Thank you Dah Hui Lau for bringing these to my attention!
Mathew McLennan – Excerpts:
Our goal is, first and foremost, to preserve capital, and then, and only then, to grow capital over time. I say over time and I say in an uncertain world because when people think about the preservation of capital they often confuse the preservation of capital with the ownership of cash and short-dated government securities.
…
When it comes to temperament, one of the things that's striking if you read any history is that human nature has changed much less than human know-how. In fact, if you go all the way back to the first recorded and reliable history that we can find, you'd probably start with a Greek author by the name of Thucydides. He wrote a history of the Peloponnesian war between Athens and Sparta. He quotes the speeches of the leading luminaries of the time as the tensions mounted between the Athenians and the Spartans. And you see, almost in a real-time sense how the mistakes played out, where the strife came from, how the war originated and there were certain recurring patterns in the nature of the key players in that time that led to problems; hubris, dogma and haste. Then, if you follow history from that point and you look at the turning points of key global crises, whether military or economic in nature, there are recurring themes in human nature that gets us into trouble; hubris, dogma and haste.
We have based our approach to investing around temperament, which is the symmetrical opposite of that; humility, flexibility and patience. Our ultimate objective as stewards of your capital and your clients' capital is to spend money wisely and that requires those three variables.
Firstly, humility. One of the things that Jean-Marie has always said and has been firmly ingrained in our culture is that the future is uncertain. It's the acceptance that the future is uncertain that distinguishes us from most. When you speak to most money managers, they will give you a very definitive view on what's going to happen, where inflation's going to be in six months' time, whether the S&P's going to be 1200 or 600, whether long-term bond yields are going to be 3.7 or 2.3 percent. We acknowledge that our crystal ball is foggy at best, and when you have the humility to accept that the future is an ocean of possibilities, it actually frees the mind to invest in a different way. Rather than saying this is my view of the future and I'm going to bet everything on this, you take a different perspective. In fact, you follow the advice of Ben Graham and you invest to avoid the landmines.
We seek a multifaceted margin of safety in every investment that we make. We like low prices. We don't want to pay for the future potential in a situation. We like to invest alongside prudent people. We prefer management teams that have grown their balance sheets at a conservative pace, that haven't financed with a lot of short-term leverage and that are good stewards of their shareholders' capital. We like resilient business platforms; businesses that are not only well-capitalized, but have something special about their market position in terms of their pricing power, their position on a cost curve, their entrenchment with a customer and their local scale economies. We look for a combination of variables.
I think there are two things that got a lot of value investors into trouble in 2008. Number one was a very definitive view about how the future was going to play out and, therefore, a doubling-down; and secondly, a one-dimensional margin of safety focusing solely on price as opposed to balancing the behavior of people and looking at the quality of the businesses that are being invested. In a nutshell, we recognize that we can't predict the future with precision so we look to buy good businesses at good prices or mundane businesses at compelling prices. That's at the core of what we do.
…
One of the other things that you see in the world of mutual funds is this belief that one has to be fully invested at all times. Again, this is an area where we perhaps differ from most. We've always been willing to have some amount of deferred purchasing power in the portfolio. Cash for us is a residual of the investment process. If we can't find good businesses at good prices then the cash builds. If, on the other hand, we see a relative abundance of good opportunities to invest in enterprise, the cash levels come down.
Seth Klarman said something revealing. He said that most money managers think that in order to earn their keep, they have to work your money aggressively. He said we think of money management almost as being like a couch potato; ultimately you only want to put things to work when you see very good opportunities, and you should have the patience to sit on it.
A decent part of the cash position we've held in gold historically. Gold for us is a form of insurance. We live in a world where there have been many changing currency regimes over time, yet gold has been a store of value that has been in existence for centuries. When the pharaohs' tombs are uncovered you see the gold on the pharaohs. We see gold coins taken up from shipwrecks from hundreds of years ago still in good form. Why is it that gold was a store value? Well, gold as a metal has special properties. Its density means that it's very easily stored relative to most other commodities. If you're going to store a real asset you want it to be relatively dense so it doesn't cost you much to store it. Secondly, the history of gold shows that a distinguishing property versus other more commodity-like metals is that it is not used predominantly in industrial applications because it's relatively chemically inert. That chemical inertia means that it doesn't rot or waste, but it also means the cumulative stock of gold is still in existence and the supply of gold is both stable and scarce. So, if something is in stable supply, scarce, lasts forever and is easily stored, there's a reason why it has been a store of value over time. Gold is not risk free. It goes through large price cycles. We've had the flexibility to hold gold as a source of insurance and it's served our clients well over time.
