Introduction to investment basics - broad outline for lay people

Inv101-1 – INTRODUCTION TO INVESTMENT BASICS – broad outline for lay people

Logic flow broadly from oldest (Inv101-1) to most recent

I postulate that “We spend a lifetime accruing money and almost no time learning how to look after our wealth”.  This makes no sense, but mostly it is because we glibly claim ignorance about investment and hand over that responsibility to others, few of whom are truly honest & professional and many of whom are outright charlatans.

This is counterintuitive, because: –

“You can delegate a task, but you can never delegate responsibility”

i.e. If it all goes wrong we have no recourse and cannot point fingers.  I maintain it is up to us to educate ourselves i.r.o. the basics, until we understand the broad investment concepts, so that we can communicate semi-intelligently with our brokers and agree the ideal diversification strategies for the ruling economic situation.  Thereafter, it is up to the brokers to refine it and select the best fund managers.

As with all things in life, true success ultimately lies in the art of getting the basics right.  One of the biggest problems with most investment brokers is that they tend to project past performance forwards, which is very dangerous because past performance does not predict future market action.  Therefore, your first order of business is to find an investment broker who is properly qualified, informed and uses current market intel to anticipate future market action.  This does not mean he will always be right, but he should be able to help you avoid the biggest losses, which is important, because if you lose nothing while everyone around you loses 50%, you are twice as well off.  Eg. In 2018 the US markets reached the distinction of “the longest bull market in history”.  While records are there to be broken, that statement tells you a major correction or crash is pending.  Getting the timing right is nearly impossible, but one can acknowledge that this is probably a time to be careful as “it is no longer about your return on investment, but the return of your investment”.  This subtle difference implies that that it would be prudent to suggest a defensive investment strategy to your broker.

The above example illustrates you that you do not need to be an expert to get your investment strategy right, as you can gather a lot from just listening to the news and to other people.  Another illustration of this is that “when absolutely everyone is talking about getting into a market or investment, as we saw with Bitcoin, it is probably time to get out” – i.e. when Greed is the dominant emotion.  On the flip side of the coin, the famous banker Nathan Rothschild said “the time to buy is when there is blood in the streets” – i.e. when Fear is the dominant emotion.   These two statements were summarised by Charles Mackay, a Scottish journalist’s quote in about 1841 “Men, it has been well said, think in herds. It will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”.  i.e. The key to successful investment lies in not following the herd, especially when Greed or Fear prevail.

It is important to understand that investment markets move in cycles on all timeframes, moving from overbought peaks to oversold dips, which means they never move in a straight line.  The dips manifest as corrections, or crashes, which are good, because they’re needed to eliminate market excesses.  While you can choose to ride out the dips, you need to avoid the crashes.

These swings manifest because markets constantly fluctuate between two emotions, namely Fear and Greed, something which can be measured using a range of tools and oscillators.  Because of these fluctuations, the basic investment strategy known as “Buy Low and Sell High” is easier said than done.  After a crash, there is widespread fear, as people who have lost money are reluctant to get back into the markets, even when they have been rising for a considerable time, because they fear there is more downside to come.  After the markets have gone up significantly and everyone is talking about the money to be made, people experience greed and get back into the market – albeit when it is approaching a top, which is actually the time to get out.  Major bull markets typically boom to the point where investors experience “irrational exuberance” feeding off widespread greed, which means the markets are driven higher than is justified by rational valuations.  This is why they say of any bull market that “when everyone, including housewives, bellhops and waiters” are telling you what shares to buy, it is time to get out.  Contrarily, at the end of a bear market, they say the time to buy is when there is widespread fear, nobody wants to buy and people are slitting their wrists, which means markets have been driven lower than justified by rational valuations.  The truly clever investors are often referred to as contrarians as their philosophy is “When everyone is out, they get in and when everyone is in, they get out”.

Many of the key economic problems the world faces today arose because of the abandonment of the Gold Standard in favour of Fiat currencies.  In principle politicians abandoned the Gold Standard because they wanted to be free of budgetary constraints, choosing instead to indulge in both deficit spending and uncapped escalating debt, facilitated by Fiat money, in order that they would be free to “buy” votes and enrich themselves.  The bankers gladly participated as this enriched them and enabled a transfer of wealth from the poor to the greedy rich.  This credit facilitated spending spree created numerous economic imbalances, for which we will pay dearly in future.  You can read more about this in my various articles starting with Econ1 at https://eelcogold.com/.  It is important to note that the introduction of Fiat money also precipitated the need to manipulate official statistics such as inflation, GDP, unemployment, etc. to mask the impact of Fiat money, deficit spending, escalating debt, etc. on society.  The consequences included the impoverishment of the masses and a looming pension crisis.

The risks embodied in the current Fiat money regime are best illustrated by these quotes:

  • Quote from Alan Greenspan: “The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. Deficit spending is simply a scheme for the hidden confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard”;
  • Thomas Jefferson: “I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property – until their children wake-up homeless on the continent their fathers conquered”. … “The issuing power should be taken from the banks and restored to the people, to whom it properly belongs”;
  • George Bernard Shaw in 1928: “The most important thing about money is to maintain its stability … You have to choose between trusting the natural stability of gold and the honesty and intelligence of members of government. With due respect to these gentlemen, I advise you, for as long as the capitalist system lasts, to vote for gold”;
  • Ludwig von Mises: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved”;
  • Ayn Rand: If you see that trading is done, not by consent, but by compulsion – when you see that in order to produce, you need to obtain permission from men who produce nothing – when you see that money is flowing to those who deal, not in goods, but in favours – when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you – when you see corruption being rewarded and honesty becoming a self-sacrifice – you may know that your society is doomed.

