Category Archives: Investor Psychology

No Price Discovery Then No Markets; A Reader’s Question

Has the meteoric rise of passive investing generated the “greatest bubble ever”?
The better we understand the baked-in biases of algorithmic investing, the closer we can come to answers.


The following article was originally published in “What I Learned This Week” on June 15, 2017. To learn more about 13D’s investment research, visit website.

In an article for Bloomberg View last week titled “Why It’s Smart to Worry About ETFs”, Noah Smith wrote the following prescient truth: “No one knows the basic laws that govern asset markets, so there’s a tendency to use new technologies until they fail, then start over.” As we explored in WILTW June 1, 2017, algorithmic accountability has become a rising concern among technologists as we stand at the precipice of the machine-learning age. For more than a decade, blind faith in the impartiality of math has suppressed proper accounting for the inevitable biases and vulnerabilities baked into the algorithms that dominate the Digital Age. In no sector could this faith prove more costly than finance.

The rise of passive investing has been well-reported, yet the statistics remain staggering. According to Bloomberg, Vanguard saw net inflows of $2 billion per day during the first quarter of this year. According to The Wall Street Journal, quantitative hedge funds are now responsible for 27% of all U.S. stock trades by investors, up from 14% in 2013. Based on a recent Bernstein Research prediction, 50% of all assets under management in the U.S. will be passively managed by early 2018.

In these pages, we have time and again expressed concern about the potential distortions passive investing is creating. Today, evidence is everywhere in the U.S. economy — record low volatility despite a news cycle defined by turbulence; a stock market controlled by extreme top-heaviness; and many no-growth companies seeing ever-increasing valuation divergences. As always, the key questions are when will passive strategies backfire, what will prove the trigger, and how can we mitigate the damage to our portfolios? The better we understand the baked-in biases of algorithmic investing, the closer we can come to answers.

Over the last year, few have sounded the passive alarm as loudly as Steven Bregman, co-founder of investment advisor Horizon Kinetics. He believes record ETF inflows have generated “the greatest bubble ever” — “a massive systemic risk to which everyone who believes they are well-diversified in the conventional sense are now exposed.”

Bregman explained his rationale in a speech at a Grant’s conference in October:
“In the past two years, the most outstanding mutual fund and holding- company managers of the past couple of decades, each with different styles, with limited overlap in their portfolios, collectively and simultaneously underperformed the S&P 500…There is no precedent for this. It’s never happened before. It is important to understand why. Is it really because they invested poorly? In other words, were they the anomaly for underperforming — and is it reasonable to believe that they all lost their touch at the same time, they all got stupid together? Or was it the S&P 500 that was the anomaly for outperforming? One part of the answer we know… If active managers behave in a dysfunctional manner, it will eventually be reflected in underperformance relative to their benchmark, and they can be dismissed. If the passive investors behave dysfunctionally, by definition this cannot be reflected in underperformance, since the indices are the benchmark.”

At the heart of passive “dysfunction” are two key algorithmic biases: the marginalization of price discovery and the herd effect. Because shares are not bought individually, ETFs neglect company-by-company due diligence. This is not a problem when active managers can serve as a counterbalance. However, the more capital that floods into ETFs, the less power active managers possess to force algorithmic realignments. In fact, active managers are incentivized to join the herd—they underperform if they challenge ETF movements based on price discovery. This allows the herd to crowd assets and escalate their power without accountability to fundamentals.

With Exxon as his example, Bregman puts the crisis of price discovery in a real- world context:

“Aside from being 25% of the iShares U.S. Energy ETF, 22% of the Vanguard Energy ETF, and so forth, Exxon is simultaneously a Dividend Growth stock and a Deep Value stock. It is in the USA Quality Factor ETF and in the Weak Dollar U.S. Equity ETF. Get this: It’s both a Momentum Tilt stock and a Low Volatility stock. It sounds like a vaudeville act…Say in 2013, on a bench in a train station, you came upon a page torn from an ExxonMobil financial statement that a time traveler from 2016 had inadvertently left behind. There it is before you: detailed, factual knowledge of Exxon’s results three years into the future. You’d know everything except, like a morality fable, the stock price: oil prices down 50%, revenue down 46%, earnings down 75%, the dividend-payout ratio almost 3x earnings. If you shorted, you would have lost money…There is no factor in the algorithm for valuation. No analyst at the ETF organizer—or at the Pension Fund that might be investing—is concerned about it; it’s not in the job description. There is, really, no price discovery. And if there’s no price discovery, is there really a market?”