In addition to humility and flexibility, the third thing in terms of our temperament that is very different from most is patience. We grow up in a world where we tend to think in an annual cycle time. You go through school, you go from grade to grade, you get your first job, you get an annual assessment every year. Yet in many fields the natural cycle time is quite different from a year. It's quite long in the case of many fields, art at one extreme. If you're a great artist existing on the meniscus of perception, it may be generations before your work is appreciated. Fortunately as value investors, we perhaps don't have to wait generations, but sometimes we do have to wait years at a time.
Our time horizon is approximately five years. We have low turnover in the portfolios, about 20 percent. We have businesses that we've held for well over a decade in the portfolio. So, while many of our competitors in the marketplace are trying to zig and zag ahead of every market development that they hope they can forecast with scientific precision, we sail a very steady course. We like to watch the trees grow, and that's quite different from most. We have the patience to be short social acceptance for sometimes extended periods of time.
…
However, we don't just look at price. We're very focused on trying to get our arms around the stock of imbalances in the world, whether it's the growth in the role of the government in the economy with deficits and budget spending going up relative to historical levels; whether it's the structure of the world's currency reserve system and the current account and balances that it produces; whether it's the increasing cost of the marginal barrel of oil from an extraction standpoint or the prospect of higher carbon taxes going forward creating higher energy prices.
Whether it's variables of this nature or others, we focus not just on price but on imbalances. If price were our only guiding light, perhaps we would have been 90 percent invested at the troughs, but we've prudently allocated capital and we have taken our time. We got out of Japan in the late 1980s and did not come back until the mid 1990s. But net/net, from a portfolio standpoint, we are more fully invested today than we were in 2007. For those of you who have followed us for some time, you would expect that kind of behavior from us.
The second thing is, if you look beneath the surface and think about where the portfolio is positioned, some of the biggest weightings in the portfolio are in areas where the excesses were not. Japan is one of the things that we've spoken about frequently. When we invest in Japan, we're not investing in Japan because we're making a specific macro call on the Ministry of Finance having the right policy mix. We're not making a specific call on a change in the lower house in a September election coming up this year in Japan. It's not a macro-based call, per se; it's the fact that, after two decades of deflation and a market that's gone down by about 80 percent from its peak, we have found a large number of very resilient businesses at very low prices run by conservative management teams. If you come back to our criteria from a bottom-up standpoint we have found a number of opportunities.
Rarely will you see a swing-for-the-fences type portfolio construction. We have a very good balance within the portfolio between businesses that are royalty-like businesses that could participate with pricing power in a world of higher inflation and the market position to preserve their earnings power in a time of deflation. And we have more traditional Ben Graham style runoff businesses that are just cheap relative to liquidation value. If you're thinking about trying to preserve capital long-term, the ownership of royalty- like businesses at low prices or mundane businesses at a discount to liquidation value is a pretty good place to start: real assets at real prices.
……….
Jean-Marie Eveillard – Excerpts:
Now, the authorities were kind of slow in noticing that we were at the beginning of a major financial crisis. Indeed, Mr. Bemanke, the Chairman of the Fed, in late 2005 or 2006, publicly said that residential real estate in the U.S. was not in a bubble at all, and residential real estate prices had gone up because of the inherent strength of the American economy.
When somebody at a high level says something truly stupid, you have to wonder whether he's just being stupid or whether he's lying through his teeth. He knows that there is a bubble, but he doesn't want to say so for political reasons or to not dent the confidence of the public. So, most of the time, those people in high places, it's not that they are stupid, but they are acting in bad faith.
And indeed, Larry Summers in 2005 at the summer meeting, which the Fed organizes in Jackson Hole, Wyoming, a lesser known economist presented a paper that said there was trouble brewing and that a financial crisis might be around the corner. Larry Summers immediately ridiculed the poor fellow. So, neither Mr. Bemanke nor Mr. Summers saw the crisis coming.