There is little doubt that the world is in a mess today and that a major global financial crisis is looming.  However, it is unlikely that the world will ever revert to a Gold Standard when it happens, but they will have to adopt some form of prudent monetary management.  The important message here is that you need to learn to protect your wealth.

Measuring wealth is a tricky concept in this era of Fiat money, manipulated economic statistics and unlimited credit.  This is explained in Econ2.  In summary, wealth was created the old-fashioned way when people produced more than they consumed, to create savings for allocation to productive enterprises, also known as capitalism. Contrarily, Fiat Money & Credit facilitated the modern illusion, where wealth is measured in your flashy lifestyle and how much you can consume, while ignoring the amount you borrowed from future income to do so.  This critical concept, that “debt is future consumption brought forward”, is explained in Econ3.

All this is further complicated by the disruptive influences of exponential Technology, which are elaborately described in numerous articles on Futurism at https://eelcogold.com/.  The transition from the old industrial era to the new multi-tech era will be disruptive and painful.

Broadly, valuations in the investment arena are driven by interest rates, which is why I dedicate a few chapters to the impact of interest rates on the prices of Properties, Resources, Bonds/Treasuries and Shares/Stocks.  Accordingly, it is useful to understand interest rate cycles, the link between inflation and interest rates and their influence on each of the asset classes.  You can read about this in Econ 5.  The chapters that follow progressively explain the most important aspects and considerations of investing.  Have fun – I tried to keep it short.

Basics concepts discussed in future chapters include the following:

  • Real returns
  • Manipulated statistics
  • Wealth, Tangibles and Ownership
  • Investment cycles
  • Various asset classes
  • The impact of interest rates and inflation
  • Risk and Diversification
  • Sell near the top, buy near the bottom
  • Blood in the streets

Warning!  While I am going to keep this very simple, investment forms a complex matrix of interdependent influences and links, which means that you will be faced with a bit of a chicken and egg situation.  i.e. I cannot explain one concept without referring to another that I have not yet introduced.  Therefore, one should read through it all before it can be grasped in its entirety and seen as a whole.  This probably means that you will want to read it all again until you get the overall picture – bearing in mind that it is your responsibility to protect your wealth.

CONCLUSION:

Broadly speaking you need to understand the investment arena without being an expert.  What I mean by this is that you need to have a sense of what is going on in the world, as many things can have a bearing on “safe” investing.  Eg. The rate of change of technology can make products, or companies like Kodak & Nokia, obsolete within a year, or reveal emerging technologies where the truly great returns can be made.  Similarly, it is always good to understand the degree of manipulation of official statistics as this distorted picture can mask huge risks, or present opportunities.

There is little doubt that the current credit binge is going to unravel as the global economy needs a reset and, when it does, it will dwarf the pain of 2002 and 2009.  The only question is “when” this will happen – probably during the decade from 2020 to 2030.


Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/.

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

The problem with most investment fund managers - Written end 2019

THE PROBLEM WITH MOST INVESTMENT FUND MANAGERS – Written end 2019

I always maintain one should not highlight problems without presenting solutions.  Therefore, this article, that highlights major problems, presents a few solutions.  However, it is followed by an absolutely extra-ordinary article, that presents Anthony Deden’s “40 invaluable lessons when investing”, which elaborates on what how investment fund managers should be thinking and what they should be doing.  They cannot mimic him exactly, but attitudes need adjusting.

Introduction

The true purpose of an investment fund manager should be to “Preserve and Grow your capital”, and to do so with your interests in mind and better managed, relatively lower risk, strategies.  Regrettably, incentive bonuses have brought about a culture where 95% of fund managers serve their bonus first and their customers last.  Therefore, you need to be extremely careful about your selection of a fund manager.  Find one who is forward, not backward looking.  One who does not presume that the historic bullish trends will project forwards indefinitely.  You also need to find one who is prepared to go very defensive when markets are toppish (overbought), such as we see/saw in 2019 after a 10 year bull market run.

The BIGGEST problems with investment fund managers is both Preserving and really Growing your capital

  1. Recovering from significant corrections or major crashes is a big deal:

Equity markets must gain 100% after a 50% equity market correction/crash, just to break even.  Furthermore, such recoveries can take a considerable time.  Therefore, significant corrections and crashes should be avoided.  A case in point would be the US Equity markets.  After the year 2000 peak at 1 550, followed by the 2000/2003 (-50%) and 2007/2009 (50+%) crashes, which were both foreseen by many, it took the S&P 13 years before it broke above 1 550.  Worse still, it took at least 17 years for it to break even after adjusting for say average 2.5% inflation and 19 years to beat 3.0% (see below).  Therefore, when the markets look toppish, fund managers should progressively start adopting more defensive, lower risk, strategies as a matter of course.  i.e. When markets are toppish, it is time to be more concerned with the return OF your capital, than the return ON your capital.  However, the attitude of “lazy” fund managers, who are more concerned with their commissions and incentive bonuses, is that eventually the markets recover and, therefore, you should ride out the dips.  How stupid.  Why would you ever want to risk losing 50% of your capital, especially if you are older?

