers in love with grand theories" while "foxes are better at curbing their ideological enthusiasms." He goes on to say foxes tend to not over-simplify and are more aware of the limits to their arguments. As a result, they become less prone to mistakes.
*** I think this quote by Charlie Munger on macroeconomic predictions captures it well.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, March 11, 2015

Investment Sins

"The fault, dear Brutus, is not in our stars, but in ourselves." - William Shakespeare in Julius Caesar

Warren Buffett, in his latest Berkshire Hathaway (BRKa) letter to shareholders*, explained the consequences of volatility being viewed, mistakenly, as a meaningful indication of risk.

In fact, he writes that such a view can "ironically" cause the investor to "end up doing some very risky things." 

Buffett then adds to remember "the pundits who six years ago bemoaned fall stock prices and advised investing in 'safe' Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement."

Since then the S&P 500 has roughly tripled. The extreme volatility that occurred during that time was more opportunity than risk.

So, unfortunately, due to the "fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).

Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to 'time' market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy."

Charlie Munger once pointed out that some of this comes down to temperament:

"A lot of people with high IQs are terrible investors because they've got terrible temperaments."

In the letter Buffett goes on to say:

"Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

The commission of the investment sins listed above is not limited to 'the little guy.' Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool's game."

Some investment pros are naturally very capable but Buffett points out it's tough to know, at least in the near-term, "whether a great record is due to luck or talent."

He also says that professional advisors mostly "are far better at generating high fees than they are at generating high returns. In truth, their core competence is salesmanship. Rather than listen to their siren songs, investors – large and small – should instead read Jack Bogle's The Little Book of Common Sense Investing."

Buffett then refers to the Shakespeare quote included at the beginning of this post.

Those who trade frequently, try to be clever about market timing, diversify insufficiently (with the right amount being necessarily unique for each investor), incur lots of frictional costs, and use leverage to purchase equities shouldn't be surprised if they end up with a rather not so great outcome.

The ability to recognize where one's own behavior and limitations might get in the way of satisfactory (or better) returns can be a big advantage.

I'd add that choosing to make a specific investment based upon what someone else thinks is asking for trouble.

As Buffett says: "Anything can happen anytime..."

Well, if prices decline, it will be tough to hang in there (assuming hanging in there makes sense longer term) when an investment isn't truly well understood. Intrinsic worth, within a narrow range, has to be clear to the investor well before the market storm clouds arrive.

When price action goes south, who can maintain a justifiably positive view about something if it's been purchased based upon what someone else thinks? Real conviction in an investment comes from doing the necessary work then reaching one's own (hopefully sensible) conclusions. Listening to others is a recipe for inopportune selling.

Most investments -- even the one's that are very sound -- inevitably require that lots of warranted conviction will be needed from time to time.

Adam

Long position in BRKb established at much lower prices

Related posts:
Stocks and Risk
Munger on Focus Investing
Buffett on Risk and Reward

* The excerpts from the letter included in this post can be found on pages 18 and 19.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, March 4, 2015

Stocks and Risk

From Warren Buffett's most recent Berkshire Hathaway (BRKa) shareholder letter:*

"The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more
volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.


It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.


For the great majority of investors, however, who can – and
should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities."


This isn't simply a minor disagreement with modern finance theory. It's a major one. Modern theory considers the idea that stocks return more than other assets because they are more risky as some kind of fundamental truism.

Warren Buffett is saying that the exact opposite, in some circumstances, can be true in the long run. Consider this the next time someone says more risk must be taken to achieve greater returns and assumes there's always a positive correlation.

More risk = more rewards?

Not exactly.

The whole idea sounds reasonable enough but, well, it's flawed at best.

In fact, the real world provides us something a far more challenging when it comes time to understand risk and its relationship with investment returns.

Howard Marks offered this take in a memo last year:

Howard Marks on Risk

"We hear it all the time: 'Riskier investments produce higher returns' and 'If you want to make more money, take more risk.'

Both of these formulations are terrible. In brief, if riskier investments could be counted on to produce higher returns, they wouldn't be riskier."

A chart on page 6 of the memo by Marks presents risk and return the traditional way (with risk and return positively correlated). A second chart on the same page explains the relationship between risk and reward in a way that, to me, much more closely represents the world as it is. As far as I'm concerned it's a much more useful and correct depiction of risk and return.

How often do investors, whether it's explicit or not, assume incremental risk is required to generate incremental returns?

This assumption is a rather costly one for too many market participants. Near-term volatility -- as measured by beta -- just isn't very likely to reveal much about the long-term risks and potential returns of an investment (despite what finance theory suggests).** It'd be nice if understanding long-term investment risk came down to a single number. Unfortunately, making judgments about risk is necessarily imprecise and tough to quantify.

Those who choose to invest based upon some torched version of reality aren't likely to produce satisfactory investment outcomes.

Contending with all the illusions, biases, and fallacies -- among other things -- already makes investing well tough enough to do consistently well. So, wherever possible, it's essential to eliminate any distraction that might be caused by plainly flawed models.

Cash for near-term needs is essential. Funds needed in the next few years (and maybe even somewhat longer) should never be in stocks. Yet cash also has the lowest possible volatility -- so theory says it shouldn't be risky -- but the long-term risk ends up being not at all small.

A diversified basket of stocks bought with funds needed in the near-term and even intermediate-term is, of course, much riskier than cash.

Sometimes risk and reward must correlate in a positive manner.

It just need not necessarily be the case with a long enough time horizon.

Owning a portfolio of fine businesses long-term -- the only appropriate time horizon for equities -- allows risk to become much reduced.

Fortunately, many convenient low cost ways exist to obtain partial ownership of a diversified basket of businesses.

Whether mutual funds (incl. ETFs) or individual stocks is the right way to go naturally depends on the investor.

Adam

Long position in BRKb established at much lower than recent market prices

Related posts:
-Quality Stocks & the Risk-Return Tradeoff
-Howard Marks on Risk
-Grantham on Efficient Markets, Bubbles, and Ignoble Prizes
-Efficient Markets - Part II
-Risk and Reward Revisited
-Efficient Markets
-Modern Portfolio Theory, Efficient Markets, and the Flat Earth Revisited
-Buffett on Risk and Reward
-Buffett: Why Stocks Beat Bonds
-Beta, Risk, & the Inconvenient Real World Special Case
-Howard Marks: The Two Main Risks in the Investment World
-Black-Scholes and the Flat Earth Society
-Buffett: Indebted to Academics
-Friends & Romans
-Superinvestors: Galileo vs The Flat Earth
-Max Planck: Resistance of the Human Mind

* See page 18.
** According to the capital asset pricing model (CAPM), for example, highly volatile stocks should produce higher returns than the less volatile stocks to compensate investors for the additional risk. CAPM is a one factor model. In this model beta is the measure of volatility and is supposed to (somehow) represent risk. Well, the estimation of risk is necessarily qualitative and can't be captured by a single factor like beta. The Fama and French three factor model adds two additional factors. Others might find this stuff useful. I find none of it to be. Pure distraction.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
 
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