Sunday, June 24, 2018

Portnoy, The Geometry of Wealth

Brian Portnoy, director of investment education at Virtus Investment Partners, has written a personal finance book that goes beyond mere finance. The Geometry of Wealth: How to Shape a Life of Money and Meaning (Harriman House, 2018) approaches the subject by way of three shapes: the circle, purpose; the triangle, priorities; and the square, tactics. The circle exemplifies how we navigate life’s ups and downs, through the back-and-forth of defining and then adapting. Portnoy imagines two triangles. The first one has risk management at its base, spending and saving decisions in the middle, and big dreams at the top. The second triangle is intended to be a bridge between planning priorities and investment decisions. At its base is behavior, then comes portfolio management, and finally individual parts of portfolios at the apex. As for tactics, the four corners of the square represent the growth we hope to achieve, the emotional pain of achieving those gains, fit (“how additional decisions improve or undermine what you already own”), and flexibility.

Portnoy addresses the sources of a joyful life because, as he writes, “if wealth is defined as funded contentment, then we need to know what we’re supposed to be funding.” He suggests four such sources: the need to belong, the need to direct one’s own destiny, the need to be good at something worthwhile, and the need for a purpose outside of one’s self.

But can we afford a meaningful life? “Purpose and prosperity,” he acknowledges, “aren’t necessarily a match for each other.” We need the wherewithal to “underwrite meaning and become truly wealthy.” And so we have to set priorities—priorities such as being less wrong rather than being more right, immunizing our liabilities before maximizing our assets, and addressing psychological vagaries.

Tactics is “the part where we strive for decent outcomes.” And where Portnoy looks at how to be a successful investor, with particular reference to returns, volatility, correlation, and liquidity.

In his final chapter, “Shapeless,” Portnoy turns to the tug-and-pull between now and later, between enough and more. “At any moment in life we have to decide whether we want, as Hunter S. Thompson once framed it, ‘to float with the tide, or to swim for a goal.’ We harbor an urge to do both, to appreciate the moment, to cherish where we are, but then also to push out for that next thing, to get to that next Great Place.”

Wednesday, June 20, 2018

Gannett, The Creative Curve

The thesis of Allen Gannett’s The Creative Curve (Currency / Crown, 2018) isn’t revolutionary. But I guess that’s the point. If it were, the book wouldn’t sell well. It would defy the science of what becomes a hit.

More interesting, however, at least to me, than how to identify the next big thing, whether it’s a new Ben & Jerry’s ice cream flavor or a blockbuster movie, is how people prepare to be creative. Because aha moments don’t happen in a vacuum. In the shower, perhaps; in a vacuum, never.

Gannett postulates four laws of the creative curve: consumption, imitation, creative communities, and iterations. Here I’ll look only at the first law.

How can some people be such successful serial entrepreneurs? In part, it’s due to pattern recognition, the ability to develop an uncanny instinct for opportunity. “Research shows that when entrepreneurs have significant prior knowledge, they no longer need to engage in slow, deliberate searches for new ideas. On the contrary, their prior experience gives them a rich library of exemplars they can access automatically.”

To build this mental library, would-be creators voraciously consume highly relevant material. In fact, in the case of already successful creative artists, it seems to be part and parcel of their daily routine. They spend about 20 percent of their waking hours expanding their knowledge of their field. Writers read, artists go to art shows, songwriters listen to music, old and new.

The 20 percent principle, the author contends, provides the building blocks necessary for aha moments to flourish. “This accumulation of prior knowledge fills up the brain with examples and concepts that artists then use to uncover non-obvious insights. … You can’t have insights about things you don’t know anything about.”

In brief, if you want to be a creative whatever, and that includes being a creative investor or trader, you need to accumulate a large repertoire of relevant material—and keep adding to it. Aha moments come only to the well prepared.

Sunday, June 17, 2018

Carreyrou, Bad Blood

On Friday Elizabeth Holmes, the founder of Theranos, and its former president Ramesh “Sunny” Balwani were criminally charged with wire fraud. These charges came three months after the SEC sued Holmes and Theranos for a “massive fraud” at the company.

John Carreyrou, a lauded investigative reporter at the Wall Street Journal who covered Theranos extensively from 2015 on, has written a spine-chilling book, Bad Blood: Secrets and Lies in a Silicon Valley Startup (Alfred A. Knopf, 2018).

It’s hard to imagine, amid all the suspicions, firings, and general upheaval, that Theranos got away with its alleged fraud for as long as it did. It was the persona of Elizabeth Holmes (along later on with some heavy legal fire power) that kept it going, that attracted big dollars from normally savvy investors and big names to the company board, that convinced companies such as Safeway and Walgreens to offer Theranos’s flawed finger-stick blood tests (although they later pulled back). People were bewitched by her “mixture of charm, intelligence, and charisma.” They didn’t see her much less flattering side.

