I’d like to start things off with some questions from the Australian Financial Review:
‘What do investors do when the leader of the free world appears bent on whipping up a global trade war? How do money managers respond to the reversal in the 30-year downward trend in interest rates? Do you chase US stocks higher or get the hell out now before the inevitable meltdown?’
Bent? Putting America first and reducing the trade deficit is what got Trump into office. Do you expect him to back away from his promises like most other politicians? Granted Trump might not always take the best course of action.
As for the second, why don’t money managers stop talking about how brilliant they are and start delivering? Our institutional dominated market is home to a bunch of mangers that do worse than the average. And they make millions for their underperformance. But what can you expect I guess. Not everyone can be in the top 50%.
And what’s all this talk about an inevitable meltdown? Sure, we’ll probably see the market fall at some point. But when and by how much?
The article did have a great piece of advice, however.
In many situations, the best thing to do is nothing.
Surely the fees are for performance?
Hollywood movies never show an investor getting up late, strolling into the office to read a book. The investor is always in front of multiple screens with flashing lights everywhere.
They’re making millions on a multitude of trades per day. They’re in the office early and leave late, if they ever leave at all.
Hollywood portrays the investor like a computer. The harder he works and the more information he can remember, the more million dollar trades he’ll make.
After all, why would you pay someone millions of dollars to do nothing? Surely because of their education and years of experience, there’s always something to do. A new trade to make. A new idea to purse.
Maybe the latter is true.
But for some reason, we think those money manager fees are paying for constant activity. Well, they’re not. Those fees are paying for superior returns.
And doing nothing will often make you millions, whereas activity will cost you a lot more.
How D.E. Shaw & Co. lost it all
Have you heard the famous line from 17th Century French scientist Blaise Pascal?
‘All man’s miseries derive from not being able to sit quietly in a room alone.’
This is extremely apt for investors. Most have ants in their pants. They don’t have the ability to sit still. They’re always looking for the next big thing in rapid succession.
While this isn’t always a bad thing. You do have to be constantly looking to have any hope of finding stocks that potentially rise 1,000% or more.
But when you’re jumping in and out of positions, never focusing on one idea before moving to the next, that’s when you start shooting yourself in the foot.
Investing extraordinaire Mohnish Pabrai has adapted Pascal’s words, which I think are appropriate:
‘All portfolio managers’ miseries derive from not being able to sit quietly in a room alone.’
In a following article, Mohnish then describes a real example of how activity can be extremely harmful. Take it away Mohnish…
‘Well, let’s start with the story of D.E. Shaw & Co. Founded in 1988, Shaw was staffed by some of the brightest mathematicians, computer scientists, and bond trading experts on the planet. Jeff Bezos worked at Shaw before embarking on his Amazon.com, Inc. [NASDAQ: AMZN] journey. These folks found that there was a lot of money to be made with risk-free arbitrage in the bond markets with some highly sophisticated bond arbitrage trading algorithms.
‘Shaw was able to capitalize on minuscule short-term inefficiencies in the bond markets with highly leveraged capital. The annualized returns were nothing short of spectacular — and all of it risk-free! The bright folks at Shaw put their trading on autopilot, with minimal human tweaking required. They came to work and mostly played pool or video games or just goofed off. Shaw’s profit per employee was astronomical, and everyone was happy with this Utopian arrangement.
‘Eventually, the nerds got fidgety — they wanted to do something. They felt that they had only scratched the surface and, if they only dug deeper, there would be more gold to be mined. And so they fiddled with the system to try to juice returns.
‘What followed was a similar path taken by Long-Term Capital Management (LTCM), a fund once considered so big and so smart on Wall Street that it simply could not fail. And yet, when economic events that did not conform to its historical model took place in rapid succession, it nearly did just that. There was a gradual movement from pure risk-free arbitrage to playing the risky arbitrage game in the equity markets. A lot more capital could be deployed, and the returns looked appealing. With no guaranteed short-term convergence and highly leveraged positions, the eventual result was a blow-up that nearly wiped out the firm.’
So what’s the moral here…
Doing nothing isn’t the answer to becoming rich and successful. But knowing when to do nothing is one way to get there.
Best part is it’s really simple. When you can’t find anything you believe is worth buying, then that’s the perfect time to do nothing. Just sit on your hands and wait for something better to come along…it usually always does.
Editor, Money Morning