Spot the Invisible Man

There are two ways to make money: create value or get a good deal. Getting a good deal normally means not a lot of people know about it. You go off the beaten track. Perhaps you find an undiscovered artist. Maybe you know a Farmer who lives a subsistence lifestyle but has a little extra. You happen to hear of someone in a rush to sell their home, and they don't want to put it on the market. At the heart of this is a lack of information.

Eugene Fama, from the University of Chicago, developed a theory called the 'Efficient Market Hypothesis'. The idea is that once information is freely distributed it is very difficult to outperform on a 'risk-adjusted' basis. It was on the back of this that John Bogle took a common sense investing approach for the average investor to develop low cost index-tracking funds. If it is very difficult to outperform, and you just accept the average returns and focus on reducing costs - you end up performing above average. There are a lot of strong arguments in the case for passive investment. So much so that Warren Buffett has said that on his death he wants to put 10% of his wife's cash inheritance in short-term government bonds and 90% in a low-cost S&P index fund. Buffett is one of the most famous active investors. He has long argued for buying businesses rather than stocks, and trying to buy them at a good price. He has a phenomenal track record and is one of the world's wealthiest men, so is this him admitting defeat and saying that he was just lucky?

I don't think so. Many of the core reasons 'passive investing' are attractive are not unavailable to active investors. Active investing doesn't mean the same thing as trading. If you are buying and selling based on the price and trying to get a good deal regularly that is one thing. I agree that it is very hard to outperform. Buffett never did that. He bought businesses with the intention to hold them for ever. He made his money not primarily out of getting a good deal but out of the businesses he invested in creating value, and him not destroying a lot of it through the costs of trading.

My concern with passive investing is if it is seen as just that. It is passive. The problem with the Efficient Market Hypothesis lies in the 'risk-adjusted' basis. Risk can't be put into a number. It tries and uses volatility which is a measure of noise, i.e. how much the price changes. The great thing about the theory is it is one of those wonderful 'theories' that can't be disproved. Every time it makes a prediction that doesn't work, you can just say that there is a missing part of the theory but the theory still works. I have seen no evidence that more noisy stocks outperform and compensate for risk. It doesn't make sense that you should get paid for taking risk that doesn't add value.

Passive investing absolves responsibility about trying to understand the risks you are taking. This is my real bugbear. Most risk doesn't hide in the open like volatility. In the game of hide-and-go-seek, risk is more like the Invisible Man than a toddler who wants to be found. Why the S&P 500 is an investment Buffett is comfortable with is because he has spent his entire career studying the risks involved in the US economy. There is nothing passive about his bet. It is a bet that Capitalism in a Liberal Democracy with Rule of Law, plenty of multinational companies that believe in looking around the globe for opportunities and an incredibly transparent and well regulated market can survive. It is a bet on America.

Source: Artist Liu Hides in Plain Sight

I think it would be great if the conversations around investing shifted from finding the best deal to understanding the risks. I agree that that is very hard in markets where information is available. I still think you can get good deals but they are rare and irregular. I don't think the price includes all the information though. It is a good average, and a reasonable approximation of what the business is worth now. Averages are dangerous. They don't talk about the range of possible outcomes or what can go wrong.

'Never forget the six-foot-man who drowned crossing the stream that was five feet deep on average' Howard Marks

It is worth reading Bogle's book. It is worth staying humble about what you can achieve in investing by aiming to search for a good deal. I also think it is worth reading books like Michael Porter's 'Competitive Advantage'. In this investing is not about some clever trick of understanding where everyone is getting things wrong, it is about the first way of making money. It is about how to create and sustain the ability to add value. It is why companies like Google, Nestle etc. are able to consistently outperform.

So maybe there is only one way. You make money by adding value. If you get a good deal you just change who is holding it.

 

Arbitrary Rules

Arbitrary rules can be powerful. They help overcome Inertia.

Seth Godin writes a blog post every day. That is an arbitrary rule. Does it really matter if he misses a day? Probably not, but it forces him to write every day. Eventually it becomes a habit... so it doesn't feel like force.

I am writing far less regularly than I would like. I realised this. I also realised that I had still written at least one blog post a month for quite some time. Hardly enough to form a habit, so fair to say that it doesn't compare to Seth's rule - and so is more arbitrary. But it was enough to force me to write one yesterday.

I used to use arbitrary rules to help me get through my studies. If a subject took 300 hours, I would break it down into the hours necessary per week and then plan how many to do each week. I would try stick to that. Again, maybe that is not arbitrary as it let me get to the end without any panic. The arbitrary part was that I would break it down into segments - study for 50 minutes, 10 minute break, repeat.

Why 50, why 10? No particular reason. It just seemed to help me get through.

Now, if the arbitrary rule gets in the way of something that is not arbitrary. That can be a problem. But otherwise, if it helps you get off the couch...

Hardcore Mothering

Stuart points to this article on Chinese Mothers. It is a rather hectic account of the differences between Western and Chinese parenting according to Amy Chua. She has a book which is about to be released called 'Battle Hymn of the Tiger Mother'.

This reminded me of a reference to an essay called 'What is it like to be a bat' by Thomas Nagel. Nagel argues that you can't imagine what it is like to be a bat. You can imagine what it is like to for you to do bat like things, but not what it is like to actually BE a bat.