Put Bad Blood at the top of your summer reading list. You won’t regret it

Wednesday, June 13, 2018

Yu, Leap

Legally or illegally, companies have for centuries copied the intellectual property of their competitors and encroached on their market share. One has only to think back to the commercial espionage of Francis Cabot Lowell, who in 1810-11, while strolling through dozens of British cotton mills, memorized critical details of mechanized textile manufacturing. Using this information, his Boston Manufacturing Company and eventually mills throughout New England took the growing American mass market away from British textile exporters.

Leap: How to Thrive in a World Where Everything Can Be Copied (PublicAffairs/Hachette, 2018) by Howard Yu is, in the best sense of the word, a story book. It tells tales of woe as well as tales of resilience. These case studies all have a point, but, even if they didn’t, they would be fascinating in and of themselves.

Wu, a professor at the International Institute for Management Development (IMD) in Lausanne, Switzerland, believes that the key to outlasting copycat competition is to leap. “Pioneers must move across knowledge disciplines, to leverage or create new knowledge on how a product is made or a service is delivered. Absent such efforts, latecomers will always catch up.”

Wu articulates five principles necessary for making a successful leap: (1) understand your firm’s foundational knowledge and its trajectory, (2) acquire and cultivate new knowledge disciplines, (3) leverage seismic shifts, (4) experiment to gain evidence, and (5) dive deep into execution. These principles, as stated, are somewhat telegraphic, but Wu develops them through compelling case studies from companies spanning the globe: for instance, Steinway (an example of what not to do in the face of competition, in its case, from Yamaha), Procter & Gamble, Novartis, WeChat, Recruit Holdings, and John Deere.

Leap is the kind of book that everyone with an interest in business can profit from. And here’s a lesson that everybody, active investors/traders in particular, can profit from. “Successful executives often exhibit a bias for action. But it’s even more important to separate the noise from the signal that actually pinpoints the glacial movement around us. Listening carefully to the right signals requires patience and discipline. Seizing a window of opportunity, which means not necessarily being the first mover but the first to get it right, takes courage and determination. To leap successfully is to master these two seemingly contradictory abilities. The discipline to wait and the determination to drive, in balanced combination, often pay off handsomely.”

Monday, June 11, 2018

Batnick, Big Mistakes

Consistently beating the market is insanely difficult. Whether it’s because the market is for the most part efficient, whether it’s due to the paradox of skill, whether it’s the result of the behavioral bogeymen that prompt us to do the wrong things at the wrong time, whatever the reason, no investor, not even the most successful, remains unscathed. Michael Batnick, director of research at Ritholtz Wealth Management, who admits to having made thousands of unforced trading errors himself, delves into this phenomenon in Big Mistakes: The Best Investors and Their Worst Investments (Bloomberg/Wiley, 2018).

In 16 chapters he writes about the mistakes of Benjamin Graham, Jesse Livermore, Mark Twain, John Meriwether, Jack Bogle, Michael Steinhardt, Jerry Tsai, Warren Buffett, Bill Ackman, Stanley Druckenmiller, Sequoia, John Maynard Keynes, John Paulson, Charlie Munger, Chris Sacca, and himself. Even though most of these mistakes are well known to students of investing history, Batnick frames them in a new, for the most part behavioral, way.

He distinguishes between “a lousy investment” and an unforced error. “Your thesis was wrong, or what you thought was already in the price; things like this are all part of the game. But oftentimes, we’ll act impulsively, even when we ‘know’ what we’re doing is a mistake. Few people are spared from unforced errors, and the way they usually manifest themselves is because we can’t handle people making money while we aren’t.” Stanley Druckenmiller, for instance, “played the game at a level few ever have.” He was 130% net long going into Black Monday and still made money in October 1987. And yet even he made an unforced error when he “couldn’t bear to see Quantum grinding its gears as a bunch of small-potato upstarts were racking up huge returns” in the late 1990s and bought $6 billion worth of tech stocks. … [I]n six weeks I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself.”

Elaborating on a quotation from Livermore and further fleshing out the distinction between a bad investment and an unforced error, Batnick acknowledges the limitations of learning from investing mistakes. “Investing is inherently an act of uncertainty, so we can never say to ourselves, ‘I’ll never let that happen again!’ Sure, there are very specific mistakes that you won’t repeat, like buying a triple-levered inverse ETF and holding it for three months. That’s something you do one time and never repeat. But like Livermore said, the mistake family is too large to avoid all of them. And no amount of market quotes will change the fact that losing money is a part of investing. Risk management is a part of investing. Repeating mistakes is part of investing. It’s all part of investing.” Even so, we can, and should, focus on avoiding unforced errors—errors such as straying outside our field of competence, confusing skill with luck or genius with a rising market, over-concentrating a portfolio (think Sequoia with Valeant or Charlie Munger with Blue Chip Stamps), buying at market tops and selling at market bottoms.