We see a similar dynamic at play with quants. Competitive advantage comes from finding data points and correlations that give an edge. However, incomplete or esoteric data can mislead algorithms. So the pool of valuable insights is self-limiting. Meaning, the more money quants manage, the more the same inputs and formulas are utilized, crowding certain assets. This dynamic is what caused the “quant meltdown” of 2007. Since, quants have become more sophisticated as they integrate machine learning, yet the risk of overusing algorithmic strategies remains.

Writing about the bubble-threat quants pose, Wolf Street’s Wolf Richter pinpoints the herd problem:

“It seems algos are programmed with a bias to buy. Individual stocks have risen to ludicrous levels that leave rational humans scratching their heads. But since everything always goes up, and even small dips are big buying opportunities for these algos, machine learning teaches algos precisely that, and it becomes a self-propagating machine, until something trips a limit somewhere.”

As Richter suggests, there’s a flip side to the self-propagating coin. If algorithms have a bias to buy, they can also have a bias to sell. As we explored in WILTW February 11, 2016, we are concerned about how passive strategies will react to a severe market shock. If a key sector failure, a geopolitical crisis, or even an unknown, “black box” bias pulls an algorithmic risk trigger, will the herd run all at once? With such a concentrated market, an increasing amount of assets in weak hands have the power to create a devastating “sell” cascade—a risk tech giant stocks demonstrated over the past week.

With leverage on the rise, the potential for a “sell” cascade appears particularly threatening. Quant algorithms are designed to read market tranquility as a buy-sign for risky assets—another bias of concern. Currently, this is pushing leverage higher. As reported by The Financial Times, Morgan Stanley calculates that equity exposure of risk parity funds is now at its highest level since its records began in 1999.

This risk is compounded by the ETF transparency-problem. Because assets are bundled, it may take dangerously long to identify a toxic asset. And once toxicity is identified, the average investor may not be able to differentiate between healthy and infected ETFs. (A similar problem exacerbated market volatility during the subprime mortgage crisis a decade ago.) As Noah Smith writes, this could create a liquidity crisis: “Liquidity in the ETF market might suddenly dry up, as everyone tries to figure out which ETFs have lots of junk and which ones don’t.”

J.P. Morgan estimated this week that passive and quantitative investors now account for 60% of equity assets, which compares to less than 30% a decade ago. Moreover, they estimate that only 10% of trading volumes now originate from fundamental discretionary traders. This unprecedented rate of change no doubt opens the door to unaccountability, miscalculation and in turn, unforeseen consequence. We will continue to track developments closely as we try and pinpoint tipping points and safe havens. As we’ve discussed time and again with algorithms, advancement and transparency are most-often opposing forces. If we don’t pry open the passive black box, we will miss the biases hidden within. And given the power passive strategies have rapidly accrued, perpetuating blind faith could prove devastating.

The Greatest Bubble Ever 13D Research   (Sign-up for their updates!)

A Reader’s question that I post below so the many intelligent folks that read this can chip in their thoughts….

The part that confuses me the most is this:

From what I gather, Greenblatt typically calculates his measurement of normal EBITDA – MCX. He then puts a conservative multiple on this, typically 8 or 10 times EBITDA-MCX. He says higher quality companies may deserve 12x or more. He often says something like “this is a 10% cash return that is growing at 6% a year. A growing income is worth much more than a flat income”. He seems to do this on page 309-310 of the notes you sent me  complete-notes-on-special-sit-class-joel-greenblatt_2.

My question is: Greenblatt’s calculation of earnings (EBITDA – MCX) only includes the maintenance portion of capital expenditure. The actual cash flow may be lower because of growth capex. Yet he is assuming a 6% growing income. It seems strange to me that he calculates the steady-state income (no growth capex. Only Maintenance capex), but he assumes that the income will grow. It seems like he is assuming the income will grow 6% but doesn’t incude the growth capex in his earnings calculation. Is it logical to assume that the steady-state earnings will grow, but not deducting the cost of the growth capex from the earnings? 