Therefore, when it is clear that markets are toppish, a better strategy would be to get out of Equities entirely and adopt a more defensive position in the Cash, Money, Bond and Gold markets.  Yes, you may only make 2-4% p.a. instead of 4-7% p.a. for the next year or two, but at least you do not lose 30%, 50%, or even 80%.  Think about it, if you lose nothing when all about you lose 50%, you are 100% better off than them, in relative terms, after the correction.  You can then re-enter the equity markets after the correction/crash.

The Chart below illustrates the performance of the S&P over the past 3 decades.  The horizontal dotted line illustrates the 2000 peak level at 1 550, with the two subsequent very significant crashes below that line.  The vertical dotted line marks where the nominal 1550 level is broken for the first time in 2013, 13 years after that level was first reached.

The table below the Chart compares the abovementioned defensive/aggressive strategy, with the more conventional buy and hold strategy that is favoured by most fund managers.  This strategy yields a compound cumulative return of over 11% per annum over 19 years, compared with the 3.6% p.a. the conventional buy and hold strategy yielded over that time.  Now, it is important to remember that this is a theoretical exercise, so your returns may be a bit less, but still far better.  I did become defensive about 1.5 to 2.0 years before the peaks, but I got in at the actual bottom, which is not always easy to pick, not a year or two later.

Table of returns, reflecting the “buy and hold” low growth inflation linked targets on left and above “defensive/aggressive” strategy on right.

  1. Diversification is not properly understood and applied, which increases risk

Diversifying across a lot of shares does not protect you when Equity markets tank or crash.  Therefore, one needs to diversify across all asset classes.  Traditionally, these are Cash, Bonds, Property and Equities, with the former being the more defensive/conservative and the latter the more aggressive.  Ideally, one should also diversify one’s investments internationally, to protect yourself against currency fluctuations, and adverse local regulations and politics.  This is particularly essential if you live in an unstable country like Zimbabwe, but also prudent if you live in a developed country like the USA.  However, the truly wealthy also diversify across tangibles, which include rarities such as artworks, stamps and coins, and precious metals.

More important, one should continually review this broader diversification strategy and be willing to make minor or major adjustments depending on shifts in market conditions.

The current investment fund manager’s mantra is that a 60/40 strategy has proven effective over the long term.  This means they recommend you hold 60% in mostly Equities and some Property funds, and 40% in Bonds and Money Markets.  Furthermore, they recommend that one should just ride out the corrections and crashes and your money will, over time, at least hold its value after adjusting for inflation.  That does not equate to growing your wealth, it merely equates to preserving your wealth and that only works when you time your entry right.

Bearing in mind that the Equity markets have been in a 10+ year bull run since 2009, which is the longest on record, it would clearly be prudent to urgently adopt a defensive strategy.  However, modern convention holds that you then go say 40/60, with less in Equities and more in Bonds, as bonds are the traditional flight to safety destination.  Agreed, in the event Equity markets enter a major correction or crash in the next year or two, bonds should again perform better than equities.  However, this is more like hedging your bets a bit and not a winning strategy as most sovereign bonds are already delivering negative returns, especially after adjusting for inflation.  Therefore, they are arguably not the place to put your money in the longer term, except just before and during a correction/crash.  Any significant correction/crash will probably drive even US interest rates into negative nominal territory, global equities into negative returns and global economies into depression.  i.e. Negative GDP growth.

Given the fact that Equity markets are long in the tooth and also likely to deliver negative yields in the very near future when markets correct or crash, you have to ask “where do I put my money”?  The answer is put some of your money in Physical Gold/Silver and Gold/Silver Equities, as these are the ultimate safe haven, particularly during periods of negative returns.

  1. “Passive” investing = chasing the dream of capital gains = perpetually rising share price, and it is inherently far riskier than “active” investing, which is based on intrinsic value, established via due diligence studies 

Shares either go up because investors are chasing good value, or because investors are chasing the dream of perpetually rising equity prices, or both.  Of late, in 2017-2019, investors are mostly chasing the dream of ever higher prices, with little regard to the underlying value, much like they did during the dot.com boom in the late 1990’s.  Furthermore, this momentum trade is largely being driven by the belief that “if you are not in, you are missing out on massive profits”, coupled with impetus from High Frequency Traders, Algorithms & ETF’s.  This is dangerous, because when the market loses faith in the rising price trend and reverts to inspecting true value, some of these shares can be found to have little or no value.  This will, in turn, exacerbate any correction or crash, as it did in 1929 and the 2000 dot.com bust.

Good investment fund managers carefully study the companies they wish to invest in, to establish the underlying value, and the markets those companies operate in.  This is called “active” or value investing as one is investing in the intrinsic value of the company and its role in the global economy.  These shares typically have a strong asset base, low debt, earn good money and pay considerable dividends, even and especially during tough times.

Contrarily, however, the modern trend of late has been to simply invest in Exchange Traded Funds (ETF’s), which hold a basket of equities and track the index.  These are often managed by Artificially Intelligent Algorithms, which focus more on price action and less on intrinsic value.  This means that most fund managers do not have to do all that time-consuming due diligence work.  This is called “passive” investing.  Thanks to momentum trading, passive funds has been outperforming the more conservative active funds, but in the long term, active funds always beat passive funds. So do not to get sucked into this temporary phenomenon.