'Our own experience provides the basic material for our imagination, whose range is therefore limited. It will not help to try and imagine that one has webbing on one's arms, which enables one to fly around at dusk and dawn catching insects in one's mouth; that one has very poor vision and perceives the surrounding world by a system of reflected high frequency sounds; and that one spends the day by hanging upside down by one's feet in the attic. In so far as I can imagine that (which is not very far), it only tells me what it would be like for me to behave as a bat behaves. But that is not the question. I want to know what it is like for a bat to be a bat.' - Thomas Nagel

Empathy is important, but empathy is limited. By being empathetic you try get into the head and experience of others - but that is only half the trip. Westerners and Chinese are both people, so it clearly not as difficult as empathising with a bat! But you can never completely understand any other human (including girlfriends and exes) through their own eyes. I can imagine the different response to Chua's piece. Some will read it and think she is crazed and draconian. Others will read it and think she is on the money. Some will contextualize it and say that they understand why she thinks the way that she does given her upbringing - but that she is wrong. Everything will be based on their own world views.

Why does this matter? Some people use culture as an excuse for behaviour others consider truly immoral. An obvious example being the abuse of women in some cultures. How on earth do we strip out the stuff we don't, and can't understand, (because we will never be able to truly see through another's eyes other than seeing their experiences through our own context) from the stuff we really should be kicking up a storm about and changing?

In this particular case, I think it is tough to argue that what Chua is doing is wrong. I suspect that it is just a different approach to parenting. But, while a little jealous of the level of dedication and achievement it can lead to, I can't quite wrap my head around the question 'What is it like to be the child of a Chinese Mother?'.

Selective Ignorance

I am busy reading 'The 4-hour work week' by Tim Ferriss.

This is definitely a case of use some, but realistically not all, of what he says. This guy takes focus to a new level. In defining happiness by excitement or the opposite of boredom, he cut down his working hours to the bear minimum cutting out the unimportant and using various other techniques to get to the point where he quite literally checks his email once a week for an hour. The balance of his time gets spent on his passions, to which he applies the same vigour, so it seems he manages to fit hundreds of lifetimes into one.

One of the efficiency techniques he talks of is cultivating 'Selective Ignorance'. There is so much information out there now days and it is in the main readily available, so the problem now is not so much in finding important information, but trying to ignore most of the information you find out there.

With facebook, email, blogs, newspapers, television, books, magazines, radio, twitter, wikipedia, etc. etc. out there, what do you choose to listen to and what do you just ignore? Trying to keep up to date on everything likely just means you won't be an expert on anything?

The Snowball

'The Snowball' by Alice Schroeder is the authorised biography of Warren Buffet. It is the warts and all story of what lead him to become the richest man in the world and then give it all away to charity.

I really like the metaphor of the snowball. Starting off slow and gathering momentum as it grows. To say he was obsessed with growing his snowball from an early age is like saying the ocean is damp. An insatiable curiosity and very little interest in money as something you spend, but rather as a scorecard lead him to a personal fortune of over $60 billion. An obscene amount of money by any measure.

Another book I have on my shelf but haven't got to yet is 'philanthrocapitalism' which I am looking forward to reading. What I find most interesting about Buffet's decision to give his wealth to the Bill and Melinda Gates Foundation is just how much it flies in the face of the image of what we have grown up to think of the uber wealthy. He loved the act of creating wealth, the recognition it gave and feedback of the scorecard that was his growing snowball. But he recognised that a large part of his wealth came from the fact that he was born into a society that recognised and rewarded his passion in this very tangible way. He won the 'ovarian lottery' by being born when and where he was. Then he worked bloody hard to get where he did. He feels he owes something to society for that.

What I also like about his decision is that he gives the money to someone who knows how to spend it in the best possible way. Gates takes a business like approach to solving specific problems in the world. Buffet knew how to make money, but recognised that spending it was outside his 'circle of competence'.

Playing to his strengths.

Swim, Speak and Dance

Tim Ferris gives an interesting talk at TED about overcoming some of his fears. He also writes a blog which I can't give comment on, but watch this space.

People like this are fascinating. I read a post the other day, but can't remember where which was talking about the difficulty of hiring great people during a downturn in the economy. This is counter intuitive since so many people are being let go, there must be more people to choose from. Thing is there is also more noise. The point the post was making is just how much of a difference productivity and efficiency really makes. It cited studies of the difference in the level of productivity between students at a university. The most effective students were able to complete tasks to a higher quality and in a shorter time. That is by definition true, but it was the scale that was surprising in one way and obvious in another. They found that the top students could complete 10 times as many tasks as the others.

So the title of Ferris' blog... 'Four Hour Work Week'
doesn't strike me as immediately ridiculous/preposterous. I can well believe that someone can get what the average person does in 40 hours done in 4. I doubt that efficient person would stop at 4, in the same way that very successful business people often continue in their job well past reach financial security.

If you could do the work you currently do in half the time, what would you do with the other half? Just imagine... You can't buy time... but you can make it.

Inbox Culture

Seth Godin talks about Inbox Culture.

How much does inbox and the emails that arrive and get answered determine what you do?

I have always got very annoyed when I go to a service desk, and the person there answers the phone instead of helping me, interrupting me getting served. I made the effort to come in, but the phone must be answered. (naturally when calling in, I also get irritated if the phone doesn't get answered quickly).

This now extends to people having there cell phones on when you are at dinner, having coffee or in meetings. I have heard of someone responding to a email on their blackberry while doing a presentation!

When do we get the chance to change from being responsive to deciding what we are going to do? If we are always online, in reach of email,sms,phone,facebook etc.?

I am going to start not opening outlook or checking my phone for 2 hours each day. I am also going to go to the beach without my cell phone for a couple of hours on the weekend. I reckon that might just lead to a smilier, more productive Trevor.

Not that I have been one to answer my phone during dinners.