The Qualities of a Good Analyst; 100-to-1 Master Class

Confidence vs. Humility

1Q17 | Bill Nygren Market Commentary (Abridged)

see: http://1Q17-Bill-Nygren-Market-Commentary

March 31, 2017

At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.

Oh Lord, it’s hard to be humble, when you’re perfect in every way.  It’s Hard To Be Humble by Mac Davis, 1974

What Makes a Good Oakmark Analyst?

I also like March because it is the month I get to speak to investment students at my alma mater’s Applied Securities Analysis Program and Bruce Greenwald’s value investing program at Columbia.  Typical topics include how I got interested in investing, my education and career path, and what makes Oakmark unique. Without fail, the aspiring investment professionals will eventually ask about the characteristics we look for when we hire analysts at Oakmark or, more generally, What do you think makes a good investment analyst?  Perhaps the answer might give some insight into how we think at Oakmark.

When I served as director of research, I used to joke that every analyst search we conducted started with the same list of requirements: A high GPA from a good university, a major in finance or accounting, intuitive math skills, strong oral and written communication ability, three to five years’ related work experience, intense competitive drive, and activities demonstrating leadership. MBA or CFA required.  Yet almost every hire was somewhat outside that box. We hired some analysts with low GPAs, some with different degrees and some from second-tier colleges. We hired some with over 10 years’ experience, and others with no experience at all. Some had neither an MBA nor a CFA. What we realized was that our search criteria, though representative of our typical hires, was not really defining the candidates we were looking for. Those criteria defined the candidates most investment firms are looking for, but didn’t at all get to what makes Oakmark unique.

Team Player
There are three additional characteristics that we believe are necessary to succeed at Oakmark that we either don’t think we can teach or don’t want to teach, so we require them to be present before we hire an analyst.  First is being a team player.   At many investment firms, analysts have a one-on-one relationship with portfolio managers.  They develop their stock recommendations and present them to a portfolio manager who decides whether or not the stocks will be purchased. If analysts pick good stocks, they will be paid well and their careers will progress. In that setup, it doesn’t really matter whether the analyst is a team player or not.  Oakmark is different.

Oakmark analysts succeed by helping the team succeed. Yes, we expect them to find good stocks to purchase, but that effort is collaborative. An analyst who begins working on a new buy idea seeks input from the rest of the investment team before the idea is finalized. When the work is presented, it is the job of every investment professional at our company to attempt to find flaws that would prevent us from investing. Throughout the time we hold a stock, the analysts will challenge each other as to whether or not our sell target correctly incorporates all the new information we’ve seen subsequent to our purchase. When the stock is sold, it is treated as a victory for the team if it went up, and a team defeat if it did not. We all understand that we do well financially when our shareholders do well financially. That’s in part because a major factor in our compensation review is how well an analyst helps improve the team’s stock selection.

We know that anyone who puts their personal success over Oakmark’s success will not last long at our company. So, we look for clues in resumes such as a history of playing team sports or other activities where accomplishments by a group are more important than by an individual. We know that we can’t teach someone how to be a team player.

Value Investor
More than 30 years ago, Warren Buffett wrote an article that has become a value investing classic: The Superinvestors of Graham and Doddsville (Fall 1984, Hermes’ the Columbia Business School Magazine). If you haven’t read it, or haven’t read it recently, it is well worth the time. In that article, Buffett explained the futility of trying to convert investors to a value investing philosophy:

It is extraordinary to me that the idea of buying dollar bills for 40c takes immediately with people or it doesn’t take at all. It’s like an inoculation. If it doesn’t grab a person right away, I find you can talk to him for years, and show him records, and it just doesn’t make any difference. They just don’t seem able to grasp the concept, simple as it is.  I’ve never seen anyone who became a gradual convert over a ten-year period to this approach. It doesn’t seem to be a matter of I.Q. or academic training. It is instant recognition or it is nothing.

We 100% agree with Buffett. Everything we do at Oakmark is based on value investing. We don’t know how to teach someone how to think like a value investor. You can’t succeed at Oakmark without practicing value investing. Therefore, we will only hire analysts who have developed a value philosophy prior to joining our team.

