A Manifesto (or what I learnt at Bear Market University)

Investing is both easy and hard: easy to figure out what you need, but oh so hard to find it.

That’s largely because of the towering edifice of rent-seekers and regulators whose job it is to make the whole thing more complicated than it is, in order to provide themselves with work and riches, always at our expense.

And if the intermediaries and watchdogs don’t bite you, the politicians and corporate suits will: the agency costs of investing our scrawny savings towards a modest retirement – fees, taxes, commissions, salaries, bid-offer spreads, hubris and incompetence – bleed us white, and keep us relying on the pension.

This has been my second big bear market, and by far the most instructive (partly because I was young and foolish in the 70s and less disposed to learn). A bear market is where share prices, on average, don’t rise, which is what happened in the 70s and over the past decade (the 1987 crash wasn’t a bear market, but a bull market correction).

Interestingly, the past ten years have seen a bear market in prices, but a bull market in dividends; since July 2006 the return from the ASX200 index has been zero (as it was during the 1970s) but the ASX200 accumulation index has returned 5% compound. During the 70s the dividend yield was half that.

That’s a direct result of dividend franking, which Paul Keating still regards as one of his greatest reforms, although I’m not so sure. I think part of the reason companies haven’t grown their value, on average, is that – under the lash of payout ratio demands – they have not been reinvesting in their businesses enough. If they had, the capital growth would have been greater than the dividends.

Which brings me to the first thing I learnt at Bear Market University:

1. Growth is a bet on the future; income is a promise.

By which I mean that stocks are not bonds (income securities) and it’s dangerous to treat them as if they are. Those who bought bank equities for income are now finding this out.

Investing is not all that complicated, but it’s important to understand the difference between growth and income; between stocks and bonds.

A bond is a promise to pay an amount of income over a certain period. The only risk is default and total loss. An equity is a speculation, and capital growth is the reward for exposing yourself to volatility, of both income (dividends) and capital.

2. Forecasting is folly.

Not much explanation needed here. Some forecasts are right, but not enough to make it worthwhile.The only things that are knowable are the past and present, and even they are sketchy and imperfect.

The only things you can rely upon when assessing either a company or a fund are past performance, and present integrity and value. That’s it – but you must assess them!

3. Be humble.

“The Big Short”, the movie about the men who picked and profited from the 2008 crash, starts with this quote attributed to Mark Twain: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” (Actually Mark Twain never said that, but it’s the sort of thing he would have said.)

You need to approach investing like a penitent monk: you know nothing; you have no ego; make no assumptions.

4. Liquidity is over-rated and expensive.

Big, liquid markets perform worse than illiquid (unlisted) ones because they are casinos as well as places to buy and sell assets, and all casinos are populated with crooks.

What’s more the liquidity is never there when you need it.

5. Understand your time frame and stick to it.

That doesn’t mean, if you’re investing for, say, 10 years, that you do nothing for a decade, but don’t set a ten-year goal and then trade as if you’re being judged by the quarter.

The great advantage that individual investors have is that they are NOT being judged by the quarter like professionals. Warren Buffett is the great hybrid: a professional who acts like an individual, and look how well he’s done! You need to use that advantage. Which brings me to…

6. Modern portfolio theory sucks.

This is perhaps my most controversial lesson, but I think Harry Markowitz has a lot to answer for. He invented MPT in 1952 and all investing, and investment advice, since then has been based on it. MPT is a theoretical framework for constructing a portfolio that maximizes return for a given level of risk. Risk is defined as variance – from a benchmark.

“Robo advice” is now all the rage, but it’s really just a cheap version of what human advisers have long been charging too much for: portfolio construction based on Harry Markowitz’s MPT, using your time-frame and “risk tolerance”.

It’s all a load of rubbish I’m afraid.

If you’re young and investing for more than 10 years, you should be buying shares in a mixture of growing companies, preferably ones that pay little or no dividends, and keeping an eye on them.

If you’re old and already built your capital, and now need to live on it, you need a mixture of promises to pay income (ie bonds – see definition above). And I mean promises, not dividends, which are hopes and expectations.

If you’re somewhere between the two – that is, in your 50s or 60s and approaching retirement – you need a mixture of the two.
It’s about as simple as that.

Harry Markowitz’s theories were aimed at professional fund managers who really do need to maximize return for a given variance from a benchmark – but you don’t need to do that.

The proposition that you need a complicated set of asset allocations – a percentage here and a percentage there – is merely designed to relieve you of fees.