Author Archives: Edward A. Studzinski

About Edward A. Studzinski

Ed Studzinski has more than 30 years of institutional investment experience. He was a partner at Harris Associates in Chicago, Illinois. Harris is known for its value-oriented, bottom-up investment approach that frames the investment process as owning a piece of the business relative to the business value of the whole, ideally forever. At Harris, Ed was co-manager of the Oakmark Equity & Income Fund (OAKBX). During the nearly twelve years that he was in that role, the fund in 2006 won the Lipper Award in the balanced category for "Best Fund Over Five Years." Additionally, in 2011 the fund won the Lipper Award in the mixed-asset allocation moderate funds category as "Best Fund Over Ten Years. Concurrently Ed was also an equity research analyst, providing many of the ideas that contributed to the fund’s success. He has specialist knowledge in the defense, property-casualty insurance, and real estate industries, having followed and owned companies as diverse as Catellus Development, General Dynamics, Legacy Hotels, L-3, PartnerRe, Progressive Insurance, Renaissance Reinsurance, Rockwell Collins, SAFECO, St. Joe Corporation, Teledyne, and Textron. Before joining Harris Associates, over a period of more than 10 years, Ed was the Chief Investment Officer at the Mercantile National Bank of Indiana, and also served on their Executive and Asset-Liability Committees. Prior to Mercantile, Ed practiced law. A native of Peabody, Massachusetts, he received his A.B. in history (magna cum laude) from Boston College, where he was a Scholar of the College. He has a J.D. from Duke University and an M.B.A. in marketing and finance, as well as a Professional Accounting Program Certificate, from Northwestern University. Ed has earned the Chartered Financial Analyst credential. Ed belongs to the Investment Analyst Societies of Boston, Chicago, and New York City. He is admitted to the Bar in the District of Columbia, Illinois, and North Carolina.

Rearranging the Deck Chairs

By Edward A. Studzinski

“In wars then let our great objective be victory, not lengthy campaigns.”

                  Sun Tzu, The Art of War

Another year-end is in sight. Those of us who have been conservative in our asset allocations and predicting the end of the world have once again it seems, been proven wrong. Or perhaps not, for as the market keeps rising, the breadth keeps getting narrower. Or least it had been. It begs the question of whether we are setting up for a blow-off, heading straight up through year-end, or something else.

Attached is a Continue reading →

Fall Frolics

By Edward A. Studzinski

“Maybe this world is another planet’s hell.”

                                 Aldous Huxley

Investment Committees and Performance

We are at that point in time when investment returns trickle in from the endowments of schools and other not-for-profit organizations for their fiscal years ending June 30, 2017. In terms of preliminary numbers, the top ten college/university endowments had total returns Continue reading →

“One for the Gipper”

By Edward A. Studzinski

“There is much to be said in favor of modern journalism. By giving us the opinions of the uneducated, it keeps us in touch with the ignorance of the community.” Oscar Wilde

A recurring theme in investment letters, usually when one suspects that performance or personnel issues (often directly related) need to be glossed over, is a discussion about the need to have “team players” in the investment management and research process. Now there were hedge funds, such as Tiger Management in its heyday and Maverick Capital which used to make a virtue of recruiting former athletes in high school or Continue reading →

Ruminations at Summer’s End

By Edward A. Studzinski

Silence is the most perfect expression of scorn.

                                 George Bernard Shaw

Book Review

David Snowball recently asked if I would have any interest in reading Joel Tillinghast’s (Fidelity Low-Priced Stock Fund) new book entitled Big Money Thinks Small. While I am usually reluctant to read what often end up being collections of anecdotes about how smart someone was, the fact that it had been published by Columbia Business School Publishing overcame my initial reluctance. Much to my surprise, I enjoyed the book immensely, and found it to be a very thoughtful work. Let me first say that I do not know Mr. Tillinghast, other than by reputation. However, I have served on committees with people who do know Mr. Tillinghast and have worked with him. They are uniform in their praise of him both as an investor and as an individual. He is a true polymath with almost total recall. And unlike many who content themselves with a formulaic approach to investing, e.g. mean reversion, he seeks to understand the quality of a business, the numbers supporting the business, and the character, intelligence, and integrity of management. Two chapters in particular I would recommend to all are “Gamblers, Speculators, and Investors” and the last chapter entitled Continue reading →

For Whom Does the Bell Toll?

By Edward A. Studzinski

In the dawn, although I know

It will grow dark again,

How I hate the coming day.