There are some characteristics for successful analysts that are simple more is better traits. Intelligence, curiosity, communication skills all are more is better.  Then you have the continuums where, like NCAA basketball teams, a strength carried to the extreme becomes a weakness. We want discipline, but we also want creativity. We demand patience, but don’t want stubbornness. We want thoroughness, but require decisions based on incomplete information. Success requires striking an appropriate balance between these traits that sound like opposites. Being at one extreme or the other is a recipe for failure.

(CSInvesting: reading the Nicomachaen Ethics by Aristotle would teach you to seek moderation.)

One of the most important continuums for us is confidence versus humility. It is especially important for a value investor to have the confidence to take a position when the vast majority of investors are on the opposing side. But without humility, one loses the ability to admit a mistake. I’m reminded of the early 1980’s TV show Happy Days with the super-cool Fonzie who could never say the words I was wrong. Fonzie would have been an awful investor.

In a book many in our research department have enjoyed, Superforecasting: The Art and Science of Prediction, Philip Tetlock and Dan Gardner state:

The humility required for good judgment is not self-doubt, the sense that you are untalented, unintelligent, or unworthy. It is intellectual humility. It is a recognition that reality is profoundly complex, that seeing things clearly is a constant struggle, when it can be done at all, and that human judgment must therefore be riddled with mistakes.

What we are looking for in Oakmark analysts is confidence paired with the humility to remain open to evidence that shows they are wrong.

One of my investing heroes, former hedge fund pioneer Michael Steinhardt, said, “The balance between confidence and humility is best learned through extensive experience and mistakes.” Unlike being a team player or a value investor, with time, almost every investor develops humility. But it is an expensive lesson to learn. We want analysts who developed their humility by losing money somewhere else.

I can’t count the number of resumes I’ve seen or conversations I’ve had with students where they excitedly state that their personal portfolio returned X percent last year. And of course, X is always some number that is astoundingly high relative to the market or to Oakmark returns. That record is almost always accompanied by scorn for incompetent professional investors and the offer to teach us the secrets of their success. I smile as I mentally mark off the box needs to be humbled by losing money.  Then I wish them great success in their job search and suggest they check back with us in a few years.

Master Class in 100 to 1 Investing (Chris Mayer).

Sure a marketing tool, but perhaps some can learn more about patience.   I am not affiliated, but thought I would share the link.  All Mayer is doing is talking about the Phelp's book, 100 to 1 Investing.

100-baggers Analysis       and     100Baggers


Free masterclass: The Mayer Method: The breakthrough new formula for identifying tomorrow’s biggest stock market winners today.

As you’re about to see, you’ve made a great decision..

Because I’ll be sharing a few simple investment strategies with you that will show you how to take advantage of one of the greatest “hidden” opportunities I see in the market.

This is completely different from anything we’ve shared with you before…

Here’s the link to video #1 to get you started: The big change coming in the market

In this series of short videos, I’m going to walk you through exactly what this opportunity is… why it’s happening now… and then I’ll show you how I’m taking advantage of it and give you the tools you need to take advantage of it, too…

By signing up for this training, you’re already ahead of the curve on this.

Remember, I’m going to limit the first of these videos to short 10-minute segments. And then, finally, on Thursday night, I’ll show you how to put it all together in a webinar, where I’ll give away the names of six stocks I recommend you watch.

Get started with the first video by clicking here.


Indexing Madness or An Indexing Bubble

A must see discussion of today’s index investing distortions   What will turn the tide for active investors. Or read commentary : Q4-2016-Commentary_Final Grant’s Conference Presentation


Q2 2016 Commentary FINAL (See section on ETFs vs. Individual Stocks)

Articles of interest:

Cargo Cults


The first principle is that you must not fool yourself–and you are the easiest person to fool.

A Real Cargo Cult

An example of cargo cult analysis would be expecting to predict future market returns from P/E Ratios or believing you can pick money managers who can overcome a 2% and 20% hurdle vs. a low-cost index fund. See pages 21-24:Berkshire Hathaway AR 2016. Why Buffett is winning his $1 million dollar bet against fund of funds manager, Ted Seides.


