This week's interesting finds

August 30, 2019

Wisdom from the Oracle

Warren Buffett is famous for his wit, and will likely go down in history as one of the most quotable and influential investors of all time. This week marks his 89th birthday. This infographic highlights some of the smartest and most insightful quotes from Buffett on investing, business, and life, accumulated through his lengthy and prestigious career.

“Never invest in a business you cannot understand.”

"The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd." 

“It’s only when the tide goes out that you learn who has been swimming naked.”

"Price is what you pay; value is what you get."

"Be fearful when others are greedy and greedy when others are fearful."

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." 

“Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press.”

“The most important investment you can make is in yourself.”

John Neff – Shunning fads and looking where others didn’t 

John Neff started managing Wellington Management’s Windsor mutual fund in 1964. Over the three decades, he was among the most successful fund managers of his era.

Mr. Neff, who died June 4 at age 87, shunned fads, such as the “go-go” stocks of the 1960s or the “nifty fifty” of the 1970s. Instead, he looked for stocks that were “overlooked, misunderstood, forgotten, out of favor,” as he put it. He favored steady performers and aimed to pay a low multiple of annual earnings.

Among his pithier tips: “When you feel like bragging about a stock, it’s probably time to sell.”

Young people’s love of cities isn't wearing off 

Some demographic experts predicted that young adults’ fascination with urban living would fade as they settled down, got married, and had children, at which point they, too, would follow their parents and grandparents to the suburbs.

A new study finds that not only have young people been a driving force in the urban resurgence of the past two decades, but they favor living in central urban neighborhoods significantly more than previous generations did at the same stages in life.

The locational preferences of young adults hold large consequences. Millennials make up America’s largest generation, bigger even than the Baby Boomers. Where they choose to live will have a lasting impact on which places grow, which stagnate, and which decline. This can be seen in the skyrocketing housing prices and affordability crises of a growing number of American cities.

Some retail investors may need a reality check

A survey of 9,100 retail investors in 25 countries finds that many are in need of a reality check. It shows that retail investors feel confident in their return expectations, with long-term return expectations in Canada at 10.1%, while financial professionals surveyed believe a return of 5.7% is more realistic for clients.

Our 10-year Partner Program

To show our appreciation for our partners who have had the conviction and unwavering long-term view by staying invested with us for 10 or more years, the 10-year Partner Program offers lower management fees. 

We believe that one of the keys to pleasing investment returns is taking a long-term view and holding good, undervalued businesses until the market fully recognizes their potential. While you can be lucky over short periods of time, it takes considerable skill to achieve long-term outperformance. The same notion applies to our investors. To succeed in getting to your Point B (whatever your financial goals may be), it takes conviction, a good financial advisor, the fortitude to embrace volatility and, above all, an unwavering long-term view.

This week's interesting finds

August 23, 2019

An important read: Why profits matter (and value investing is not dead)

We have currently reached the point in this cycle where many investors/commentators have started to question whether profits no longer matter, and also whether value investing is dead. As is often the case, the arguments put forward in the affirmative derive mostly from recent market experience/outcomes, rather than reasoning from first principles. Hyper-growth (and generally loss-making) tech companies have seen outsized share price gains, with many recent IPO vintages also seeing triple-digit gains, despite the absence of any profits either in the past or foreseeable future, in echos of the dot.com bubble. Meanwhile, many profitable and cash-generative companies with low growth, and especially with falling earnings/revenues, have been absolutely massacred.

Profits are vitally important, not only because that is the only means by which stocks ultimately generate returns for, but also because profits (and losses) are absolutely vital to the healthy functioning of a capitalist economy, and indeed are the ultimate test of whether a company is doing anything worthwhile at all.

Over the past decade, the need for profitability has broken down in many areas of the economy, as loss-making companies have not only been allowed to survive but are also rapidly growing. In many cases, they have only grown because an extraordinary amount of capital has flown into venture capital and other tech-based funds.