The problem with passive investing is that it is subject to the vagaries of momentum trading.  Momentum trading is trading that is driven by share price performance and not the intrinsic value of the company, and it works well for as long as the stock prices and markets are rising.  This is where the share keeps going up and everyone says you better get in before it is too late.  This is where everyone focuses on the capital gains, but that only works for as long as the shares are going up.  However, such irrational exuberance pushes shares way beyond their intrinsic value and the problem with that is that they come down very quickly and hugely when the markets turn.  We saw this after the Dotcom crash, where many shares fell from stellar prices to near zero.  For example, we have many technology companies that are persistently making losses, yet their share prices continue upwards as these are “fashionable” stocks to hold.  Why would you want to hold onto a company like Netflix, that has publicly stated it will never be cashflow positive as all its money is going to making new films?  Why would you want to own WeWork that owns no assets?  As at mid 2019, some 15% of companies in the S&P 500, are so called zombie companies that do not make enough profit to cover their debt service costs.

Therefore, in the longer term, it is always better to stay with active investment fund managers.

  1. Fund Managers are not good at hedging against all that can “unexpectedly” go wrong

A man called Nicholas Taleb wrote a book called Antifragile.  The concept is that when things go wrong in nature, only the strong survive.  However, they not only survive, they emerge stronger than before.  Therefore, one needs to diversify across all asset classes and hedge against every market “quake” eventuality.  Accordingly, both you and your investment fund manager need to anticipate all the things that can go wrong with your investments and adopt strategies that will help you emerge financially stronger, not weaker.

He coined the phrase “Black Swan” for unforeseeable events.  However, this term is now misused.  For example, countless analysts foretold the 2007-2009 Sub-prime Mortgage crash, yet it was labelled a “Black Swan”.  The fact that the lazy self-absorbed Fund Managers ignored the warnings and hid behind the unforeseeable “Black Swan” excuse is unforgivable.  They should have been gravitating to defensive strategies in 2006, long before the crash.

In this regard, we need to worry about the fact that this 100 year Fiat money experiment, which led to out of control deficit spending, spiralling record debt, negative interest rates and, subsequently, misallocation of investments/assets will one day come to an ugly end.  This is why asset classes like Gold and Silver should be on your horizon, because they have held their value for 5000 years and truly withstood the “safe haven” test of time.  In fact, Gold and Silver have not gone up in price, it is the currencies have gone down, which is illustrated by the fact that Gold was $20 in the 1930’s and is now over $1500.  Similarly, Gold has easily outperformed both the global Equity and Bond Markets since the 2000 Crash.

Conclusion

This is a time to adopt Antifragile strategies.  This is a time to convince your investment fund manager to go defensive or change your fund manager.  Now, more than ever, it is important to ensure that your diversification strategies are comprehensive and that you are biased in favour of actively managed funds.  Having a second passport, having money offshore, having property offshore (if you can afford it), are all important considerations.

————————————————————————————————————————–

Note!  All these reports are educational, free and published weekly.

Free Subscription – if you want to subscribe to this free newsletter, click on this LINK.  These, and earlier reports, can all be viewed at https://eelcogold.com/

Disclaimer!  The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests.  Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.

Mr Lodewijks is not a qualified Investment Advisor.  His investment reports aim to educate and help investors understand investment considerations and strategies.  As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.

Anthony Deden - 40 Invaluable lessons when Investing

ANTHONY DEDEN – 40 INVALUABLE LESSONS WHEN INVESTING

I believe this “investment perspective” gem will enrich and change your life

IT IS ABOUT ANTHONY DEDEN’s EXTRAORDINARY INVESTMENT STRATEGY

This is the way investment advisors should be thinking. This summary encapsulates his philosophies. The result: an investment manager who beats all fund managers.

BELOW IS THE FREQUENLTY PUBLISHED SUMMARY – 20 minutes read. 

40 ‘invaluable’ investing lessons from Tony Deden

Who is Anthony ‘Tony’ Deden?

Tony Deden is the Chairman of Edelweiss Holdings, a Bermuda-based investment holding company that he first launched as a fund in 2002. After building a remarkable track record, Tony converted Edelweiss into a holding company with over $300 million in assets and holdings that range from branded dairy products to a fragrance company and a salmon farm. Tony prizes safety of capital above all else and has structured Edelweiss to survive any type of economic situation.

Tony came into the profession of wealth management by accident when in 1985, he was asked to manage the monetary affairs of a family and then one family became two then three and since then he has never looked back. He had never worked in the finance industry prior to that and he learnt everything on the job as he wanted to serve his clients the right way.

Media averse Tony is well known for his old-school investment methodology based on integrity with a supreme focus on the preservation of wealth of his clients. He prefers to spend his time reading and thinking, tries to avoid the spotlight and resides in the Swiss Alps away from the chaotic world of finance. This theme of preferring to stay in seclusion is quite prevalent amongst the super investors as even Warren Buffet prefers to operate out of Omaha instead of Wall Street.

His conscious awareness that its ‘permanent irreplaceable capital’ of his clients that he is handling sets him and his thought process apart from 99% of fund managers today who have become infamous for making imprudent investments with no accountability as they seem to have an undefined, an unlimited amount of capital at their disposal.

If a manager can simply replace the word ‘wealth’ with ‘savings’ when he thinks about his client’s money, he would begin to act and invest differently. Learn to manage money as if it were your own savings.

He believes that for someone who has already earned the fruit of past labour and has significant wealth at hand, the tools with which you protect his wealth are different from the tools that are needed to create it. So, the tools, framework, objectives, methods, language are all different.