The cargo cult mindset — mindlessly aping something without understanding *how* it works — is rampant. E.g. young people who “go to college” and end up unemployed or making minimum wage. They’re not much different than the islanders who made fake airplanes and control towers based on simple observations.

“So I wish to you—I have no more time, so I have just one wish for you—the good luck to be somewhere where you are free to maintain the kind of integrity I have described, and where you do not feel forced by a need to maintain your position in the organization, or financial support, or so on, to lose your integrity. May you have that freedom.”

If we look at the active management world, we see many (most?) asset managers don’t have such freedom. It’s for that reason that Jeremy Grantham believes career risk is what dominates investing. Better to be wrong collectively and focus on relative returns, right?

Fast-forwarding some years, we see Feynman having such freedom during the investigation of the cause of the Space Shuttle Challenger disaster; he was an effective investigator precisely because he wasn’t beholden to NASA and was motivated by the pursuit of truth. His “Appendix F” in the Rogers Commission Report is another must-read:

Feynman eschewed the “standard” investigative approach and instead wandered around and talked to engineers and technicians, to the consternation of Rogers and others. (Didn’t W.E. Buffett and/or one of his associates do something similar after the Salad Oil Swindle hit AMEX in the ’60s? He saw that actual AMEX customers didn’t much care, so decided to go ahead with his investment.)

In Appendix F, Feynman uses basic engineering concepts and “numbersense” to expose NASA’s defective management culture. The disparity between the engineers’ estimate of flight risk and NASA management’s is astounding. The lesson here is that you oftentimes don’t need very much to sense-check, or falsify your hypothesis — the whole being generally right instead of precisely wrong concept. Going back to the Salad Oil Swindle, the whole thing would’ve never happened if anyone involved decided to reconcile the deposit receipts (known) to the USDA report on national salad oil production (known) to see how the receipts were inflated to the point of absurdity. Looking back at various case studies of failed investments, how often were the warning signs staring us right in the face if only we thought to look?

Since this is an investing website, we might modify Feynman’s closing sentence to something like, “For a successful investment, economic reality must take precedence over public relations, for you cannot fool everyone forever.”

Fundamentals vs. Technicals, Templeton, Ackman, Analysis of Valeant

Fundamental vs. Technical Analysis

Technical analysis, in all of its forms, uses the past price movements to predict the future price movements. In some cases (e.g. momentum analysis) it calculates an intermediate signal from the price signal (momentum is the first derivative of price). But no matter the style, one analyzes price history to guess the next price move.

This is necessarily probabilistic. There is no way to know that a particular price move will follow the chart pattern you see on the screen. There is no certainty. And when it does work, it is often because of self-fulfilling expectations. Since all traders have access to the same charts, and the same chart-reading theories, they can buy or sell en masse when the chart signals them to do so.

Fundamentals or Arbitrage:

Arbitrage works just like a spring. If the price in the futures market is greater than the price in the spot market, then there is a profit to carry gold—to buy metal in the spot market and sell a futures contract. If the price of spot is higher, then the profit is to be made by decarrying—to sell metal and buy a future.

There are two keys to understanding this. One, when leveraged speculators push up the price of gold futures contracts, then that increases the basis spread. A greater basis is a greater incentive to the arbitrageur to take the trade. Two, when the arbitrageur buys spot and sells a future, the very act of putting on this trade compresses the spread.

If someone were to come along and sell enough futures contracts to push down the price of gold by $50 or $150 or whatever amount is alleged, then this selling would be on futures only. It would push the price of futures below the price of spot, a condition called backwardation.

Backwardation just has not happened at the times when the stories of the big “smash downs” have claimed. Monetary Metals has published intraday basis charts during these events many times.

The above does not describe technical analysis. It describes physics—how the market functions at a mechanical level.

There are other ways to check this. If there was a large naked short position in a contract that was headed into expiry, how would the basis behave? The arbitrage theory predicts the opposite basis move. We will leave the answer out as an exercise for the interested reader, as thinking this through is really good work to understand the dynamics of the gold and silver markets (and you can Google our past articles, where we discuss it).

This check can be observed every month, as either gold or silver has a contract expiring (right now it’s gold, as the April contract is close to First Notice Day).


Ackman and Valeant

Ackman and his disasterous investment in Valeant The are many psychological lessons in this article.  What can you learn?