Many investors today are currently impressed with rapid rates of revenue growth, regardless of the state of the bottom line. Much as with the dot.com bubble and its subsequent unraveling, where many 'old world' value businesses were left for dead, only to stage dramatic recoveries in the following decade, a likely consequence of the coming tech wreck will be a significant resurgence in the performance of many 'value' stocks, as their sales, market share, and profitability recover as 'disruptive' competitors go broke, and their multiples dramatically recover.

When will the reckoning occur? It is impossible to say, but it will occur when the funding bubble bursts and companies are forced to once again fund themselves from operating cash flow.

Could it be when the pace of cumulative losses across the upstart tech ecosystem starts to exceed the pace of new fundraisings? Softbank has been a major contributor to startup fundraising with its outrageously-sized US$100bn Vision Fund. Softbank has already blown through the majority of this funding in only two years. But the pace of operating losses continues to mushroom, and Softbank is now running out of money. As a result, Softbank is currently trying to hastily prepare a second US$100bn Vision Fund to keep the house of cards intact. Time will tell whether they succeed.

On the Other Hand - implications of the Fed’s interest-rate management

Is it the Fed’s job to sustain expansions and keep market dislocations at bay ad infinitum?
Many people take Fed actions at face value.  When the Fed cuts interest rates investors take that as a “buy” signal.  Their thought process is simple: weak economy → rate cuts → economic stimulus → stronger GDP → higher corporate profits → higher stock prices.  
Are low-Interest Rates a Good Thing?

The Fed’s decision early this year to depart from its announced program of rate increases to the S&P 500’s gain of roughly 20% so far this year. But how, exactly, do low rates contribute to wealth creation?

Low rates reduce the discount factor used in calculating the net present value of future cash flows.

By reducing the interest expense on companies’ floating-rate debt, low rates enhance companies’ profits; make it easier for them to service their debt; and leave them more cash for capital expenditures, and dividends and stock buy-backs.

What about the downside? 
Low rates stimulate the economy, and most economists and businesspeople believe there’s such a thing as the economy becoming too hot.  The principal worry is excessive inflation.  While some inflation is a good thing, too much isn’t.  

When low rates penalize savers by reducing the returns available on instruments like cash, money market funds, savings accounts.

Should we be happy to see the Fed trying to prolong the economic expansion and the bull market when they’re already the longest in history?  Should it try to produce perpetual prosperity and permanently ward off a correction?  Are there risks in its trying to do so?  It all depends on which hand is doing the weighing.

Three Mindsets of Great Investing Teams

Culture reflects the mindset of a firm. The mindset is the set of attitudes that the firm holds. So what sorts of mindsets correlate with investment success and better decisions?

Understanding 
Great investment teams are more interested in getting the facts on the table and searching for the truth than they are in winning the argument or looking good. The best among them learn to recognize when they have become defensive so they can shift back to that curious mindset.

Candor
The ego wants to win, but the good team member wants to encourage open and honest communication. Success means that we have encouraged others to remain curious. Failure is when the discussion turns defensive and unproductive.

Appreciation
All criticism and no appreciation creates a fearful environment. When we’re in such a space, we wonder if any of our work is valued, if we’re doing anything right. And we become more risk-averse and myopic: If our normal work generates negative feedback, why take a chance and stretch beyond our already constricted comfort zones?


Less size and more insight

The age of asset gatherers has peaked and the asset management industry is re-entering the age of the boutique, where it began. What will matter is less size and more insight, which will support the outcomes sought by asset owners. Delivering that added value will require closer economic alignment between asset managers and asset owners.

This week's interesting finds

August 17, 2019

U.S. mortgage debt hits a new record
U.S. mortgage debt reached a new record in the second quarter, exceeding its 2008 peak. The steep drop in mortgage rates boosted borrowers’ incentive to take out a mortgage or refinance. Alongside higher home prices, a factor behind rising mortgage debt balances is homeowners tapping into home equity for cash when they refinance. Still, the household debt picture is different in 2019. Despite the higher debt levels, Americans appear to be keeping up with their payments.