Here is the knowledge & thought process of this ‘investing maestro’ distilled into 40 pearls of wisdom;

  1. At the outset let’s get one thing clear, if you can’t read a balance sheet, you have no business in the stock market or any other market. You will end up deciding on a ‘hunch’ a ‘gut feeling’ or a neighbour’s hot stock tip. You will listen to the crowd from Wall Street that is just as lost or self-serving. You can’t fly an aeroplane on a hunch and neither can you invest money.
  2. The capital being given to the money managers is a‘lifetime’s worth of savings’ of a family and must be respected, as its hard to make money and even more difficult to keep it. Its hard enough to protect the capital from external factors like inflation, taxation etc. that one mustn’t compound the error by internal factors such as imprudence while choosing investments.
  3. The real riskwith investing is the idea of losing one’s capital permanently with no ability to ever recover it rather than people’s definition of risk which is actually means uncertainty. Look out for what could go wrong rather than what can go right. It’s better to err on the side of inaction than taking thoughtless action in haste. 
  4. There is no point in having different portfolios for different clients based on their unique special needs and risk perceptionbecause what they really consider risk might not be a risk at all. Instead, it’s better to have all the portfolios aligned to a core principle of capital protection because, in the end, it’s not the money that you make that makes you rich rather it’s the money you get to keep that makes you and keeps you wealthy.
  5. When you start viewing your investments as a collection of assets in the form of securities, having a purpose, each of the components having a sub-purpose of its own rather than looking at them as a mere portfolio, that’s when you separate yourself from the herd and the opinions of others stops to matter. This collection of assets must endure and withstand the pressures exerted upon them by time and turbulence.

The goal should be to take irreplaceable capital and deploy it to irreplaceable assets

  1. When you are younger and new to investing, you want to believe the authorities, rating agencies, government statistics etc but as you grow older you realise that they all lie and everything is phoney.This realisation alone will make you look at places where no one is looking and help in developing the courage to acquire the things that everyone has brushed aside.
  1. Instead of trying to impress your customer, try to protect what he has spent years accumulating.
  2. In the times of ‘seeming‘ prosperity, always examine the causes to figure out if it’s real or simply an illusionof prosperity. A rising level of consumer spending and elevated lifestyle of the society is simply an illusion if the majority of it is funded by credit.
  3. As a money manager, one must not participate in an environment in which one has to do things because they were expected rather than doing what’s right. Unfortunately, that’s not how the industry functions these days.

When you start thinking about enriching yourself from the assets of those who participate in your scheme, then you are no longer a custodian rather it becomes a business

  1. Instead of being on a constant lookout for growth, investors should deliberate upon the idea of endurance and durability of a company.Try to figure out what are the ingredients that have contributed to their survival as a company over so many years. Rather than studying why companies fail, start looking for traits that make companies survive the test of time.
  2. The first principle to follow while investing is the ‘idea of exclusion’. When you consciously start doing that, you will realise that you are left with a handful of companies that are worth your time let alone owning a piece.
  3. There is a substantial difference between people who are investors and people who are owners of businesses. No owner of a business wakes up every morning asking himself what he’s worth then why should an investor if he actually believes he is a part owner. And if he believes he is a part owner then his first goal is to make sure the company survives, has a great product, a happy workforce, stable suppliers and a delighted customer.Now to think like that an investor needs to have time preference which is different from other people.

Investors who think like owners don’t indulge in the pseudo-intellectual activity of analysing companies based on how the price of the stock will move the next year or the next

It’s the liquidity you enjoy as an investor that entices you to act more like a price speculator rather than an owner of a business.

  1. The idea of having a fragile balance sheet for the sake of a higher growth doesn’t lend itself to the idea of ownership, an owner must be really concerned with his balance sheet. The balance sheet should be more important to him than the income statement. A company’s ability to endure and to survive is based on the strength of his balance sheet and the ‘nature’of the assets on it.
  2. As a wealth manager, you are the captain of a ship and you have passengers on board who wish to go to a destination you all had decided upon before setting sail. They will judge you eventually by having gotten there rather than how long it took as you had to avoid certain weather. Then again, if you had set sail with preservation of capital as the core principle, more often then not you would have a group of satisfied passengers on reaching the promised land.
  3. Like-mindedness is not just necessary with clients but also with the owner of a business in whose company you are going to investThe owner should make decisions in the long-term interest of the company rather than next quarter or next year.

Like-mindedness, whether it is in marriage, in a business, or in any enterprise is a principle and important factor in doing the right thing in the right way

  1. So what should be theright attitude towards investing?

Look to own a participation in a business that is run by owners whose motivation is the same as yours, who are responsible to their family and to their community, and to the capital as much as you would have been if you owned the enterprise. So, instead of owning 100%, you own 2% or 3% of the company. You should be able to sleep well at night

  1. Here is why the concept of EBITDA is flawed;
  • The only reason why EBITDA is around is on account of the ability to finance acquisitions through credit. If it was not for credit creation, there wouldn’t be an EBITDA;
  • Real owners do not think of the value of their business as a multiple of the earnings they generate before everything which is EBITDA;
  • The word EBITDA owes its very existence and relevance to dishonest money.
  1. What aboutPE multiple?
  • Earnings are important, a company must be profitable and equally important is the cash generated by the company. Profitability can’t just be an accounting entry;
  • The price to earnings ratio is meaningful but it’s not really essential in terms of value as profitability over a short term or from one period to another is often times a function of certain temporal events. So an investor mustn’t pay too much attention to that;
  • Rather more important is the recapitalization of those earnings and the compounding to those earnings to book value per share which is a far more important indicator of a company’s ability to compound and that’s where the wealth lies.