Ironically, one of the best research on Valeant was done by Allergan: Allergan analysis of Valeant 2014.   Did Ackman’s analysts even read it?   At least you have an example of solid research.

Compare to Ira-Sohn-2015-Presentation on Valeant and Other Platform Companies   Studying the two different presentations provides a FREE course on valuation and presenting a research idea.  But not 1 person in 10,000 would be willing to sweat the details like studying the two documents linked above.

Oh well, opportunity for those who work.

A Strategy for Resource Stocks; Investing Course

A Strategy for investing in highly volatile, cyclical stocks

Once again, gold, silver and their mining stocks are selling off for whatever reason: risk-on as money floods into the stock market, rising nominal yields, 95% certainty of a (meaningless) 0.25% interest rate hike, momentum–take your excuse. The main point is to know your companies (valuation) and wait for sales like you do at the grocery store.   This week we are having a sale on some miners.

As Sprott’s Rick Rule often says, “If you are not a contrarian in the resource sector, you are a victim.  The above video is provided to show a particular investing strategy when your quality miners are selling off to prices where you estimate a margin of safety.  However, it doesn’t mean you predict THE exact bottom.  If your holding period is three-to-five years, you can occasionally pick up cheaper merchandise. Use prices to your advantage, not disadvantage.  I also wouldn’t be surprised to see the miners sell-off further because of their highly volatile nature–huge operational and asset-based leverage–when gold or silver goes up or down, both the price of their product goes up or down and the value of their reserves.  Never expect exact timing–a fool’s game.  Also, miners are impacted by the cost of their inputs, so a rising gold/oil ratio is a positive, for example.

What about the gold price in my assumptions?   I am assuming gold is money (“All else is credit”–JP Morgan) and thus I can benchmark it against world currencies. Gold has been THE strongest money relative to all other currencies for the past 20 years, 30 years, 40 years, 50 years, 100 years.  Gold is THE only money and store of value that can’t be created out of electronic bits like FIAT MONEY.  The stability of available supple is what makes gold the premier money. Of course, due to LEGAL TENDER LAWS, gold is not a currency in the U.S., except that may be changing in some states like Arizona:

In fact, gold (originally silver) is the only Constitutional money allowed–!/articles/1/essays/42/coinage-clause

You can get a historical overview of gold’s‘ price history below. Notice a trend? Now view the miners in perspective.

P.S. Let me know if anyone wants to see a NPV case study on a miner.

Designing an analyst course

My goal is to organize a comprehensive analyst course using the best investors’ teachings and lectures. For example, Buffett, Munger, Graham, Fisher, Tweedy Browne, Walter Schloss, Klarman, and many others etc.  Why not use original sources of the best practitioners?  This is the course I wish I had twenty years ago.  It will be Buffett and Munger teaching not me.

The course would cover search, valuation, portfolio management, and you (how to improve decision-making).   There would be different modules continuing articles, case studies, videos from Columbia Business School and others. We would go from DEEP VALUE to FRANCHISE INVESTING.   Valuing assets to assessing franchises. Understanding reversion to the mean and slow reversion to the mean.  You need to understand that when a moat is breached-watch out! Note Nokia in cell phones.

I would have to make it a private web-site because of copy-right.   This would be more of like a private study place, library, and discussion area for learning.   There could be a in-person value class in some convenient location depending upon interest once folks have had a chance to go through the modules.

For example, putting ebitda into perspective might be a mini-module on a sub-set of cash-flow:   Now, if you scroll down to the last link, you can see that it was taken down.   With a private web-site, you would see this:

Let me know your thoughts because this would be a huge project to complete.  What focus do YOU want?   How would YOU design and make the course.

Have a great weekend!

Recent Munger Wisdom

Recent Munger Transcript 340444245-Munger-2017-DJCO-Transcript340444245-Munger-2017-DJCO-Transcript


A Deep-Value Canadian Grahamite Teaches His Process

Tim McElvaine explains his simple but effective process.

2016-05_conference_transcript_McElvaine Fund An excellent tutorial on Graham-like investing. Note his simple four-pronged approach.   Read more below:

Time to Index? Got Gold?

A portfolio manager who will manage the Dogs of the Dow Portfolio.