EdgePoint bond desk: Four more rate cuts might be excessive
Core prices rose 2.2% versus a year earlier in July, the largest increase since December. Even this increase counts as tame and suggests that the Fed's preferred measure of core prices may remain below the 2% inflation target. Still, after the two largest back-to-back monthly increases in core prices since 2006, when the Fed was on the inflation-fighting warpath, it is harder to get worked up about “too low” inflation. Especially with the unemployment rate at 3.7%. 

It's never been cheaper to borrow in Denmark
Banks in Denmark are now effectively paying qualified homebuyers who take out a 10-year fixed-rate mortgage. Jyske Bank, the third-largest bank in Denmark, will now lend to prospective homebuyers at an interest rate of -0.5%.

Risk in investing
Risk is the four-letter word of investing, but it is poorly understood. Consider, for example, the two different investments in the accompanying table: Investment A and Investment B.

Which investment would you prefer? A or B?

Everyone would prefer investment A. After all, you end up with more money after three years. But, which investment is riskier? According to investment orthodoxy, Investment A is riskier! Why? Because it has a higher standard deviation (or volatility of returns) at 23.6% than Investment B at 0%. Doesn’t that strike you as odd? In investing, if you don’t want volatility, then you have to accept that you won’t have much upside potential.

Sandro's movie recommendations 

We asked Sandro, the most passionate movie buff at EdgePoint, for his top 10 movie picks of all time. After agonizing for days over this list, this was his response:

Films have had a profound influence on shaping the man I am. In fact, great films have the power not only to entertain but more importantly to transform the way we see the world. Truly great films, like a great vintage wine, get better with age. Each subsequent viewing reveals new pleasures and they become more socially and culturally relevant.

Ok. That’s enough with my ramblings. Keep in mind that if you asked me next week, it might be a completely different list. I didn’t even include a foreign film. I love foreign films!

Sandro’s Top 10 of All Time… more specifically on August 13, 2019

Citizen Kane (1941) - Welles
Casablanca (1942)  - Curtiz
Vertigo (1958) – Hitchcock
The Good, the Bad & the Ugly (1966) - Leone 
The Godfather (1972) – Coppola
Annie Hall (1977) - Allen
Goodfellas (1990) – Scorsese
Pulp Fiction (1994) – Tarantino
Boogie Nights (1997) – Anderson
The Social Network (2010) - Fincher

This week's interesting finds

August 10, 2019

Half the world’s bonds have yields that can’t match inflation

About $30.2 trillion of bonds offer yields below zero after accounting for inflation. The amount has surged from $25 trillion less than a month ago. The figures are based on the bonds in the Bloomberg Barclays Global Aggregate Bond Index, which has a market value of $55.6 trillion.

10-year yields
There are now 12 countries whose government debt sports negative 10-year yields. Switzerland leads with a 10-year yield of -0.92% followed by Germany, with a 10-year yield of -0.53%, down to Slovenia in 12th position with a 10-year yield barely in the negative of -0.04%.

The US, with its 10-year yields of 1.73% is in 30th position of the 51 countries. This puts the US two places behind Italy, in 28th place, with a 10-year yield of 1.51%. The list has only 51 places, and the US already has a low 10-year yield of 1.73% is all the way down in 30th position! Greece, which defaulted on its debts in 2012 and imposed big haircuts on holders of Greek government bonds, is in 33rd place with a 10-year yield of 2.02%. 

10 years of US stock market prices
Below is a visualization of the US stock market in the past 10 years returns. Every day for the past 10 years is captured in the graph. The worst day of the market in the past decade was August 8, 2011, which was a response to the credit rating downgrade of the US sovereign debt. The S&P 500 Index dropped nearly 7% that day.

One of the best days was on December 26, 2018, where the S&P 500 rose to 4.9%. This was the first trading day after the dramatic Christmas Eve sell-off.

