The Big Debate...Big Versus Small

Over the weekend I read Michael Lewis’s “The Big Short”.  It’s his re-cap of the Sub-prime mortgage meltdown that profiled a few individuals who profited greatly by betting against the mortgages they considered most likely to fail. Of course, it takes a classic good versus evil stance to make the book an interesting read. At the same time if the melt down hadn’t happened in the way it did there would be another book with a different cast of characters. 

I find myself looking beyond the characters to the actual structure of the entities involved and can’t help but believe that the structure of the organizations involved were more of the problem than the greed of the individuals involved. 

Information:  It became clear to me very early on that the communication up and down the levels was not effective in the large, multi-national investment banks. It reminded me of the parable of the 20 blind people taken to an elephant, and asked what they thought it was based on them using their hands to see. Of course, they had 20 different answers depending on what part of the elephant they “explored’. They had no perspective of the big picture. 

The independent investment firms had a very clear picture of what was going on since they did not need to rely on someone else’s translation of what the situation was. They were able to access vast quantities of research easily due to their independent status. More importantly, their clients had better information since they had the ability to communicate directly with the decision makers.

Product Vs. Process: Since the marketplace for financial products is so broad, much energy is put into every product line and evaluating each product line and it’s profitability.  The focus of the large investment firm was always on the mass appeal of the offering and how much they could sell versus whether or not the product was good for clients.  Profit was the overwhelming motive. The individual bonus and the next quarter’s earnings clearly won the day, and the incentive programs put in place provided a very attractive inducement to benefit the firms and individuals involved. 

I received a vey different picture from the independent firms. Yes, they had a profit motive personally, but they also clearly knew that they had clients to please in the process. They had brought them to the dance and they clearly wanted them to benefit.  I think this is due to the direct relationship with the advisor and the end client.

Structure: In summary, the story is the classic “David and Goliath” story of small versus big and good versus evil. Some are concerned about the independent firms resources. Don’t the big firms hire all the “best and brightest” and have hundreds if not thousands of people? Yes, they do! Yet, as pointed out in the book this put the independent firms at no disadvantage. 

The White Oaks experience is similar to the ones of small firms outlined in the book.   Information can and is found from these firms themselves and from independent sources. Every firm had the same access, but how the structures, incentives and processes were used is what made the difference. Personally, I would not have put into place a strategy of extreme win or lose propositions. In our process high payoff strategies are used, but judiciously to not put our client’s money at risk. 

I do have a strong bias towards independent, fee-only, advisory firms. Firms that know their bread is buttered by how well they take care of their clients.

It' All Good!

As I was scanning a number of the sources I follow, this post entitled “Bigger Isn’t Always Better: Remembering to Appreciate What I Already Have” struck me as being particularly relevant to me. I have to admit that, too often, I get caught up in comparing what I have to what everyone else has. Of course, I already overstated by saying “everybody else”.  When I take the opportunity to reflect on the feelings I get when I do let myself get sucked into the comparison trap; I find that no usefulness has come out of the comparison at all. 

Every day we do have something to be grateful for, we just need to look for it. Three questions have been helpful to me. “What went well today?” is one. Yes, there are days that seem harder than others to find it, but if I ask myself the question there is an answer most days. The second “Why did it go well?” takes the focus off of surface things and on the relationships and talents around us. The third “What am I grateful for?” allows me to expand on the good things around me. 

I do have a lot to be grateful for and it seems silly that I need to remind myself, but I guess I’m not the only one!

The Market Pot Continues to Boil

This week the market officially hit a “corrective phase” meaning it has dropped 10% from the high. Much of the blame has been placed on the “European Problem” that stems from their high debts regionally. It’s not so much that the the high debt suddenly appeared out of nowhere, but rather in the past couple of years the economic weakness has shown a spotlight on the cracks that were already there. The apparent posturing of the various governments of the European Union have only served to fuel a lack of confidence in the system and raise concerns of their ability to deal with it. 

Those who have attended our Market Updates are aware that we have been warning since November of 2009 that a 10-15% correction should be expected. We also indicated the market could just as easily go up by 10-15% or more before an inevitable correction ensued. It did, and after this corrective move it is still higher than the 1st of November. Did we forecast that Greece would have the problems it did or the discord in the European Union? No we didn’t, but it is reasonable to assume that after a long run-up the the markets will pull back at some point as they always have. The reason of blame that the news media will give is not known in advance, but when you’re looking for a reason any one will do. 

Should we expect a waterfall decline like 2008? It does not appear likely that will happen from our perspective for a number of reasons.  First, in late 2007 and in early 2008 we were facing the worst recession since the 1930’s. The economic evidence suggests that the economic environment has improved considerably since then and has positive momentum. Second, earning increases have been quite good and the market is reasonably valued. This pullback in prices solidifies the valuation argument. Third, volume and breadth of the markets are not signaling a panic. Even the PIIGS (Portugal, Italy, Ireland Greece and Spain) are starting to show some signs of strength. 

So what should be done with my portfolio? I was somewhat taken by an article in the Wall Street Journal recently entitled “Klarman: Why Investing is Like Chess”. The article includes a metaphor that investing today is much more like Chess than Checkers like it used to be. A well thought out strategy may evolve over several moves but the obvious choice is often not the correct one. Combine this with the Carl Richards New York Times piece about investor behavior. Investor’s make bad decisions largely because they are driven by fear and greed. The evidence is clear that those who react to market moves such as these have an extremely high probability of bad results. Following the media and the “thundering herd” of investor’s emotional reactions has not been a recipe for building wealth so far. Portfolio’s constructed with “Chess like” strategic moves most often do.