Most institutional and individual investors will find the best way to own common stock is through an index fund that charges minimal fees. Those following this path are sure to beat the net results after fees and expenses delivered by the great majority of investment professionals. –Warren Buffett.

A minuscule 4% of funds produce market-beating after-tax results with a scant 0.6% annual margin of gain. The 96% of funds that fail to meet or beat the Vanguard 500 index Fund lose by a wealth-destroying margin of 4% per annum.  “Unless an investor has access to incredibly highly qualified professionals, they should be 100 percent indexed. That includes almost all investors and most institutional investors. –David Swensen, chief investment officer, Yale University.

“In modern markets, most institutions and almost all individuals will experience better results with index funds.” –Benjamin Graham.

Those who have knowledge, don’t predict. Thos who predict, don’t have knowledge. — Lao Tzu, 6th Century B.C.

I am reading, The Index Revolution: Why Investors Should Join It Now by Charles D. Ellis

The author presents a compelling case why most individuals should index:

  1. Indexing outperforms active investing
  2. Low Fees are an important reason to index
  3. Indexing makes it much easier to focus on your most important investment decisions
  4. Your taxes are lower when you index
  5. Indexing saves operational costs.
  6. Indexing makes most investment risks easier to live with
  7. Indexing avoids “Manager Risk”
  8. Indexing helps you avoid costly troubles with Mr. Market
  9. You have much better things to do with your time.
  10. Experts agree most investors should index

Articles proliferate such as: and research for the past few decades has shown that Index Funds Outperform.

Now lets journey into the real world:  I picked this fund family at random. Look at each of their funds’ long-term performance compared to their comparable benchmarks.   Not ONE outperforms. Not one.   Who in their right mind would invest?    As money managers become desperate to beat the index, they tend to mimic their benchmarks, so their amount of underperformance closes towards the index, but GUARANTEES underperformance due to fees and slippage of commissions and taxes.

Time to pack it in and index?   First, do not underestimate how difficult it is to “outsmart” the market.   I personally believe that the ONLY way–obviously–to do better is to be very different from the indexes.   You will either vastly UNDER-perform or OUTperform.  You have to be different and right.  So how to be right?  You must do things differently like use all available information in the financials (read footnotes and balance sheet), have a longer-term perspective such as five to seven years–at a minimum–three years to give reversion to the mean a chance to work or time for franchises to compound.   You have to pick your spots where you are confident that you are buying from mistaken, uneconomic sellers.   And when you do find a great opportunity (assuming that you can distinguish one) you heavily weight your position.  NOT EASY.


Here is what Seth Klarman recently said about current conditions (New York Times, Feb. 7th, 2017:

Most hedge funds have found themselves on the losing side of trades over the past several years, a point Mr. Klarman addressed in his letter (2016). Noting that hedge fund returns have underperformed the indexes — he mentioned that hedge funds had returned only 23 percent from 2010 to 2015, compared with 108 percent for the Standard & Poor’s index — he blamed the influx of money into the industry.

“With any asset class, when substantial new money flows in, the returns go down,” Mr. Klarman wrote. “No surprise, then, that as money poured into hedge funds, overall returns have soured.”

He continued, “To many, hedge funds have come to seem like a failed product.”

The lousy performance among hedge funds and the potential for them to go out of business or consolidate, he suggests, may become an opportunity.

Perhaps the most distinctive point he makes — at least that finance geeks will appreciate — is what he says is the irony that investors now “have gotten excited about market-hugging index funds and exchange traded funds (E.T.F.s) that mimic various market or sector indices.”

He says he sees big trouble ahead in this area — or at least the potential for investors in individual stocks to profit.

“One of the perverse effects of increased indexing and E.T.F. activity is that it will tend to ‘lock in’ today’s relative valuations between securities,” Mr. Klarman wrote.

“When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership),” he wrote. “Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings.”

To Mr. Klarman, “stocks outside the indices may be cast adrift, no longer attached to the valuation grid but increasingly off of it.”

“This should give long-term value investors a distinct advantage,” he wrote. “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”


What do YOU think?