Wealth is in the compounding of earnings

Basically, a company should be able to re-invest in itself to generate more future earnings which is what compounding of earnings means.

  1. What about the idea of earnings estimate, forecasts and forward guidance?
  • That’s all nonsense. No CEO has a clue as to what is going to happen in future let alone give any precise numbers;
  • Secondly, even if a CEO has some idea, the only reason he would share it with you is if he has stock options. The only purpose of asking or giving forward guidance is the stock price. This leads to the price of stock becoming a product and the whole thing turns into a game;

The focus then shifts from making a better product to finding innovative ways to make more money

  • Ideally, a business should make money as a result of doing something well. That is the foundational principle, you make money because you add value to somebody’s life for which he is willing to pay you. What these financial tools like ESOPs end up doing is to take the focus away from the business;
  • These days more often than not, a listed company’s principal business is their stock. What they do is an unnecessary complication to the idea of the stock going up. If it was owners running such businesses, there would be no disputes overcompensation. An owner of a business doesn’t take options. He owns common stock.  He owns the company.

The idea of corporate responsibility is thrown around all the time these days but the truth is owners don’t need to be reminded to be responsible

  1. Know what can go wrong;
  • Try to learn about businesses rather than stocks. When you read about varied industries and the businesses operating in them, you will have a better understanding of what can go wrong. Over time, even a marginally good business will do well if nothing goes wrong;
  • To base an investment decision barely on available financial information is a superficial way of investing. But if you are buying simply for the purpose of selling then you don’t need to understand what can go wrong as you are seeing everything in terms of price;

It’s your duty to know, what can potentially go wrong in the businesses you own

  • Knowing what can go wrong is more important than what can go right. You can never really know what anything is worth until you understand what can go wrong;
  • We value companies differently because we weigh various components differently. There is no such thing as valuation metrics based on some standardized formula unless you see it in conjunction with other issues;
  • In a world where there is a distortion of the economy and the cost of money is nearly zero, it’s important to have your own subjective way of measuring and accessing value;
  • Always include an element of risk in your valuations based on the risks that are particular to a business, particular geography and so on.
  1. Scarcity, Permanence and Independenceare the three components that make investments endure the test of time.
  • Scarcity is the most important law of economics. It is an important ingredient in any action that deploys capital in future. Anything that is scarce accrues in value over timebe it savings, resources (tangible and intangible) or the human character traits that help in building great businesses that last. The oligopoly of a business in an industry is an example of scarcity;
  •  Scarcity can be seen not only in quantifiable and material considerations but also in a company’s culture and ability to endure, survive and adapt. Or it could be its competitive advantage or the aggregate technical skill in some particular field of endeavour that is difficult to duplicate;
  • Scarcity element reigns supreme when it comes to people running the company;

There are far more original multi-million-dollar Picasso artworks out there than there are company CEOs in whose enterprises you would be willing to deploy your savings

  • Permanence is the idea of creating a framework that makes you invest in a company and people whose practices and behaviour is designed to endure rather than just grow. A company can grow but become fragile at the same time and die;
  • Dependence makes a system fragile. If its a company then dependence on suppliers, a single customer, government subsidy etc can reduce a company’s ability to endure in the long run. A company independent of external factors is more likely to adapt and endure in tough times than the one which is a lot of dependence on the system.
  1. Liquidity can be a curse;
  • When you invest in something that isn’t quoted on exchanges, you are excited about the idea of being a part of a real business. You make the extra effort to study the intricacies of the business and try to figure out what can go wrong. But when it comes to investing in listed companies, you tend to throw money based on tips as they can always be sold the next day.

The liquidity gives you an excuse to not want to know or understand anything about a business

  1. Build a habit of re-visiting your decisions, good or bad, and ask yourself;
  • What is it that I should have seen that I didn’t?
  • What was possible to see which was overlooked?
  • What did I see and how did I focus on those that others didn’t;

The idea behind this exercise is to be able to separate an element of luck and happenstance from skill

