Keep a Calm Head in Battle

Dan WilliamsDan Williams, CFP, Investment Analyst

The Battle of Thermopylae, dramatized in the 2007 movie 300, is the story of how a relatively small group of 7,000 disciplined Greeks in 480 B.C. held off a group of 100,000-150,000 invading Persians for three days. Due to the size disadvantage of the Greeks, their eventual defeat at this battle was inevitable. However, this group kept a calm head in battle while the Persian leader Xerxes was said to become so enraged by the delay these Greeks had caused his army that at the battle’s conclusion, he decapitated and crucified King Leonidas of Sparta, the fallen hero of the Greeks, elevating his status as a martyr. While the Greeks lost this battle, at the Battle of Plataea in 479 B.C. the Greek forces won the war. The manifestation of this Greek discipline was the Phalanx formation which lined up troops in close order to form a shield wall defense that marched forward using spears to take down any army in front of them. Given that the Phalanx was only as good as the weakest point, discipline was crucial to its success. This concept was later further refined and improved upon by the Roman legions that used it to great effect to build their empire.

shutterstock_141582367_collegeMay and June mark the end of another school year and the arrival of almost 20 college interns to Brinker Capital. These college students, the most successful not being strangers to discipline, have been exposed to the science of investing in their college courses but have come to Brinker in many cases to help fill the gaps regarding the art of how to identify good investment strategies. To help lay the groundwork for this understanding, we encouraged them to read Money Masters of Our Time by John Train, a book profiling 17 different investment managers of the 20th century.

While all investment managers have proven successful, there was no one right process identified. T. Rowe Price had a process of identifying leaders in very fertile growth areas and holding them long-term until they become mature businesses in a mature industry. Benjamin Graham on the other hand focused on systematically buying the stocks that were thrown away at less than two-thirds of their net current assets and selling once they returned close to intrinsic value. Warren Buffet took a Benjamin Graham initial approach to valuation but then overlaid it with attention given the quality of the businesses and patience to hold these higher quality companies long-term like T. Rowe Price. John Templeton brought a similar attention to valuation and patience but was more willing to go global to find his bargains. George Soros went global as well but speculated more than invested with much more frequent trading in an effort to time the market. This is just to name some of the “money masters” this book discusses.

shutterstock_38215948-soldiersIt is clear that, although all of these managers have been very successful on their own, if hypothetically a super investment management team was able to be formed with these members, the fund would likely suffer from way too many and way too different processes. Like an army with too many generals, having more leaders is not always better. The only element that they seemed to have in common is the fact that they had processes in place that were fundamentally sound and that they stuck to in times of short-term market stress. Some ignored the market swings, some used it as buying opportunities, but all found success by putting their emotions in check when many market participants were caught up in fear or greed. In other words, they had discipline. Like a Roman Phalanx facing down an enemy, a steadfast commitment to a sound plan in the heat of the battle wins the day more often than not.

As such when we evaluate managers this is exactly what we look for. That is to say we need managers to have an effective, sustainable, and proven investment plan and ability to stick to the plan. Much has been made of how individual investors chase performance in good times and break rank at exactly the wrong time in times of stress. While very few of us will prove to be as successful as Warren Buffet, if we can all strive to at least have a plan and stand our ground to keep emotions out of investment decisions we all can be better off.

Technology Watch: Investing Into The Future

Dan WilliamsDan Williams, CFP, Investment Analyst

I recently had the opportunity to attend a conference that centered on the big ideas in technology happening right now. Hearing from such people as Andrew McAfee (author of the 2012 book Race Against the Machine and his most recent The Second Machine Age), Steven Kotler (author of Abundance: The Future Is Better Than You Think), and Charles Songhurst (former Head of Corporate Strategy at Microsoft), I can make a few blanket statements.

First, these guys are humbled, awestruck, and blown away by the advances being made in technology; specifically in robotics, 3D printers, and in general computing power. Second, the individual and the consumer will be empowered by this technology. Lastly, don’t try to pick the winning company, rather win by picking the area as a whole.

3D PrintingThis last point may seem to some as a “coward’s way out”, but consider the CNN Money article from December 31, 1998, Year of the Internet Stock. In this article Amazon, eBay, AOL, TheGlobe.com, Cyberian Outpost, and a few other names that have since been lost to history, are listed as stocks that had a great year and are part of the revolution. In the 15 years (1/1/1999 to 12/31/2013) following this article, Amazon and eBay clearly have proven to be the winners among the group, returning a cumulative return of 644.81% and 445.81% respectively as the others essentially went to zero. However, if you broaden the technology space, Apple would have been the big winner with an astonishing 5,569.77% cumulative return for this 15-year period. In other words, the idea that the internet was going to be a game changer in the way we communicate and the technologies we use was right, but our clever execution by picking the few likely winners likely would have missed the boat.

Now, let’s fast forward to today as we stare upon a robotic and biotech revolution. While there are a few select names that seem to be the smart bets to land among the big winners—given the magnitude of impact these two areas will have on the way we live and the uncertainty in the specifics of the path this change will actually take—picking an individual winner involves a level of hubris, while diversification within this idea can add value.

Future of TechnologyI left the conference fully convinced that these concepts, both current and future, are going to change the world; however, I remain very cautious regarding the execution and process. Without giving any type of recommendation, there exists at least half a dozen Biotech-focused ETFs. Late last year, the first robotics-focused ETF (ROBO) was launched—and it won’t be the last. All of these are less exciting answers to investing in new technologies versus trying to pick the winner, but as the American poet Ogden Nash once wrote, “Too clever is dumb.”

An Ode to Barnes & Noble

Dan WilliamsDan Williams, CFP, Investment Analyst , Brinker Capital

On July 8, 2013 the CEO of Barnes & Noble, William Lynch, abruptly resigned. His rise and fall were tied largely in part to his belief that the future of B&N was in its NOOK digital reader. Lynch also felt that being a brick-and-mortar business would overcome the technology headwind of competing with Google, Amazon, and Apple on their turf, the tablet space. In fairness, he is likely right that people do derive a lot of benefit from being able to physically visit their book store. Still the struggle for B&N, and Borders prior to their demise, seems to be compensation for this social benefit. Now the debate is whether the physical book stores can survive in the Amazon age. In my biased opinion, I believe the answer is yes.

8.1.13_Williams_BookstoresTo say that I am a regular at my local B&N is an understatement. Over my career, I have studied for various FINRA licenses, the CFP designation, and all three levels of the CFA exams. The vast majority of this studying was done at my local B&N. On the rare occasions when I did not have anything to study for, I could not help but continue to go to B&N as it had become such a part of my life. This amounts to a total of about ten years of trips to my local B&N, usually multiple times per week. During this time, I have witnessed a lot of life from my table in the crowded B&N café.  From college interviews, job interviews, dates, people doing quasi-library research (most often on vacation destinations) and people who are clearly looking at books to purchase—of course, not at B&N, but later at a discount from Amazon.com. You can see them all at B&N. And for the most part, these people did not purchase anything from B&N outside of the food items in the cafe. It was fairly typical for me to spend three to four hours on a Saturday studying but only purchase an iced tea and a sandwich. Often, I would grab a new book off the shelf to read, and often I would end up reading a whole book without ever taking it out of the store. It is clear the store was being used less as a place for B&N to sell books and more like a community center or an improved library.

This social benefit of this institution is echoed by Lydia DePillis in her July 10, 2013 Washington Post article “Barnes & Noble’s troubles don’t show why bookstores are doomed. They show how they’ll survive” when she notes:

8.1.13_Williams_Bookstores_2“Here’s the thing: Bookstores, more so than movie rental and record stores, are oases in the middle of cities (and even in suburban malls). We go there to kill time, expose ourselves to new stuff, look for a gift without something specific in mind, and maybe pick up something on impulse while we’re there. Even Borders’ disorganized warehouses left holes in the urban fabric when they disappeared, and Barnes and Nobles would do the same–they’re a kind of public good, at a time when the public is getting less good at supporting libraries.”

However, the free-rider problem is also a known challenge as Lauren Hazard Owen in her July 9, 2013 paidContent.org article “Barnes & Noble throws out its CEO, but that won’t save the company” writes:

“While everyone likes the idea of a neighborhood bookstore, that doesn’t translate into business success. While Barnes & Noble is, in fact, the only neighborhood in a lot of areas, consumers who advocate shopping local may still think of it as a big box store, and they’re not likely to show the same loyalty to it as they might to the charming indie bookstore on Main Street. Instead, they’ll keep doing what they do now: Go in to the store to browse and for the AC, then go home and order books on Amazon.”

The clear lesson here is that providing service to society is only good business if you can be compensated for supplying it. I, however, also know that providing something that people want is a great place to start a business. Ultimately, I think that in ten years we will still have Barnes & Noble at least in some tangible form. First, as I noted above, the café part of B&N works. People who are enjoying their time here are drinking a coffee while doing it. In many ways it is an improvement on the Starbucks experience by having this attachment to the book store. Second, Amazon clearly benefits from B&N existing as an uncompensated partner in many of their transactions. Third, publishers and authors don’t want to be left with an Amazon-only world as book stores represent their physical retail outposts to host book-signings, book-release frenzies, and the like. Fourth, our society seems to value physical book stores (even though they will try to free-ride if they can) as something beyond a retail space.

8.1.13_Williams_Bookstores_3When you have this many interested parties wanting something to exist, I expect it to exist. Maybe B&N survives through a business model with a leaner book store and larger café business model. Maybe Amazon buys B&N and accepts that they will barely break even on the physical book store, but their overall profit will be improved for having B&N around. Maybe B&N, in name, does go away, but Starbucks opens a book store/coffee house location type, recognizing it as part of their positive social image campaign to improve the Starbucks experience—or maybe just the hubris that they can make it work. Some publishers may even band together to create some physical retail super store to replace B&N or cut some deals with to keep them around. The hard part is that it seems best for all parties involved to have someone else step up.

I could be delusional and perhaps thinking with my heart rather than my head as many a beloved business have been washed away by the waves of retail climate change. With that said, as long as there is a B&N,  you can find me sitting there drinking an iced tea blend known locally as “The Dan” (told you I was a regular), reading a book I am perpetually thinking of buying but never do, and watching yet another awkward college interview.

Security mentioned is shown for illustrative purposes and is not owned by Brinker Capital

Seeking a Greater Purpose in Investing

Dan WilliamsDan Williams, CFP, Investment Analyst

The “science” of investing is well known. The modern portfolio theory (MPT) of investments developed over the past 50 years, starting with Harry Markowitz, has become so ingrained into the investment management culture that the concept of portfolio diversification has become second nature to most people. This is of course due to the mathematical analysis showing that diversification improves investment portfolios’ risk and return characteristics. To say differently, it makes good math sense.

6.27.13_Williams_1Recently though, investment management research has begun to venture into the new field know as Behavioral Finance. At a high level, this theory points out that the owners of these investment portfolios are not emotionless robots that are attempting to optimize the expected value of portfolios for a given level of risk, but rather humans who have reactions to watching their portfolios change in value and who also have goals for the wealth created. Often times this theory’s task seems to be to point out our human flaws and biases so that we can move closer to MPT. This includes our confirmation bias (seeking out only information we agree with rather than information that challenges our thinking), overconfidence bias (believing we are above average in our skills), and loss aversion (finding that we will irrationally gamble to avoid a loss already sustained but unwilling to take a gamble that might result in a loss, even when the odds are in our favor). Still, this idea also points out what gets lost in the math of MPT. Specifically, that an investment portfolio has greater purpose than just the accumulation of money.

The meaning here can be shown in the following dream scenario. You take a trip to Vegas, you see a slot machine, you put a dollar into the machine for fun, pull the lever, and you hit the big jackpot. You are then told that you can either have the $10 million prize immediately, or a flip of a coin for the chance to win $25 million or lose it all. The vast majority of people would take the $10 million dollars. Consider instead the experience of the MPT optimizing robot. First, the robot would likely not put the $1 into the slot machine. Why put $1 in when the expected value is $0.95? Second, given the jackpot options the robot would likely gamble it all at the chance for $25 million as the expected value of $12.5 million is greater than the $10 million. The math is clear—the robot is optimizing and we are not. But that is not the whole story.

6.27.13_Williams_2First, most humans get utility from putting a dollar into a slot machine outside of the outcome of the gamble. As such, we may be rational to gamble if the utility of the $0.95 expected value and the experience of gambling together are greater than the utility of the $1 in our pocket. Second, given the jackpot options, outside of the fear of losing the $10 million, there is also a diminishing marginal utility to money. That is to say simply that an extra $1 million to you or me changes our lives a lot more than an extra $1 million to Warren Buffett. It is quite possible that the utility we tie to that first $10 million is greater than the utility to that next $15 million. As such, we could be rational in both the action to gamble and the decision to take $10 million.

While lottery dreams are nice, the practical meaning is that our investments allow us to do things. Said differently, our investment balance is not just a number, it represents our ability to meet goals. To some, that $10 million meant the ability to have the freedom to travel, to retire for others, a fleet of cars to those so inclined, and a chance to make the world a better place for still others.

NorthstarIn this line of thinking, the relatively newly developed bucket approach to investment management ties specific assets to specific goals. This simple concept turns a portfolio that is invested based on some risk profile that in an opaque manner will meet your goals into a portfolio of portfolios that represent directly your goals. Accordingly, rather than having portfolio performance measured against a generic market benchmark, the measure that matters is whether each of these portfolios is on track to meet their assigned goals. Accordingly, Brinker Capital’s recent offering in this area is appropriately named “Personal Benchmark.” A final point is that people draw utility not just from spending their investments to meet goals, but also from where and how they invest. Socially Responsible Investing, also known as ESG (Environmental, Social and Governance), allows people to allocate capital where they believe the welfare of those outside themselves is best considered. Outside of the fact that there is evidence that investing in industries and companies that have these positive attributes may also improve investment performance, the fact that we are able to encourage positive change in the world while we save for our goals is a powerful concept.

In aggregate, the recent changes to investment management are brilliant in their simplicity to give purpose back to investments. The more empowered we feel with meeting our goals with our investments, the more likely we are to meet, and even exceed, those goals.

The Optimism for an Economy with a 7.8% Unemployment Rate

Dan WilliamsDan Williams, CFP, Brinker Capital

Currently, the U.S. unemployment rate stands at 7.8%, an improvement from the 8.5% a year ago and the 10% from the recent peak in October 2009. Still, compared to the consistent sub 6% rates we were used to seeing from the mid-1990s to mid-2000s, it is hard to feel good about this current state of employment and what this means for the health of the economy. There are those that argue that the “real” unemployment number is even worse (due to discouraged works exiting the equation and poor measurement methodology etc.). While it’s hard to show optimism for our economy, that is what I aim to do here.

A meaningful place to start is to define what an economy is. By its simplest definition an economy is a measure of the value of the goods and services the people of an area produce. Increase your number of people, increase the amount each person can produce, or produce more valuable stuff and the economy should grow. As you trade and cross-invest between economies, you can make further optimizations. In the short run, economies go through cycles and go by the whims of politicians, the media, central banks and consumer confidence. Still at its core, the economy is just a measure of what the people of a country are able to produce.

More Efficient Per EmployeeThe clear point here is that unemployment represents a failure to produce all we could. However, even with that fact, looking at GDP (expressed in 2005 dollars) we stood at $13.3 trillion at the end of 2011 (the highest year end number ever) and have seen continued growth such that 2012 will be even higher. So we have managed to become more efficient with what each employed person produces. This is the equivalent of a factory using fewer workers but producing more. If the real unemployment rate is actually higher than the 7.8% stated, that means we did it with even fewer workers. This seems like a good thing, right?

What makes the unemployment statistic different from a company having unused equipment is, of course, that people are not computers who can have their software updated over a lunch hour to be instantly redeployed to a new task. The fact is that many of those who are presently unemployed are trained for jobs that are no longer available. Also, people suffer when they are not able to work. There is no spin I can put on that other than to say things will get better given the time to retrain and redeploy. However, is this true?

A challenge to the idea of time healing this employment wound is the fear that technology efficiencies will replace more jobs such that even if the real GDP grows, maybe not all of us will get to be a part of it. Professor Andrew McAfee in a June 2012 TED Talk “Are droids taking our jobs?” echoes this sentiment when he references that in his expected lifetime, he believes we will see a “transition to an economy that is very productive but just does not need that many human workers.” He even notes that in the future an algorithm will be able to do writing tasks so a computer could author this blog. Basically, he sees no current job that we do as safe as these technologies accelerate.

This, however, does not mean that McAfee is pessimistic about our future employment. He is in fact quite optimist. He believes that these new technologies of efficiency represent the opportunity “to make a mockery of all that came before us”. (A phrase originally used by historian Ian Morris when he was speaking of the industrial revolution). What the industrial revolution did to magnify the productivity of our muscles, he feels the technology revolution is going to do to the productivity of our minds. To say differently, he expects we should expect an acceleration in our ability to innovate as technology improves.

A more skeptical reader would be right to ask that if innovation is accelerating, why are we still in the aftermath of the great recession? Thankfully Mr. McAfee is not alone in this technology optimism and has an economist among his group with an explanation. Joe Davis, Vanguard’s chief economist, in a December 2012 speech titled “Better days are in store” notes that the growth of industrial revolutions do not proceed in straight lines. The steam revolution of the late 1770s led to an economic overconfidence and collapse that occurred in the 1830s. The telephone revolution beginning in 1876 led to an economic overconfidence and collapse that occurred in the late 1920s with the Great Depression. In both cases Dr. Davis argues these tough times caused businesses to go through the required creative destruction to survive and took these technologies to a major inflection point of further growth. Today, we are in that inflection point of the microprocessor revolution that began in the 1970s. If history is any guide, this is the economic hiccup that will cause us to get to new technology heights.

Unused Human CapitalSo where does this leave us? Over the past five years, the U.S. has learned to do more with less, has additional unused human capital to deploy, and the efficiencies afforded to us by technology are likely to accelerate. While the near term may be messy, there is an undeniable potential for us to be so much greater and “make a mockery of all that came before us”. While the details of this future and what an economic blog of 2063 will read like are unknown, there does seem to be rational reasons for great optimism. With that let me say, Happy New Year!