Letters to Our Clients
Most of us believe that experience in an occupation, measured by time spent on the job, leads to higher productivity for the employer and greater income for the employee. I agree that this belief holds true for most occupations. However, I disagree when it comes to the business of providing investment advice. In this business, the best experience is gained when an advisor’s own wealth is at risk, and his or her decisions are measured by personal dollars gained or lost. While it’s always good to be right about your investments and make money, the most valuable knowledge is gained through the experience of being wrong.
“When the facts change, I change my mind. What do you do madam?”
- Winston Churchill, John Maynard Keynes, Paul Samuelson?
The CFA Institute’s second quarter 2017 Financial Analysts Journal included a research article penned by Martijn Cremers, professor of finance at the University of Notre Dame, entitled “Active Share and the Three Pillars of Active Management: Skill, Conviction, and Opportunity.”
We are currently struggling with portfolio construction due to historically high stock prices and interest rates that provide little reward, and I thought it would be beneficial to share with you Cremers’ understanding of what it takes to be a successful money manager:
One of the greatest strengths of American capitalism is how it addresses the problems faced by its citizens. The greater the problem, and the more lives impacted by the problem, the more entrepreneurs, academics and government officials there are seeking solutions. As it is, government tends to attack problems with laws and regulations that they hope will then steer profit seeking entrepreneurs to find a solution benefiting all of society. In the world of investment management, these profit seeking entrepreneurs rely heavily on the work of academic researchers to isolate a process that can then be manufactured into a product and monetized.
Three decades ago Sir John Templeton provided 22 rules for investment success to William Proctor who then shared these rules in his book, The Templeton Touch. Templeton’s first rule was: “For all long-term investors, there is only one objective – maximum total real return after taxes.” Around this same time, another famous investor, Warren Buffett, was developing his own investing rules. Warren made it simple and clear. When asked what his rules were, he replied, “Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1.” This month we are going to share with you how we believe common stock dividends help in meeting both rules, but first I want to share some thoughts on a few major events that have taken place recently.
We all know that our government and its agencies are very good at reacting to a real or perceived crisis with new laws and regulations designed to reduce the chances of another similar event occurring. The most recent example of this concerns the cost and availability of health care. The solution designed and implemented into law, affectionately known as Obamacare, was well intended. However, we all know that it has major problems that will need correcting.
Robert C. Merton, Nobel Prize Winner, Shares Some Common Sense Advice for Index Investors and Robo-advisers
Over the years I have been quite disappointed with investment research provided by academia. The majority of this research mines some data, wraps it with some pretty mathematics and presents it to the world in a format that very few can understand. One group of people who can understand this research refer to themselves as “financial engineers.” It is this group that takes a look at the research, determines if the research has some marketing qualities and, if it does, creates or engineers a product that can be sold to us, the investors. Most of these products have little chance of creating long-term wealth for us, but they can easily give a short term boost to the profits of the sponsors of these engineered products.
Kendall J. Anderson, CFA