Where Have All the Long-Term Investors Gone?
Everything is cyclical – spring/summer/fall/winter…recession/recovery/boom periods…deflation/inflation. An experienced farmer knows full well that weather directly affects the harvest, so he is prepared for both good and bad years. His success lies in the patient preparation and planting of the soil. Today, it seems that investors are obsessed with short-term performance (three years or fewer). Impatient investors jump from one strategy to another without any long-term plan, or end, in mind. Market cycles are three to 10 years in length, so timing (i.e., buying solid opportunities at the right price and time) and patience are paramount. Leo Tolstoy wrote in his epic novel War and Peace that “The two most powerful warriors are patience and time.” It seems today that investors are forgetting that success is measured in decades – like the ability to “stay” retired.
In July, billionaire investor Carl Icahn criticized Laurence Fink, CEO of BlackRock, at a CNBC conference, for selling exchange-traded funds (ETFs) that own “extremely illiquid” securities like high yield bonds. Icahn singled out BlackRock’s iShares high yield ETF, saying it held bonds that were “extremely dangerous.” Fink shot back saying that “ETFs create more price transparency than anything that is in the bond market today.” Adding power (I assume) to his remark, Fink added, “To trade ETFs at every minute [emphasis added] of every day, you have to have a valuation of every bond at every minute.”
I do not wish to give a discourse about the specifics of high-yield bonds or ETFs. What struck me was the idea that if an ETF trades every minute, then the underlying securities also trade every minute. Who needs to trade bonds every minute anyway – except perhaps speculators trying to pick up nickels? For fun, I tested the “every minute of every day” liquidity that Fink mentioned against a holding in his $13 billion high yield fund, HYG. It seemed fitting to select the Wynn Resorts and Casino 5-3/8%bonds of 3/15/22 for this exercise. On July 16, 2015, these bonds traded only 16 times in a range of 104.79 to 101.76, a far cry from trading “every minute of every day.” To ensure I didn’t research an “off” day, I looked at the previous Friday’s performance and saw there were eleven trades – still a far cry from the 390 minutes each day that Fink’s high-yield fund trades each day in New York (not to mention other exchanges).
A so-called liquid investment comprised of illiquid, not easily traded securities is a recipe for failure. I will side with Carl Icahn’s thoughtful approach on this matter. Like me, he is not selling anything – he manages portfolios as a professional investor.
ETFs are fairly new and amazingly popular because they allow investors to “speculate” (or invest) in another “hot” area of investing: indexing. They are designed to simply reflect the day-to-day performance of whatever index they are tracking (e.g., S&P 500, emerging markets, junk bonds, etc.). Index investing started out innocently to help investors save costs, diversify and invest long-term, but it has morphed into a “product” that allows investors to speculate “by the minute.” The champion and “father” (to some) of indexing (and long-term investing), Vanguard founder John Bogle, said recently, “In my experience – almost 64 years – I have learned to beware of investment ‘products,’ especially when they are ‘new’ and even more when they are ‘hot.’”
Bogle started his index funds to help investors, especially smaller investors, lower costs. He emphasized patience, advising investors to not get rattled by day-to-day fluctuations. Bogle has written extensively on investing, and his book The Clash of Cultures: Investment vs. Speculation ends with 10 lessons for investors. While my own “10 lessons” would differ slightly from Bogle’s, there are four that stand out:
- Time is your friend, impulse your enemy (Be patient)
- Remember reversion to the mean (What’s “hot” today isn’t likely to be hot tomorrow, and what’s “cold” today is likely to again have its day in the sun – everything is cyclical);
- There is no escaping risk (Volatility is a side effect to good long-term performance no matter what the insurance, annuity or limited partnership salesperson tells you); and
- Stay the course (Be disciplined, patient and don’t be rattled by the ups and downs).
So…Where Have All the Long-Term Investors Gone?
There are many excellent long-term investors in the business, but today there’s an epidemic of short-termism. I see it in the way politicians speak (sound bites without depth) and the news is reported (few photos, short video or a small quote or two … and on to next “story”), but as professional investors serving clients, we see it every day in the questions our clients ask.
Years ago, I asked a fellow investment manager, Harvey Eisen, to tell me the best way to improve his performance. Without hesitation he said, “If my clients only looked at their portfolios once every five years.” I didn’t necessarily agree with his five-year theory, but we both agreed that as a matter of practicality, clients need to understand and pay attention to their portfolios, without ever becoming too obsessed over short-term exposure.
