Query: I was wondering what you thought about the equity market – even though I know that you are not a market timer.
Obviously the global situation is very bad, and arguable things are reasonably bad here as well – be it the macro economic situation or the politics. However, over the past few years I have tended to be even more conservative than usual because of the unusual issues in the global environment (with parallels to the great depression etc).
In that context I wondered what your thoughts are – at least tactically. Do you feel that now is the time to be at weight or working towards getting more over weight in equities (for a long term investor). What do you feel about debt – I have a fear that we may be in for a period of reasonably high inflation and have therefore been more in fixed instruments with a shorter duration. Gold was also a good asset class to be in, but all this talk of it being a bubble is making me wary?
In fact the way assets are positioned anything that one invests in could go terribly wrong right now. And therefore interested in what you think?
Mr. Gerard Colaco: I do not think about the equity market in the sense of either discussing or reflecting endlessly over present political or economic situations or the course they will take in the short, intermediate or long term. This is because I know I can neither foresee these events nor exercise any control over them. I believe focusing on things I can control, not things I cannot control.
What I can control is my response to market fluctuations. If I have the depth, knowledge, expertise and stature, I can also control the response of my clients to the vagaries of the markets. When it comes to investment advising, the manner in which I exercise this control is very simple and would generally fit into one of the three situations mentioned below.
1. If I earn in the form of roughly regular monthly inflows, I would invest systematically whether in stocks or equity mutual funds or asset allocation funds, provided my investment programme is for a minimum of 5 years. I would ignore market fluctuations in between.
2. If I have a lump sum to invest and there is a margin of safety, that is if any popular diversified equity index is more than 25 percent below its last peak and the PE ratio of that index is less than 20, then I will invest in a well diversified portfolio of stocks, or an equity index fund or a diversified equity fund, after ensuring that the money I have invested can be locked away for at least 5 years.
3. If I have a lump sum to invest and there is no margin of safety, then I will invest in either a liquid or short-term floating rate mutual fund and transfer one percent of the principal amount per month to one or more diversified equity funds or index funds. I would double the systematic transfer when a margin of safety arose. I would transfer the entire balance from debt to equity if I were fortunate enough to encounter a drop of 50% in the index value from its last peak.
Beyond that, the global situation, politics, economics (whether micro or macro), bubbles in stock, real estate or commodity prices, fears of another great depression, and other such gibberish would entertain rather than bother me. In fact I do not like ordinary depressions. I would simply love another truly great depression and so would investors advised by my firm, since their assets lie in the kind of asset allocation strategies designed, as Benjamin Graham put it so well “to profit from other people’s folly, not participate in it.”
I wonder whether you have read Warren Buffett’s op-ed in the New York Times, written at the height of the Global Financial Crisis, in November 2008. I quote: “In the 20thcentury, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
As regards the role of debt which you have mentioned in your mail below, the best advice ever given would come from John Bogle: “Irrespective of what the future holds, it seems to me that equities should remain the investment of choice for the long time investor – the dominant component of a well-balanced asset allocation programme. Bonds are best used as a source of regular income and as a moderating influence on a stock portfolio, not as an alternative to stocks.”
As for gold, commodities, collectibles, and the much vaunted “alternative investments,” my opinion is that these are not investments at all. The long term returns on gold, commodities and “things” are likely to equal the inflation rate not beat it. This is because virtually all their prices are included in the basket of commodities, goods and services based on which the consumer price index is calculated. So their prices ARE the inflation rate, to a large extent.
Timothy Green an internationally renowned bullion expert reminds us that “the great strength of gold throughout history has not been that you make money by holding it, but rather that you do not lose. That ought to remain its best credential.”
Genuine wealth-enhancing investments like equity and real estate have two attributes which most investors lose sight of. One, the principal invested increases in value over time. Two, they yield a stream of income which also grows over time. For example, real estate yields rent and rent increases over time. The value of real estate also increases over time. An equity portfolio yields dividends and these dividends increase as time passes. So does the value of the portfolio.
But precious metals and commodities can at best be described as sterile investments, yielding neither dividends nor rentals nor any income streams that grow over time. So, when an investment adviser like me is rooted deeply in the fundamental principles of investment and when the experience and expertise that a good investment adviser commands confers upon him/her a stature that makes most of his/her clients listen and implement plans suggested by the adviser, we reach the happy state that Warren Buffett described when he mentioned that “bad news is an investor’s best friend.”
As for the few clients who will not listen, we do not want them do we? They are eased out of our office with a speed that should surprise them, because it certainly surprises me!!
Since you are an investment adviser, let me end with a small piece of advice. I attribute two reasons for my success. The first way in which I built up my business was to listen to all other stock brokers and so-called investment advisers and then do exactly the opposite. I am gratified that this supremely arrogant strategy has paid rich dividends.
The second way in which I built up my business was to build up my own expertise. I therefore took the trouble of identifying the world’s best knowledge, not the crappy, superficial and shallow academic knowledge found in such abundance today, and then mastering and implementing this truly great knowledge. When I look at stockbrokers, investment advisers, insurance agents, mutual fund distributors and other monkeys in the financial services industry today, I am impressed only by the remarkable consistency with which they choose to remain poor quality.
This wallowing in the cesspool of a dismally low quality makes them compete maniacally with each other, slash brokerages and income streams, constantly crib that they don’t earn enough and then go out of business or fill their offices with new, exotic and alternative slot machines like commodities and derivatives terminals.
True knowledge opens up your mind, changes your personality for the better, and gives you the stature to lead, not to bleed. With this in mind, I am attaching to this mail our updated list of recommended reading. I guarantee you that if you take some time away from your work and go through the books and material recommended, you will never send me emails of the kind you have written below.
Query: Thanks for your candid views. Your confidence in the system you have for dealing with uncertainty is admirable.
Mr. Gerard Colaco: The confidence is borne out of 31 years of learning, which includes 26 years of practice. And it is backed by 400 years of stock market history, ever since shares of the Dutch East India Company were traded for the first time on the Amsterdam Stock Exchange.
As British PM and statesman Benjamin Disraeli put it so beautifully: “The lesson that we learn from history is that we do not learn from history.”
One more reason for the confidence is that the system has never failed to deliver the goods whether in managing risk or delivering optimum returns over the last two-and-a-half decades.