Big Mistakes is a humbling book. Sentences such as “Imagine that you were physically exchanging stock certificates with Jim Simons of Renaissance Technologies every time you went to buy or sell a stock” might be enough to send investors scurrying to buy an index fund. But the lure of joining the pantheon of great investors/traders remains powerful. Batnick may not provide the path to such success, but he demonstrates that perfection is not required. “Mistakes,” as Peter Bernstein once said, “are an inevitable part of the process.”

Wednesday, June 6, 2018

Pearson, How Hard Can It Be?

I read a lot of fiction, mostly mysteries/thrillers, for relaxation and/or escapism, the vast majority of which I never write about. After all, who cares about my reactions to the latest exploits of Armand Gamache or Jack Reacher or all those girls or women “on/with/in,” pick your preposition?

Perhaps no one cares about my reactions to Kate Reddy either, but since I requested a copy of Allison Pearson’s How Hard Can It Be? (St. Martin’s Press, 2018) from NetGalley, I feel a duty to write a few words about it. Moreover, the reason I requested it was that, in the novel, Kate returns to the hedge fund she started years earlier, even though, as it turned out, this was the least realistic thread of the storyline.

How Hard Can It Be? is a sequel to Pearson’s blockbuster (four million copies sold worldwide) debut novel, I Don’t Know How She Does It, described by Oprah Winfrey as “the national anthem for working mothers.” I didn’t read the original novel, but its sequel is both incisive and hilarious. It speaks, of course, more to women than to men.

Kate Reddy, now pushing 50 and impatient to relinquish her all-engulfing role as wife and mother, sets out to re-enter the workforce. Of course, the kids, now teenagers, don’t go away, nor does her increasingly distant husband. And the financial world isn’t exactly scrambling to hire a 50-year-old whose only “relevant” work experience in seven years was serving as treasurer of the village parochial church council and chairman of the governors at a community college.

How hard can it be? Very hard. But Kate didn’t compile an impressive track record in the City and survive years of motherhood to be daunted by little things like forgetfulness, a spreading middle, and the truth (does she really have to be nearly 50?).

This novel is a paean to grit, resourcefulness, humor, and new-found love. Women can rightfully be proud of Kate.

Sunday, June 3, 2018

Ball, The Fed and Lehman Brothers

Laurence M. Ball, a professor of economics at Johns Hopkins University, is convinced that (1) the Federal Reserve Bank had the authority to rescue Lehman in 2008 and that (2) in any event, the beliefs of Fed officials about their legal authority were not the real reason they chose not to rescue the firm. In The Fed and Lehman Brothers: Setting the Record Straight on a Financial Disaster (Cambridge University Press, 2018), based on publicly available sources, Ball makes his case.

After a deal to sell Lehman to Barclays fell apart on September 14, what could the Fed have done to avert Lehman’s bankruptcy the next day? Actually, as Ball points out, not all of the Lehman enterprise failed on the 15th. LBHI, the holding company, filed for bankruptcy, along with most of its subsidiaries. But one subsidiary did not: Lehman Brothers Inc., the company’s broker-dealer in New York. “The Fed kept LBI in business from September 15 to September 18 by lending it tens of billions of dollars. After that, Barclays purchased part of LBI and the rest was wound down by a court-appointed trustee.”

The usual explanation for the Fed’s refusal to lend to LBHI was that, under Section 13(3) of the Federal Reserve Act, the loan had to be “secured to the satisfaction of the Reserve Bank.” Fed officials took this to mean that the Fed cannot make a loan if there is a significant risk that it will lose money on the deal. This provision did not require that Lehman be solvent, but “examining Lehman’s solvency helps us to understand what assistance the firm needed to survive its liquidity crisis, and to assess its longer-term prospects.” Ball contends that, with mark-to-market valuation in the distressed markets of September 2008, Lehman was near the edge of solvency, so “it was probably solvent based on its assets’ fundamental values.” The problem, of course, was not solvency but liquidity. Lehman, Ball calculates, “would have needed about $84 billion of assistance to stay in operation for a period of weeks or months” while it looked for long-term solutions to its problems.

Ball argues that the real villain in Lehman’s bankruptcy was Hank Paulson, that he insisted on the bankruptcy and that Fed officials acquiesced. Moreover, he suggests, neither Paulson nor Fed officials fully appreciated the severe damage to the financial system that Lehman’s bankruptcy would cause.

Ball supports his hypothesis with ample documentation. Whether readers come away convinced that the Fed made a grievous error in not being the lender of last resort to Lehman will probably depend on their view of the Fed. And even if future Fed leaders “take the Lehman lesson to heart,” they may be hamstrung in their actions. The Dodd-Frank Act revised Section 13(3) to limit the Fed’s lending authority and to make all lending subject to the approval of the Secretary of the Treasury, a political appointee.