The Psychology of Prediction
Here are some notable flaws, errors, and misadventures that occur in people’s heads when predictions are made.

The distinction between “wrong” vs. “early” has less to do with analytics than the social ability to prevent listeners from giving up on you. Say it’s 2003 and you predict the economy is going to collapse under the weight of a housing bubble. In hindsight, you got that right. But it’s 2003. So those who listened to your predictions have to wait four years for that prediction to come true. 

Credibility is not impartial: Your willingness to believe a prediction is influenced by how much you need that prediction to be true.
History is the study of surprising events. Prediction is using historical data to forecast what events will happen next.

Predictions are easiest to make when patterns are strong and have been around for a long time – which is often when those patterns are about to expire.

Predicting the behavior of other people relies on understanding their motivations, incentives, social norms and how all those things change. That can be difficult if you are not a member of that group and have a different set of life experiences.

If you refuse to make predictions because you know how hard they are you may become suspect of everyone else’s predictions even if they have insight and skills you don’t.

The effort put into a prediction may increase confidence more than accuracy. There are stories of Tiger Woods hitting 1,000 balls at the range without a break. And of Jason Williams practicing dribbling for hours on end without ever shooting a ball. That’s how you become an expert.

This week we all combined for a midsummer potluck! 

This week's interesting finds

August 3, 2019 

Oxymoron Alert: some high yield bonds go negative

In the latest sign of financial markets going into uncharted territory, more than a dozen junk bonds, which usually carry high yields, now trade in Europe with a negative yield.

China accounting scandal threatens corporate fundraising

An accounting scandal rocking corporate China is drawing comparisons with the collapse of the US firm Arthur Andersen, as dozens of Chinese companies are forced to halt public listing work.

China is trying to clean up its stock market and they are finding big problems with the way that auditing is being done. A string of auditing scandals this year has shaken investor confidence in Chinese equities at a time when global investors are increasing their allocation to the Chinese market through the MSCI emerging markets index.

MSCI recently increased the weighting for Chinese stocks in its EM index, a move that is expected to lead to an inflow of more than $100bn as investors are obliged to allocate more to China. But critics have said the increase has also increased investors’ exposure to many of the accounting irregularities on the Chinese stock market.

When to Ignore a Fund Manager

The active asset management industry is overpopulated and hugely competitive, and as with any sales activity, delivering the ‘appropriate’ message to prospective and clients is hugely important.  These messages often feel as if they are intended to cultivate a certain image or manage client concerns, rather than present a realistic assessment of crucial issues. 

The types of statements listed below should be considered with a liberal dose of skepticism:

“ESG factors have always been at the heart of our investment process”.
“Markets are not rewarding fundamental analysis”
“I think that interest rates are going to…” 
“I spend 95% of my time at my desk on pure investment work”
“I don’t think we suffer from any biases in our recruitment policy, it just so happens that the best candidates all went to the same universities and look the same”.
“The merger/acquisition/ restructure has not been a distraction”.

If all firms and teams present themselves with a similar sheen, then there is a significant cost to being an outlier that is frank about problems, challenges, and limitations. 

The overplayed world of artificial intelligence

Today’s buzzword is AI. It’s difficult to find a manager that doesn't claim to be using artificial intelligence to improve its investment process.

The generally poor performance of the active management community and the existential threat from “the machines” have managers grasping for a quick fix. Many seem to think that AI offers that solution. 

But many are more likely than not to find their experiments with AI to be expensive distractions. For this reason, don’t discount managers who are avoiding the hype. A manager that honestly admits that it doesn’t see an application for AI in its process may be a realist rather than a Luddite. 

Friday funnies: an EdgePoint partner submission

A major divergence has opened up in my proprietary quant model. Historic correlations are breaking down, presenting a unique opportunity for investors brave enough to take advantage of the temporary dislocation. Yes, it is time to sell avocados to buy Bitcoin!

G(LOW)bal bond yields: