Manual of Ideas - Exclusive Interview with Tom Gayner

This Monday, April 6th, the Manual of Ideas will publish an exclusive interview with Thomas S. Gayner, Chief Investment Officer of Markel Corporation (NYSE: MKL). The interview will cover Tom's views on a wide range of topics, including 

• his investment approach,
  
• his outlook for international investing,
  
• the single biggest mistake that keeps investors from reaching their goals,
  
• the conflicts created by the extreme separation of ownership and control,
  
• whether he is a bull or bear right now,
  
• and many other subjects of interest to equity investors.

The interview will be available at midnight, April 6th at www.manualofideas.com.

Here is a brief excerpt:

MOI:  You have stated that the businesses you seek should have (1) a demonstrated record of profitability and good returns on total capital, (2) high measures of talent and integrity in management, (3) favorable reinvestment dynamics over time, and (4) a purchase price that is fair or better.  Perfection, however, is rarely attainable in the stock market.  Have you had to compromise on these criteria, and if so, could you illuminate for us how you decide on acceptable versus unacceptable trade-offs?

Tom Gayner: While you say that perfection is rarely obtainable in the stock market, I would go so far as to say that it is never obtainable in the stock market. Perfection doesn't exist in this world. All of my choices involve various degrees of compromise and trade offs. As an accountant, I can tell you that my wife and children are sick of hearing me use the phrase "opportunity cost". Every decision is also another decision (at least) and every non-decision is also a series of other decisions.

The challenge is to get the balance roughly right between the choices that actually exist. All of the 4 points I lay out are north stars that guide me. I admit though, that I have never personally been to the North Pole.

The one area where I will not compromise is in the area of integrity. I may not make every judgment correctly when I'm trying to make sure I'm dealing with people of integrity but I will never knowingly entrust money to people when I am concerned about their integrity. Even if you get everything else right, the integrity factor can kill you. My father used to tell me that, "you can't do a good deal with a bad person." And he was right.

The other factors can be thought of as shades of gray and nuances. We look for as much of the good as we can find and weigh that against what we have to pay for it, our expectation of how durable the business will be, and what our other alternatives are. I don't have a formula or algorithm to get that precisely right, I just spend all my time thinking, reading, and adapting as best as I can.

Link: manualofideas.com

Wesco Financial 2008 Letter

The worldwide economy is currently suffering the effects of a deepening recession, perhaps the worst economic disaster since the Great Depression. We will not attempt to prognosticate the effects that Wesco will suffer or when the economy will recover, but we are certain that in due course, Wesco will prosper. In the mean time, Wesco’s operations will bear their share of economic woes. We will continue to practice Ben Franklin’s advice, that “a penny saved is a penny earned,” as we trim expenses, albeit in higher denominations, to better endure the weakening economic conditions that surely lie ahead.

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Related previous post: Wesco Financial 1990 Letter

Fairholme Fund March 30th Conference Call on Pfizer

Pfizer CEO Jeffrey Kindler joined Bruce Berkowitz, Fairholme Capital Management's Chief Investment Officer, for a Conversation with Bruce

Click here for access to the Conference Call

Nathan Wolfe: Hunting the next killer virus

Charlie Rose Show: Tom Friedman and Nandan Nilekani Discuss India and Globalization

John Wooden: Coaching for people, not points

Thanks to Miguel for spotting this talk on TED!

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Related links:

Coach Wooden's Official Website

Pyramid of Success

Book mentioned in Poor Charlie's Almanack:

Be Quick But Don't Hurry

Influence in the Madoff Case

Before getting to the two articles below, consider this quote from Warren Buffett:

“An argument is made that there are just too many question marks about the near future; wouldn’t it be better to wait until things clear up a bit? You know the prose: “Maintain buying reserves until current uncertainties are resolved,” etc. Before reaching for that crutch, face up to two unpleasant facts: The future is never clear and you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.”

Keep that in mind as you read through the articles and/or Robert’s Cialdini’s book, Influence. Uncertainty in investing can lead to attractive buying opportunities (per Buffett’s quote), but it is also a factor that leads to bad decision making, both on the conscious and subconscious level. That also reminds me of a quote from Ben Graham:

“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”

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You don’t have to be a Dupe to be Duped: Lessons from the Madoff Affair
By Dr. Robert Cialdini

The Power of Persuasion under Conditions of Uncertainty

Under conditions of uncertainty like those Madoff cultivated, a pair of principles of social influence gain special traction: Authority and Social Proof. Let’s take each in turn and examine how they were commissioned by Madoff to advance his persuasive success.

Authority. When people are uncertain of what to do, they don’t look inside themselves for answers; all they’ll see there is vexing ambiguity. Instead, they look outside. One prominent place they look is to the counsel of experts, credible authorities on the topic. And, by any measure, Bernard Madoff certainly had the look of a credible authority in financial matters. He possessed expert credentials from long years in the investment industry. After starting his firm in 1960, he grew it into a juggernaut that was reported to be the largest dealer in NYSE-listed stocks in the United States. His firm helped to develop the NASDAQ, where he served as Chairman of the Board of Directors and where Madoff Securities became the exchange’s largest market-maker. Beyond expertise, Madoff spent substantial time and money establishing a reputation for possessing the second element of credible authority—trustworthiness. He was active in an organization oriented to the self-regulation of the securities industry, the National Association of Securities Dealers, and even sat on its Board of Governors. Moreover, he was widely known for his good heart via multiple charitable and philanthropic involvements.

Against such a backdrop, we can begin to understand why so many knowledgeable and experienced financial professionals followed Mr. Madoff down the garden path. Under conditions of uncertainty, they did not look inside (to their own knowledge and experience) for direction. They looked outside to credible authorities on the topic. And, there were few on the murky topic of derivative-based hedge funds more credible than Bernie Madoff.

Social Proof. Besides authorities, do people seek any other source of external information when uncertain of how to choose? They do. They look to—and then follow—what most people just like them are doing. Here, the proof of a correct choice isn’t based on knowledge or logic or empirical evidence; it’s based on social evidence of what one’s peers and those in one’s social network have decided to do. For instance, if the evidence were clear that your friends and coworkers were flocking to a new restaurant for lunch, you’d likely follow suit. At developing, honing, and providing this kind of social evidence, the Madoff client recruitment program had few equals. Madoff is Jewish, and so, too, are the majority of his victims, who were often recruited at country clubs by Madoff’s lieutenants, who were also Jewish and also members of the same country clubs. Plus, new recruits knew and were similar to past recruits, who served as unwitting sources of social proof that an investment with Madoff must be a wise choice “for someone like me.” Of course, fraud of this sort is hardly limited to one ethnic or religious group. Called affinity schemes, these investment scams have always involved members of a group preying on other members of the group—Baptists on Baptists, Hispanics on Hispanics, Armenian-Americans on Armenian-Americans. Indeed, Charles Ponzi, who gave his name to the infamous Ponzi scheme that Madoff copied, was an Italian immigrant to the U.S. who fleeced other Italian immigrants to the U.S.

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The Bernard Madoff Case: Trust Takes Another Blow
Knowledge@Wharton

Knowledge at Wharton: Why is it that even sophisticated investors are being snookered in Ponzi schemes, still?

Maurice Schweitzer: The Madoff scandal is a story about several powerful influence principles working in concert. These are textbook principles. And in this case, you have four that are key. One is scarcity, where investors were told, "The fund is closed. But maybe I can get you in." It was exclusive, and there were some clients that got fired [because they asked too many questions]. The second key principle is authority. Madoff was somebody who in 1990 was the chair of NASDAQ. He pioneered electronic trading. He was a board member. He had this air of authority. And we know from the Milgram experiments and other studies that authority figures exert a huge amount of influence over us. Third, social proof. Everyone's doing it. From the Abu Dhabi Investment Authority to Line Capital of Singapore, to Stephen Spielberg and the owner of the New York Mets. You look around and everybody else is investing here. It seems like a reasonable thing to do. And fourth, the liking principle. We're influenced by people that we like. And here, social networks, meetings in country clubs, the charity events -- this is what brought people in. So you have in concert these four classic influence principles working together. And on the other hand, you have motivated reasoning. You have these investors who want to believe. They want to believe that they can earn the 10%, 11% interest, like clockwork. So they're willing to suspend their disbelief. And I think we failed to realize how powerful all of these factors are, when they work together.
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Adam Smith, Behavioral Economist

From the Journal of Economic Perspectives – Summer 2005

In The Wealth of Nations, published in 1776, Adam Smith famously argued that economic behavior was motivated by self-interest. But 17 years earlier in 1759, Smith had proposed a theory of human behavior that looks anything but self-interested. In his first book, The Theory of Moral Sentiments, Smith argued that behavior was determined by the struggle between what Smith termed the “passions” and the “impartial spectator.” The passions included drives such as hunger and sex, emotions such as fear and anger, and motivational feeling states such as pain. Smith viewed behavior as under the direct control of the passions, but believed that people could override passion-driven behavior by viewing their own behavior from the perspective of an outsider—the impartial spectator—a “moral hector who, looking over the shoulder of the economic man, scrutinizes every move he makes” (Grampp, 1948, p. 317)

The “impartial spectator” plays many roles in The Theory of Moral Sentiments. When it comes to choices that involve short-term gratification but long-term costs, the impartial spectator serves as the source of “self-denial, of self-government, of that command of the passions which subjects all the movements of our nature to what our own dignity and honour, and the propriety of our own conduct, require” (Smith, 1759 [1981], I, i, v, 26), much like a farsighted “planner” entering into conflict with short-sighted “doers” (Shefrin and Thaler, 1981). In social situations, the impartial spectator plays the role of a conscience, dispassionately weighing the conflicting needs of different persons. Smith (I, i, v, 29) recognized, however, that the impartial spectator could be led astray or rendered impotent by sufficiently intense passions: “There are some situations which bear so hard upon human nature that the greatest degree of self-government . . . is not able to stifle, altogether, the voice of human weakness, or reduce the violence of the passions to that pitch of moderation, in which the impartial spectator can entirely enter into them.”

Adam Smith’s psychological perspective in The Theory of Moral Sentiments is remarkably similar to “dual-process” frameworks advanced by psychologists (for example, Kirkpatrick and Epstein, 1992; Sloman, 1996; Metcalfe and Mischel, 1999), neuroscientists (Damasio, 1994; LeDoux, 1996; Panksepp, 1998) and more recently by behavioral economists, based on behavioral data and detailed observations of brain functioning (Bernheim and Rangel, 2004; Benhabib and Bisin, 2004; Fudenberg and Levine, 2004; Loewenstein and O’Donoghue, 2004). It also anticipates a wide range of insights regarding phenomena such as loss aversion, willpower and fairness (V. Smith, 1998) that have been the focus of modern behavioral economics (see Camerer and Loewenstein, 2004, for a recent review). The purpose of this essay is to draw attention to some of these connections. Indeed, as we propose at the end of the paper, The Theory of Moral Sentiments suggests promising directions for economic research that have not yet been exploited.

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Related books:

The Theory of Moral Sentiments

The Wealth of Nations

The Authentic Adam Smith: His Life and Ideas
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No Safety in Numbers - By Roger Lowenstein

Is there such a thing left as a safe investment? Stocks have been massacred, real estate all but wiped out. Each was promoted in its day — as was gold — as safe and secure, appropriate for widows and orphans.

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If there is a truly last bastion of safety, it would be, of course, the U.S. Treasury bond, that venerable instrument with the full faith and credit of the United States behind it. Perhaps it is esteemed so highly because we think of it not as an “investment” per se but as an article of faith in Washington and, by extension, the entire country. It is our tax dollars, after all, that stand behind it — the accumulated output of our citizens. And ever since the Wall Street meltdown, as investors have fled from any security carrying a whiff of danger, Treasuries have been in hot demand.

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So it is an eye-opener, and rather depressing, to report that even Treasuries bear risk, in particular, the risk that flows from crowd psychology. Last month, in his annual letter to shareholders (of which I am one), Warren Buffett wrote: “When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.”

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Related link: Warren Buffett's 2008 Letter to the Shareholders of Berkshire Hathaway Inc.

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GR-NEAM Reflections: Investing With Leviathan

The monthly publication written by John Gilbert, CIO, GR-NEAM (General Re-New England Asset Management).

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Summary: The scale and complexity of governments' responses to the financial crisis is very large. While it is early to tell, it may increase the role of policy anticipation in investment analysis. Participants in the Chinese stock market have behaved that way all along.

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Link to past issues: HERE

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