Once the authorities could see that it was a major financial crisis, they have three ways to go. The first possibility was immediately discarded. That's what the Austrians were talking about, "Hey, there are major excesses in the system. They have to be purged." To purge the excesses at that stage would have resulted in a return to the Great Depression. It's not just a matter of the politicians liking the idea of being re-elected, but they would not like their name in the history books saying they were responsible for a return to the Great Depression. Inflation is bad but deflation is worse. So, there was no consideration whatsoever given to the idea of purging the excesses.
The second possibility was similar to what happened in Japan in the '90s after their gigantic credit bubble. The Japanese managed to avoid, after a gigantic credit bubble, a real estate credit bubble, which resulted in almost unimaginable real estate prices and abusively high stock prices. Then the double bubble burst in late 1989 and the Japanese managed to avoid a return to the Great Depression, but had economic stagnation for 10 years. American economists, including Mr. Bernanke, heavily criticized the Japanese, saying the Japanese government and central bank really botched it and their policies were miserable. My own impression is that there were policy mistakes. Everybody makes mistakes, but if the Japanese policymakers did not make mistakes, they would have had to settle for five years of economic stagnation instead of ten. In essence, there is always a price to be paid, in life as well as in finance, for the mistakes one makes.
The third way to go was full speed ahead, "Damn the torpedoes," what the French call, the flight forward. Both Mr. Obama and Mr. Bernanke used the expression, "We will do whatever it takes," to get the economy going again as soon as possible. Let's fight the deleveraging process every step of the way, let's get credit expansion going again, let's have the banks lend. It was a combination of monetary and fiscal steps, some of them unorthodox. The monetary steps taken by the Fed had never been taken before since the Fed was created in 1913. Not only did the Fed take short-term interest rates down to practically zero very quickly, but they also engaged in quantitative easing, which is code for printing new money as quickly as possible. On the fiscal side, we're talking about a budget deficit of close to $2 trillion. Mr. Obama has already indicated that it is not just this year that the budget deficit would be gigantic, but also for several years afterwards.
Jim Grant, who writes a very interesting newsletter, has estimated that the monetary and fiscal stimulus put in place, is 10 times as big as the average stimulus during recession in the post-World War II period. I believe that it's likely, although nothing is certain, that the economy will stabilize at some point and economic recovery will begin as a result of the enormous stimulus plan.
The key question that remains is, once the economic recovery begins, will we get a recovery which is along the lines of the typical post-World War II economic recovery? After a major recession goes on for three to five years, will the economic recovery peter out quickly and go into stagnation? People talk about the paradox of savings. If you and I save, that's fine, but if the entire U.S. population starts saving, that's not good for the economy because it has an impact on consumer spending.
There is also a paradox of debt. If too much debt has been the problem, which I think it has been to a large extent, then how can adding debt on debt be the cure? The government is adding debt on debt by saying the banks have to lend again.
There is also the possibility of unintended consequences. The government and the central bank are perfectly aware that there are possible unintended consequences. But politicians tend to address today's question and if there are negative unintended consequences of today's policies, then they will have to address the problem one or two years down the road. Among the possible unintended consequences of the extremely unorthodox monetary and fiscal steps is the possibility that the dollar goes into a disorderly decline and inflation appears because of the current policies. There is no doubt that the policies are potentially widely inflationary.
The Fed is aware of this and will pull some of that extra liquidity out of the system once the economy is doing better. There are also timing problems in preventing inflation from really taking off. If Mr. Bernanke tries to pull the extra liquidity out of the system when unemployment is still high and the economy has only been improving over a short period of time, politicians will scream, "Let the good times roll," not realizing that the good times may be inflationary. Another possible unintended consequence is that Treasury note and bond yields would start going up, complicating the task of the government and the Fed considerably.
…
I do not believe that deflation would be a problem with the stimulus in place, and if necessary, there will be more stimulus put in place. The current stimulus is enough so that the economy will stabilize and start recovering. Some people say stocks are not as cheap as they were in 1974 and 1982, which is admittedly true, but at the same time, there is much less competition today from cash and treasury bonds than there was then. If I owned treasury notes or bond, I wouldn't sleep too well at night. To some extent they are an accident waiting to happen.
………………..
