Out of the frying pan, into the frying pan

January 7, 2013
Talca, Chile

There are few original thinkers in professional finance. It’s much easier for an individual to step back and say, “Holy Meltdown, Batman, this system is deeply, woefully, fundamentally flawed…”

I can see it, you can see it. But somehow, as soon as they put someone in charge of managing hundreds of millions of dollars, professional money managers lose their instincts to see the obvious.

The groupthink in the world of finance is some of the worst on the planet. It’s incredible how such an educated, experienced group can willfully ignore reality, stick their heads in the sand, and repeat the same mantras over and over again until they become axiomatic.

Home prices never fall. The economy is recovering. Governments in the developed world won’t default. Conjuring money out of thin air, infinitely, has no consequences. Etc.

The desire to be accepted by one’s peers is part of human nature. And when it’s one’s peers who are rigging the financial system, the pressure to adopt industrial groupthink is enormous.

So like I said, there are few original thinkers. And one of the few is my friend Tim Price in London for whose wit, intellect, and professional acumen I have the deepest respect.

Tim recently sent along a letter which I’d like to excerpt below because he highlights a critical lesson: despite the steady aural drubbing from financial media that we should all go buy stocks with wanton abandon, this is one of the most difficult times in recent history to invest. And investors may need to realign their goals from capital appreciation to capital preservation.



From Tim Price:


The dawning of a new year is invariably a time for forecasts. One of our New Year’s resolutions for 2013 is not to join the crowd in issuing them. Another is not to waste any time in reading them.

Having spent the past decade honing an investment approach designed to be proof against the very worst that an imperfect world of politicians and bankers can throw at it, it would be a capitulation to suddenly subcontract asset allocation to someone’s subjective assessment of the world.

And yet, we still devour investment commentary as if there were some unfound nugget of wisdom and insight that, once located, would finally reveal all the investment answers…

One British personal finance journalist confessed last week that he had sold all the bonds in his company pension to buy shares instead. His arguments are all rational:

– He expects bond prices to fall when interest rates rise, (nearly a mathematical certainty);
– Interest rates have sunk to derisory levels and can barely go lower;
– Most bonds are by no means as riskless as conventional thinking dictates;
– Most bonds are by any sensible analysis ridiculously overvalued.

But we have some reservations about the binary decision to ditch bonds and put the proceeds into the stock market, as if these are the only two asset choices in town. And while his decision may lead to a very comfortable retirement, we will now deploy two words that most professionals will never use: nobody knows.

The reason for our caution lies with a healthy respect for the volatility of the listed stock markets, especially at a time when the prices of all financial assets are being fundamentally distorted through the mechanism of money printing by the world’s major central banks.

Western government bond markets may blow up this year, or they may yet see their yields creep even lower, courtesy of a sudden wave of risk aversion, fears of deflation, state coercion and financial repression, or some other strange cocktail of the surprising.

The future, of course, is not known to us, or to anybody else. But there is a possibility (a possibility too heavy for us to entirely ignore) that equity markets will disappoint, perhaps at a profound level, those investors for whom they have become a panacea out of desperation at any obvious alternative.

To put it more plainly, ditching bonds to buy stocks may be jumping from the frying pan into another frying pan. To put it more plainly still, stock markets are only cheap by reference to grotesquely expensive government bonds, and the risk of significant price falls is ever present, especially at what is likely the tail-end of a multi-decade expansion in credit.

A falling tide might sink more than one type of boat.

As a result, the only true conviction we have is in capital preservation. For us, this includes a four-fold, multi-asset approach in cash (including exposure to non-western currencies), defensive equities, gold, and judicious exposure to one type of actively managed fund.

Kyle Bass, a fund manager for whom we have extreme respect, quotes Dick Mayo, founding partner of fund management group GMO, who recently said that it was the most difficult time to invest in his lifetime. We concur.

That markets remain weirdly ebullient doesn’t discredit our thesis. The reality is that we’re shepherding the irreplaceable assets of our clients. And if we weren’t pursuing a mandate of capital preservation in extremis, we would simply be pursuing the wrong mandate.


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