  • The unseen and unmeasurable are more important than the other kind. Things that kill you are often things that you cannot measure or cannot see;
  • Understanding just the notion of risk isn’t enough, you need to know the nature of risk and the possible places from which risks to an investment can emerge.
  1. There are companies where the owners have a mindset to protect, preserve and enhance what they have been handed over by the previous generation and pass on the baton to the future generation when the time is right. These are the kind of owners you would want to partner with.
  • The time horizon of such owners is not in years but in generations. When you partner with owners with such ideology, rest assured that the company will continue to do well for decades to come and your capital is secured.
  1. More frequently you look at the price of something, more frequently you start to second guess why you own it. So frequent checking of the portfolio can be dangerous to long term compounding and having so much liquidity in the system doesn’t help either.
  1. One of the greatest abilities that one must have as an investment manager is the ability to judge people in order to associate with like-minded clients and also the owners of the companies you’ve invested in.
  • This can only be achieved by practice and observing thingsA single sentence uttered by a CEO or CFO can completely change your decision on whether or not you should be investing in that company;
  • When you hear them say something that is not aligned to your philosophy of business then you mustn’t rationalise staying invested only on the basis of good financial performance, you simply get out;
  • A great question to ask yourself in such situations is that if you owned this entire business would you hire the current managers to run your company. If the answer is no, then why would you even want to hold a 1000 shares?
  • One way to develop this judgement is by meeting the management but sometimes you don’t even need to meet them. If you can see that over the last 20-50 years, they have made the right decisions at the right time and they have been consistently doing this all their lives then you don’t need to meet them to invest with them.
  1. Any good investment operation, particularly when it deals with irreplaceable capital, must have embedded in it a source of continuity, substance and reservethat can be deployed when a favourable investment opportunity presents itself.
  • This reserve can be in the form of treasury bills, commercial papers, short term bonds or time deposits. The problem with these so-called ‘paper assets’ is that they are actually debt. So, you do not want your liquidity to be somebody else’s liability.
  • Physical Gold solves that problem. Gold gives scarcity, permanence and independence from the financial system. It is something that;
  • you can hold see, touch and hold in a vault;
  • can be sold to anybody, anywhere in the world at a moment’s notice;
  • no one actually owes you anything when you hold gold. It’s not a claim on anything;
  • has a sense of peace to it as it possesses a financial strength that even some financial institutions can’t boast about.
  1. Don’t own something you don’t understand.If it is going up, it makes no difference.
  • Commodity-based businesses have a low barrier to entry. The acceptance of their product is subject to whims of the public, the buyers;
  • Similarly, the companies that provide any sort of transport like aerial, trains or trucks have no operating leverage. They are subject to inputs and costs that are beyond their control, subject to government regulation. So they lack substance.
  1. While deciding where the probable investible company should be in the structure/hierarchy of production;
  • It doesn’t matter where the company stands in the structure of production rather it should have natural barriers to entry based on various factors that make it difficult to compete with;
  • Nothing is permanent, so this advantage and these barriers need to be cultivated and the company needs to adapt in order to keep its competition at bay;
  • But you don’t want to be partnering in a company that makes something the nature of which is so large as a component of something so as to subject to the seasonal demand or subject to external risks through government intervention, regulation or competition. You want that element of independence to be there.
  1. Don’t just make an investment because you want to make a quick buck from it, rather have a strong framework and a set of questions that you ask yourself before making an investment.
  • Do you like this business?
  • Do you understand it?
  • Do you want to be in this business?
  • What is the history of this firm?
  • What is the competitive advantage that this company has?
  • What is the larger environment in which it operates?
  • Where does the demand for the product come from? In essence, does it come as a result of government policy, subsidy, regulation or does it result from a choice on the part of the consumer, customer etc?
  • What are the components that go into this business and how are they regulated?
  • What risks are there?
  • What is the market for this company’s product?
  • How honest are the revenues?
  • How permanent are they?
  • What are the factors that influence their operating margins or unit growth?
  • How have they deployed their earnings in the past?
  • How have they grown? A company growing purely on acquisitions or financial engineering is an accident waiting to happen;
  • What is the ownership structure of the company, who owns it, for how long and what have they done with it?
  • Who are the people involved and how long have they been there?

More often than not when you start answering these questions, you will come across something significant that makes you disinterested in the company.

In a handful of cases, at the very end of your analysis, you will realize that you are onto something substantive, valuable, enduring, scarce, extraordinary, beautiful. It is then that you ask yourself, well what is it worth? Understand that there is a difference between what a company is worth and what it’s selling for.

  • What are the components that add to value?
  • What are the risks inherent in the business that you would want to take haircuts against?
  • How do other people think it’s worth and under what circumstances over a period of time?
  • Is it something that’s neglected?
  • Is it something that is followed by every mutual fund and ETF in the world? Because if it is then that makes a company uninteresting.

Then ask yourself some broader yet critical questions before you actually make an investment;

  • If you could, would you want to own the entire company? Is this something you would want in your collection of assets? – If the answer is no, then why would you want to buy a piece of it?
  • If you could own the whole company, would you want the same people to run it?
  • Is this business likely to be around 20 years from now? You can get an idea of that by looking at some decision that the owners have taken over the past decades. By looking at the decisions you understand the motivations of those who own the firm and understand whether or not they are sowing the seeds for the next decade or two.
  1. Investing is not a science. There is no one size fits all or there are no fixed checklistsyou can adhere to. It is a subjective process;
  • . Sometimes you come to a quick conclusion to the attractiveness of something. Love at first sight actually happens in investing as well;
  • At other times, you don’t love something right away rather you take your time and slowly start seeing value in the company.
  1. The price is important no matter how good the company.No one can predict earnings accurately and consistently. So, don’t base your investment decisions on ‘potential’ earnings.

Try to develop some mental tools with which to think about the economic value of a business endeavour rather than its financial value. It’s easy to say, ‘ this company sells for X number of dollars a year’ but what’s difficult to say is, ‘what is this company worth and why?‘.

  1. What is ‘intrinsic value’?
  • In its essence, it is a sounds like a necessary idea. Yet, to the extent we wish to quantify it, we end up excluding what is unquantifiable and unseen—the very essence of what concerned the prudent man of olden times;
  • We conjure unknown future flows of money, that is, something we guess, from a business whose results are subject to interventions and distortions, or from one that is being hollowed out and sacrificed at the altar of shareholder value, and run by persons who don’t quite care if the company is likely to be around in twenty years’ time;
  • We then discount it all by a number—a rate of interest that bears no relationship to anything. We get a number and we compare it to the monetary value of an investment instrument. The math can be impressive to the customer, but what does it really mean?