Related paper: William White: Is price stability enough? – April 2006
Mathew McLennan – Excerpts:
Our goal is, first and foremost, to preserve capital, and then, and only then, to grow capital over time. I say over time and I say in an uncertain world because when people think about the preservation of capital they often confuse the preservation of capital with the ownership of cash and short-dated government securities.
…
When it comes to temperament, one of the things that's striking if you read any history is that human nature has changed much less than human know-how. In fact, if you go all the way back to the first recorded and reliable history that we can find, you'd probably start with a Greek author by the name of Thucydides. He wrote a history of the Peloponnesian war between Athens and Sparta. He quotes the speeches of the leading luminaries of the time as the tensions mounted between the Athenians and the Spartans. And you see, almost in a real-time sense how the mistakes played out, where the strife came from, how the war originated and there were certain recurring patterns in the nature of the key players in that time that led to problems; hubris, dogma and haste. Then, if you follow history from that point and you look at the turning points of key global crises, whether military or economic in nature, there are recurring themes in human nature that gets us into trouble; hubris, dogma and haste.
We have based our approach to investing around temperament, which is the symmetrical opposite of that; humility, flexibility and patience. Our ultimate objective as stewards of your capital and your clients' capital is to spend money wisely and that requires those three variables.
Firstly, humility. One of the things that Jean-Marie has always said and has been firmly ingrained in our culture is that the future is uncertain. It's the acceptance that the future is uncertain that distinguishes us from most. When you speak to most money managers, they will give you a very definitive view on what's going to happen, where inflation's going to be in six months' time, whether the S&P's going to be 1200 or 600, whether long-term bond yields are going to be 3.7 or 2.3 percent. We acknowledge that our crystal ball is foggy at best, and when you have the humility to accept that the future is an ocean of possibilities, it actually frees the mind to invest in a different way. Rather than saying this is my view of the future and I'm going to bet everything on this, you take a different perspective. In fact, you follow the advice of Ben Graham and you invest to avoid the landmines.
We seek a multifaceted margin of safety in every investment that we make. We like low prices. We don't want to pay for the future potential in a situation. We like to invest alongside prudent people. We prefer management teams that have grown their balance sheets at a conservative pace, that haven't financed with a lot of short-term leverage and that are good stewards of their shareholders' capital. We like resilient business platforms; businesses that are not only well-capitalized, but have something special about their market position in terms of their pricing power, their position on a cost curve, their entrenchment with a customer and their local scale economies. We look for a combination of variables.
I think there are two things that got a lot of value investors into trouble in 2008. Number one was a very definitive view about how the future was going to play out and, therefore, a doubling-down; and secondly, a one-dimensional margin of safety focusing solely on price as opposed to balancing the behavior of people and looking at the quality of the businesses that are being invested. In a nutshell, we recognize that we can't predict the future with precision so we look to buy good businesses at good prices or mundane businesses at compelling prices. That's at the core of what we do.
…
One of the other things that you see in the world of mutual funds is this belief that one has to be fully invested at all times. Again, this is an area where we perhaps differ from most. We've always been willing to have some amount of deferred purchasing power in the portfolio. Cash for us is a residual of the investment process. If we can't find good businesses at good prices then the cash builds. If, on the other hand, we see a relative abundance of good opportunities to invest in enterprise, the cash levels come down.
Seth Klarman said something revealing. He said that most money managers think that in order to earn their keep, they have to work your money aggressively. He said we think of money management almost as being like a couch potato; ultimately you only want to put things to work when you see very good opportunities, and you should have the patience to sit on it.
A decent part of the cash position we've held in gold historically. Gold for us is a form of insurance. We live in a world where there have been many changing currency regimes over time, yet gold has been a store of value that has been in existence for centuries. When the pharaohs' tombs are uncovered you see the gold on the pharaohs. We see gold coins taken up from shipwrecks from hundreds of years ago still in good form. Why is it that gold was a store value? Well, gold as a metal has special properties. Its density means that it's very easily stored relative to most other commodities. If you're going to store a real asset you want it to be relatively dense so it doesn't cost you much to store it. Secondly, the history of gold shows that a distinguishing property versus other more commodity-like metals is that it is not used predominantly in industrial applications because it's relatively chemically inert. That chemical inertia means that it doesn't rot or waste, but it also means the cumulative stock of gold is still in existence and the supply of gold is both stable and scarce. So, if something is in stable supply, scarce, lasts forever and is easily stored, there's a reason why it has been a store of value over time. Gold is not risk free. It goes through large price cycles. We've had the flexibility to hold gold as a source of insurance and it's served our clients well over time.