Based on my experience, I find most investors would rather follow the crowd and be wrong in company than take the risk of being successful but shunned by the crowd. Today’s “crowd” is embracing indexing and ETFs, but these are mere tools used in investing, not the means of successful investing. Success involves numerous factors – value, paying the right price, present value of future cash flows, patience, experience and discipline.
Let’s Look at Cycles
First, positive performance tends to be compressed. As we all know, investments go down and up and interest rates rise and fall. Success happens when we embrace these facts and use them to our advantage. One key is to be early. The chart “Be Early and Bear Markets” uses the U.S. stock market to illustrate the importance of
- being invested before things turn around; and
- being well-compensated while accepting the volatility of being early.
As you can see, sitting in cash for the six months after a bear market ends cuts performance in half for the ensuing three years. Most investors reading this experienced firsthand the crash of 2008/2009, and the real losers, as we know, were those who went to cash and “sat it out” only to see markets come back up quite quickly.
One certainty is that investors that tend to have poor performance generally sell or switch strategies when things are performing poorly because they don’t understand that “everything is cyclical.” They need to re-evaluate whether or not they own “good” investments and take a longer-term view (e.g., five years) on the investments they currently hold.
Let’s examine simple currencies. One reason that FIM Group portfolios are facing some headwinds these last few quarters is our exposure to the Canadian dollar, euro, Australian dollar and Swiss franc. The U.S. dollar as a currency is strong, which means it is also strong against other currencies. The table “Foreign Currencies Significantly Below 10-Year Highs” (below) illustrates that foreign currencies have had a rough go. Specifically, factors like Greece’s economic woes, recession and such have caused the euro to go down 31% from its high, which means that the euro would need to go up approximately 45% against the dollar to get back to its all-time high. Is that likely to happen? Who knows? The chart merely illustrates that because markets are cyclical, investments can go from being too expensive to too cheap. It’s hard to say, “Let’s sell our international investments and wait for quiescence,” which we know does not happen. Everything moves.
Let’s look at some of FIM Group’s largest holdings in local currencies and in U.S. dollar terms. Keep in mind if we were reporting our performance in euros, our portfolio returns would be 10% higher this year. As you can see in the table “Select FIM Group Holding Share Prices,” the securities are not near their 10-year highs in either their local currency or the U.S. dollar. While a security valued at a price much lower than its former high is not a statement of value, as sometimes companies destroy value and their securities should go down, often it is just investors’ psychology that causes the investment to be shunned. Let’s look closer at the four holdings in the table.
While Pargesa’s earnings are down less than 10% from its all-time high, it seems that the stock being cut in half is going a bit too far relative to the company’s fundamentals. Pargesa, a holding company with a long-term focus on creating value, sells at a significant discount to its breakup or intrinsic value, pays a cash dividend and has a rock solid management that owns more than 50% of its shares. Pargesa’s management’s interests are aligned with ours.
Canadian holding company Dundee, which has investments that include energy, mining, real estate, agriculture and investment management, is down 49% in Canadian dollars and 61% in U.S. dollars from its high in August of 2013. What is interesting about Dundee is that its book value is only 15% less today than it was in 2013. Dundee was selling near its book value in 2013, but today it sells at less than half its book value. Warren Buffett advises us to invest with a margin of safety (which comes from buying at good prices). Certainly he would agree that buying Dundee at less than half of book and Pargesa at around 75% of book gives us a nice margin of safety. The two other holdings, Quest for Growth and Atrium Real Estate, are both currently priced at less than their book (intrinsic) value. Atrium paid a 6% dividend and Quest for Growth a 7% dividend this year based on current share prices. Atrium has seen its dividend rise by 18% per year over the past three years.
FIM Group strives to find companies where we expect dividends to rise over time to help offset inflation and provide compound growth in portfolio values.
Five Years Out
Taking a long view is important as a manager. Our job is to keep our retired clients retired, and to help grow wealth to be used in the future for retirement, kids’ education, a legacy for family or charity, or a new organ for a church whose money we manage. When I look at our portfolio holdings in five years under any scenario – recession, inflation, boom times, a currency collapse or even hyper-inflation – I am confident we will be able to keep our mandate to our clients. This is so because the companies and investments we own are creating real value and are making earnings and cash flows that they can either pay out as dividends or use to build share price. If you compound the value of the earnings and cash these companies generate, and add that we have bought the securities at great prices – maybe a bit early of course, but better early than late as illustrated so well in the “Be Early and Bear Markets” chart – it is very easy to be optimistic.