Using Charts (NVGS)

So if charts have NO FORECASTING ability or, in my humble opinion, no investor/trader can use chart formations like rising wedges, cup and handles, head and shoulders, etc to PREDICT where the market will go IN THE FUTURE. Charts might work for Hindsight Capital, but I have yet to see any research showing the efficacy of chart reading.  Despite that vicious attack on chartists, I do use charts.   Take for example, Navigator’s Holdings (NVGS).   Let’s zero in a bit more:

Note the time period from August 2016 to December 2016.  As the price accelerated downward on larger than normal volume–note in the second week of August the plunge in price from $9.50 t0 $8.10 in one day or about 15%, OUCH!  The price decline occurred on the anouncement of second quarter earnings:

Navigator Holdings misses by $0.04, misses on revenue Aug. 8, 2016

So you have a plunging/falling knife on an “earnings miss” or worse than “expected” news.  Now look at the opposite of the trade. Since I was fundamentally bullish, who was on the other side selling?  First from the holdings, you can see that 41% of the 53 million shares outstanding is held by a private equity firm, Invesco run by Wilbur Ross–a deep value investor. Invesco bought at $9 a share back in 2012, then sold some shares at $20 a year and a half later.  Over 50% of the shares seem to be held by long-term investors.   The NVGS share price had been declining for over two years from $32 per share while it bought more ships, then LPG freight rates declined sharply and the arbitrage shrunk for some of NVGS’s products.  In short, the sudden high volume rapid decline indicated MOTIVATED sellers who were either distressed or late momentum sellers.  Some of the sellers are selling AFTER a long price decline and bad news being announed.  I consider those emotional/weak sellers. Now there is no guarantee that the news won’t worsen and the price won’t keep declining.

I feel confident saying that because NVGS’ balance sheet was not overburdened with debt. See September-2016-Update for NVGS.

INVESCO PRIVATE CAPITAL, INC. 21,863,874 $ 157,201,000 41.05% 53.08% 1 NaN%
PARAGON ASSOCIATES & PARAGON ASSOCIATES II JOINT VENTURE 1,050,000 $ 7,550,000 8.73% 10.85% 4 86,516 NaN%
EMANCIPATION MANAGEMENT LLC 683,422 $ 4,913,000 7.57% 6.95% 3 187,961 NaN%
HOLLOW BROOK WEALTH MANAGEMENT LLC 855,072 $ 6,148,000 3.63% 2.91% 10 489,875 NaN%

Then prices CONTINUED to decline as negative news and research reports came out reporting the known bad news of declining freight rates, over-supply of ships, economic uncertainty, etc.

Let’s set aside that on a normalized basis, I have a value for NVGS above $20, how do I know the price won’t go to $8 or $5 or $2? I don’t!   But I do have context to see if the price is “OVER” discounting the news/fundamentals. is an example of several negative research reports that implied, “Yes, the stock is cheap with solid management and the company is profitable, BUT supply will increase next year.” Stay away.

Then for the next two months, September and October, the price chart showed a change in trend from rapidly down to sideways. Why was the price going sideways with negative reports and negative news constantly coming out each day?  Perhaps the chart was showing that prices had ALREADY discounted the known NEGATIVE news and extrapolating a long period of negative news.   Unless the news became much worse–despite frieght rates at 30 year lows–all you needed was slightly less bad news.

Sure enough, the announcement of earnings Nov. 4th 2016 showed that the company could still generate profits in an extremely negative operating environment. The price rallied confirming the prior discounting.  Now I could really start to add to my position.  The chart had helped me “eliminate” one side of the market–the downside.

The combination of fundamentals, the action of majority shareholders (holding firm), extreme negative news coupled with NON-DECLINING prices, gave me a signal that the market had ALREADY discounted negative news.    This is more of an art or combination of fundamentals, sentiment, and human incentives than just looking at chart patterns.

Hope that helps.

You are Hired! A Trump Playbook For Fixing Americas Economy

If you were against the New Deal and its wholesale buying of pauper votes, then you were against Christian charity.  If you were against the gross injustices and dishonesties of the Wagner Labor Act, then you were against labor.  If you were against packing the Supreme Court, then you were in favor of letting Wall Street do it.  If you are against using Dr. Quack’s cancer salve, then you are in favor of letting Uncle Julius die.  If you are against Holy Church, or Christian Science, then you are against god.  It is an old, old argument. –H.L.Mencken