In addition to humility and flexibility, the third thing in terms of our temperament that is very different from most is patience. We grow up in a world where we tend to think in an annual cycle time. You go through school, you go from grade to grade, you get your first job, you get an annual assessment every year. Yet in many fields the natural cycle time is quite different from a year. It's quite long in the case of many fields, art at one extreme. If you're a great artist existing on the meniscus of perception, it may be generations before your work is appreciated. Fortunately as value investors, we perhaps don't have to wait generations, but sometimes we do have to wait years at a time.
Our time horizon is approximately five years. We have low turnover in the portfolios, about 20 percent. We have businesses that we've held for well over a decade in the portfolio. So, while many of our competitors in the marketplace are trying to zig and zag ahead of every market development that they hope they can forecast with scientific precision, we sail a very steady course. We like to watch the trees grow, and that's quite different from most. We have the patience to be short social acceptance for sometimes extended periods of time.
…
However, we don't just look at price. We're very focused on trying to get our arms around the stock of imbalances in the world, whether it's the growth in the role of the government in the economy with deficits and budget spending going up relative to historical levels; whether it's the structure of the world's currency reserve system and the current account and balances that it produces; whether it's the increasing cost of the marginal barrel of oil from an extraction standpoint or the prospect of higher carbon taxes going forward creating higher energy prices.
Whether it's variables of this nature or others, we focus not just on price but on imbalances. If price were our only guiding light, perhaps we would have been 90 percent invested at the troughs, but we've prudently allocated capital and we have taken our time. We got out of Japan in the late 1980s and did not come back until the mid 1990s. But net/net, from a portfolio standpoint, we are more fully invested today than we were in 2007. For those of you who have followed us for some time, you would expect that kind of behavior from us.
The second thing is, if you look beneath the surface and think about where the portfolio is positioned, some of the biggest weightings in the portfolio are in areas where the excesses were not. Japan is one of the things that we've spoken about frequently. When we invest in Japan, we're not investing in Japan because we're making a specific macro call on the Ministry of Finance having the right policy mix. We're not making a specific call on a change in the lower house in a September election coming up this year in Japan. It's not a macro-based call, per se; it's the fact that, after two decades of deflation and a market that's gone down by about 80 percent from its peak, we have found a large number of very resilient businesses at very low prices run by conservative management teams. If you come back to our criteria from a bottom-up standpoint we have found a number of opportunities.
Rarely will you see a swing-for-the-fences type portfolio construction. We have a very good balance within the portfolio between businesses that are royalty-like businesses that could participate with pricing power in a world of higher inflation and the market position to preserve their earnings power in a time of deflation. And we have more traditional Ben Graham style runoff businesses that are just cheap relative to liquidation value. If you're thinking about trying to preserve capital long-term, the ownership of royalty- like businesses at low prices or mundane businesses at a discount to liquidation value is a pretty good place to start: real assets at real prices.
……….
Jean-Marie Eveillard – Excerpts:
Now, the authorities were kind of slow in noticing that we were at the beginning of a major financial crisis. Indeed, Mr. Bemanke, the Chairman of the Fed, in late 2005 or 2006, publicly said that residential real estate in the U.S. was not in a bubble at all, and residential real estate prices had gone up because of the inherent strength of the American economy.
When somebody at a high level says something truly stupid, you have to wonder whether he's just being stupid or whether he's lying through his teeth. He knows that there is a bubble, but he doesn't want to say so for political reasons or to not dent the confidence of the public. So, most of the time, those people in high places, it's not that they are stupid, but they are acting in bad faith.
And indeed, Larry Summers in 2005 at the summer meeting, which the Fed organizes in Jackson Hole, Wyoming, a lesser known economist presented a paper that said there was trouble brewing and that a financial crisis might be around the corner. Larry Summers immediately ridiculed the poor fellow. So, neither Mr. Bemanke nor Mr. Summers saw the crisis coming.