It means absolutely nothing

  1. Instead of looking at the stock price fluctuations on a daily or weekly basis, look for the seeds that are being sown today in the company, good or bad, that are likely to bear fruit a year, two, three or four years down the road.
  1. When you find something that looks very nice in the first instance, ask yourself the question that there is something wrong here. Seek out the reasons why you shouldn’t add something to your collection of assets.

Always be a ‘doubting Thomas’ while analysing investments

  1. Once you are in a participation with a company, there will be times when you will have doubtsabout something. Here you can create a decision-making framework based on your comfort level with the past actions of the owners of the company.
  • Some managements have shown extraordinary faithfulness to their companies, families and shareholders over many years that it’s not worth second guessing them in case it’s a one-off ‘perceived’ anomaly that you have noticed. You need to trust their judgement and decision-making abilities;
  • There will be other companies where you would need to second-guess, in that case, seek to get some answers by politely writing to the management;
  • If a company has a series of errors and actions that you are not sure are in the best interest of the company long-term, it’s better to quietly exit. As that’s really the only thing you can do, being a minority shareholder.
  1. It’s not important to be looking for opportunities.What is important is to acquire an understanding so you can recognize the opportunities when you see them. If there is an opportunity, it comes across for everyone to see it but very few people recognize it. So, the people who recognize it are the ones who are prepared to recognise it.

So, what are the tools that will help you recognize opportunities that others don’t;

  • Understand the business;
  • Understand the sector;
  • Understand what the market needs;
  • When you go through hundreds of probable investment ideas, you invest a lot of time and effort working on them and in the meantime, you learn something about the process;
  • This time spent is never wasted, you keep making mental notes as you go on researching company after company and industry after industry. And the next time the situation comes, you have the tools with which to think;
  • In the process, you develop a third or fourth sense of things which sets you apart from the crowd.
  1. There is no value in reading the financial press.
  • The news is not news, it’s fake and it always has been;
  • A lot of reports for news are poorly disguised promotions or written by people who have no clue;
  • People who are involved in real economic endeavour don’t have the time to indulge in meaningless activities;
  • The reason why people are looking at the press constantly and seeing, what do other people do is because their investment decisions are largely based on other people’s decisions. Instead, you should figure out what’s right for you by yourself because you don’t know what the real motivation of the person behind the news is.
  1. Remember that a play on words can change the whole perspective on how your brain processes things. Over the years, the gambling business has changed its name to the gaming business. This is not by accident. They want to infer to you that there is an element of fun in giving money to the house when all odds are against you.

If you can simply replace the words ‘shareholder/stakeholder in a company’ with ‘participation/partnership/ownership in a company’ in your investing vocabulary, you will start looking at your investments differently especially in terms of your time preferences

  1. What does the economy or money in the modern day world actually means, is it real or simply an illusion?
  • we look at prices on an exchange to reckon value, having failed to see that wealth creation via the stock market does not create resources in the economyWe don’t see that booming markets without savings is not an accumulation of resources but an accumulation of claims on existing resources;
  • We hail growth by looking at a meaningless aggregate such as GDP and we hope for higher prices, dismissing the fact that such aggregate growth in money terms more often than not comes from debt creation and the consumption of our capital. Yet we reckon all this as a modern financial miracle;
  • We have abolished the idea of failure—nature’s cleansing mechanism. As a consequence, we’ve lost real economic vitality. We’ve substituted finance for an industry as the locomotive of economic growth. In GDP terms, it looks terrific. But it is neither enduring nor real;
  • A promise to pay is not money. We dress it up as a bank deposit, a treasury bill or some variation thereto and insist on calling it an asset. But we also laugh at the man who chooses to keep his cash in gold. The price of something becomes our value determinant rather than its characteristics in being real, enduring, or suitable as a means to our objective;
  • Dishonest money begets dishonest statistics, dishonest accounting, dishonest balance sheets, dishonest means, dishonest objectives, dishonest compensation policies, and dishonest relationships; that it begets ambiguousness and corruption in every aspect of life—from the loftiest of boardrooms down to the lowliest economic agent;
  • We need to appreciate the fact that our own claims, promises and debts are nothing but a false reckoning of wealth. We trade instruments on financial exchanges that possess no inherent economic value. We trust there will always be a bid or a greater fool as they say;
  • One of the most nefarious consequences of dishonest money is to destroy our ability and willingness to act responsibly in light of our own judgments. It has led us to replace common sense by compliance;
  • We have substituted the law for what is moral and what is right. We have substituted audit checklists for an auditor’s judgment about what is true and fair. And we have substituted phoney mathematics for the judgment we once possessed in understanding the nature of value and that of risk.

Conclusion:

  • Tony believes that;

Wealth in created on the main street and not on wall street. Our job as custodians of that wealth is to understand the irreplaceability of that capital created over generations of hard work and savings. It must be respected

  • The history of business and money is replete with stories of companies like Xerox where fortunes made over a lifetime were lost due to some inappropriate decisions.  So, we need to view the financial process with some humility. For unless you inherit it or win the lottery, creating great wealth is quite difficult and, keeping it, is substantially harder.

‘Humility’ and ‘Judgment’ are two foundational traits they don’t teach in Business School. They are impossible to identify or quantify

A little arrogance, over-confidence or lack of judgment results in disaster. Be it money or life in general

  • More importantly,

The best thing you can pass onto your children is not money, it’s the way of doing things

END OF ANTHONY DEDEN’s 40 LESSONS

Eelco Lodewijks

View all posts