Once the authorities could see that it was a major financial crisis, they have three ways to go. The first possibility was immediately discarded. That's what the Austrians were talking about, "Hey, there are major excesses in the system. They have to be purged." To purge the excesses at that stage would have resulted in a return to the Great Depression. It's not just a matter of the politicians liking the idea of being re-elected, but they would not like their name in the history books saying they were responsible for a return to the Great Depression. Inflation is bad but deflation is worse. So, there was no consideration whatsoever given to the idea of purging the excesses.
The second possibility was similar to what happened in Japan in the '90s after their gigantic credit bubble. The Japanese managed to avoid, after a gigantic credit bubble, a real estate credit bubble, which resulted in almost unimaginable real estate prices and abusively high stock prices. Then the double bubble burst in late 1989 and the Japanese managed to avoid a return to the Great Depression, but had economic stagnation for 10 years. American economists, including Mr. Bernanke, heavily criticized the Japanese, saying the Japanese government and central bank really botched it and their policies were miserable. My own impression is that there were policy mistakes. Everybody makes mistakes, but if the Japanese policymakers did not make mistakes, they would have had to settle for five years of economic stagnation instead of ten. In essence, there is always a price to be paid, in life as well as in finance, for the mistakes one makes.
The third way to go was full speed ahead, "Damn the torpedoes," what the French call, the flight forward. Both Mr. Obama and Mr. Bernanke used the expression, "We will do whatever it takes," to get the economy going again as soon as possible. Let's fight the deleveraging process every step of the way, let's get credit expansion going again, let's have the banks lend. It was a combination of monetary and fiscal steps, some of them unorthodox. The monetary steps taken by the Fed had never been taken before since the Fed was created in 1913. Not only did the Fed take short-term interest rates down to practically zero very quickly, but they also engaged in quantitative easing, which is code for printing new money as quickly as possible. On the fiscal side, we're talking about a budget deficit of close to $2 trillion. Mr. Obama has already indicated that it is not just this year that the budget deficit would be gigantic, but also for several years afterwards.
Jim Grant, who writes a very interesting newsletter, has estimated that the monetary and fiscal stimulus put in place, is 10 times as big as the average stimulus during recession in the post-World War II period. I believe that it's likely, although nothing is certain, that the economy will stabilize at some point and economic recovery will begin as a result of the enormous stimulus plan.
The key question that remains is, once the economic recovery begins, will we get a recovery which is along the lines of the typical post-World War II economic recovery? After a major recession goes on for three to five years, will the economic recovery peter out quickly and go into stagnation? People talk about the paradox of savings. If you and I save, that's fine, but if the entire U.S. population starts saving, that's not good for the economy because it has an impact on consumer spending.
There is also a paradox of debt. If too much debt has been the problem, which I think it has been to a large extent, then how can adding debt on debt be the cure? The government is adding debt on debt by saying the banks have to lend again.
There is also the possibility of unintended consequences. The government and the central bank are perfectly aware that there are possible unintended consequences. But politicians tend to address today's question and if there are negative unintended consequences of today's policies, then they will have to address the problem one or two years down the road. Among the possible unintended consequences of the extremely unorthodox monetary and fiscal steps is the possibility that the dollar goes into a disorderly decline and inflation appears because of the current policies. There is no doubt that the policies are potentially widely inflationary.
The Fed is aware of this and will pull some of that extra liquidity out of the system once the economy is doing better. There are also timing problems in preventing inflation from really taking off. If Mr. Bernanke tries to pull the extra liquidity out of the system when unemployment is still high and the economy has only been improving over a short period of time, politicians will scream, "Let the good times roll," not realizing that the good times may be inflationary. Another possible unintended consequence is that Treasury note and bond yields would start going up, complicating the task of the government and the Fed considerably.
…
I do not believe that deflation would be a problem with the stimulus in place, and if necessary, there will be more stimulus put in place. The current stimulus is enough so that the economy will stabilize and start recovering. Some people say stocks are not as cheap as they were in 1974 and 1982, which is admittedly true, but at the same time, there is much less competition today from cash and treasury bonds than there was then. If I owned treasury notes or bond, I wouldn't sleep too well at night. To some extent they are an accident waiting to happen.
………………..
Related paper: William White: Is price stability enough? – April 2006