                        Fujiwara No Michinobu

Buffett’s irreproducible edge

First, some addenda to last month’s comments, as there were a number of readers interested in private equity. One reader, whom I happened to agree with, identified Berkshire Hathaway as a private equity proxy, given that (a) Buffett is dealing with permanent capital with a true long-term time horizon, and (b) he has been clearly disciplined and dedicated to going where opportunities surface that others are inclined or required to ignore. It has actually been quite instructive to watch him complement his major holdings in Berkshire’s insurance businesses as well as the equity investments that he owned pieces of, such as American Express and Coca Cola, with the wholesale acquisition of an Continue reading →

Summer Musings

By Edward A. Studzinski

“Change is the law of life. And those who look only to the past or the present, are certain to miss the future.”

      John Fitzgerald Kennedy. Speech, Frankfurt, 25 June 1963.

The first six months of 2017 are gone, and most global markets have surged during that period. So those like me who thought valuations were starting to look extreme at the beginning of the year, once again cried “wolf” too soon. For those six months, Vanguard’s S&P 500 Admiral Fund achieved a total return of 9.3%, with an expense ratio of four basis points. Many actively managed funds, alas, did not perform quite as well for their investors, although their managers continued to do quite well, purchasing Continue reading →

The Boys of Summer

By Edward A. Studzinski

Everything is on such a clear financial basis in France. It is the simplest country to live in. No one makes things complicated by becoming your friend for any obscure reason. If you want people to like you, you have only to spend a little money.


In recent weeks, a number of articles and books have made their way into print, and they are things worth taking a gander at as one ponders where we are in the economic cycle One of my favorite blogs to read is “The Brooklyn Investor,” which can be found at which is updated intermittently. A recent piece was titled “High Fees” and posted May 19, 2017. The author discusses a Continue reading →

The Fifty Year Reich

By Edward A. Studzinski


“It is dangerous to be sincere unless you are also stupid.”

  George Bernard Shaw

Some thirty-odd years after its founding, the transformation of Morningstar is complete. From a firm that got its start providing tools and research to assist the individual investor, we now see a firm that exists to offer tools, support, and research to financial advisors or intermediaries. To a large extent, that evolution was necessary given the changes in the marketplace for mutual funds, as well as the changes in the regulatory environment. And once Morningstar became a public company, it would have been incumbent upon its employees and management to focus on Continue reading →

Nothing Personal, It’s Just Business

By Edward A. Studzinski

“This is the business we’ve chosen. I didn’t ask who gave the order, because it had nothing to do with business.”

Hyman Roth speaking to Michael Corleone in the movie “Godfather II”

Another month has gone by, and the current period of disruption has not only continued, but accelerated in the mutual fund management business. For all but the true believers (or perhaps those holding stock in the publicly-traded fund managers), it should be apparent that we are witnessing not just a cyclical decline, but a secular one.

Let’s start with the settlement between Bill Gross and Continue reading →

Half a league, half a league, half a league onward —–

By Edward A. Studzinski

“Frost on grass: a fleeting form, that is and is not!”


This is the time of the month when I am usually wrestling with what to say and trying to avoid repeating myself, which can be pretty difficult after several years of columns. This month, I have something of a surfeit of material, so I will apologize in advance for the rambling.

A few weeks ago, I attended the annual Graham and Dodd Conference at Columbia University’s Graduate School of Business in New York. As always, the speakers were Continue reading →

Survival of the Flushest?

By Edward A. Studzinski

“Cynic, n. A blackguard whose faulty vision sees things as they are, not as they ought to be.”

Ambrose Bierce

A question I have been pondering with increasing frequency is, of the mutual funds around today, how many of them will still be around in ten years? This grew out of a year-end luncheon with a friend of mine who heads up the strategic planning effort for a large financial services firm out of Chicago that has gone global and now has its fingers in many pies. Our discussion started around the problem with Continue reading →

“What Goes Around ……”

By Edward A. Studzinski

Democracy – “The substitution of election by the incompetent many for the appointment of the corrupt few.”

        George Bernard Shaw

So, another calendar year has gone by, and fund managers everywhere are dissecting their relative performance in comparison to some benchmark index. To put things into perspective for a real-world comparison (at least in terms of the performance numbers), the Admiral shares of the Vanguard S&P 500 Index Fund, which charges a five basis point fee, had a one-year Continue reading →

Behind Door Number Two Is?

By Edward A. Studzinski


“I and my public understand each other very well: it does not hear what I say, and I don’t say what it wants to hear.”

Karl Kraus

I recently had occasion to read proxy materials for San Juan Basin Royalty Trust. The issue involved an attempt to remove the current trustee, Compass Bank, the successor to TexasBank, which had been acquired by Compass, with Southwest Bank. The story is a recurring one in banking – a smaller local institution gets gobbled up by Continue reading →

Priceless – Worth Absolutely Nothing!

By Edward A. Studzinski

“Under this flabby exterior is an enormous lack of character.”

  Oscar Levant

This has proven a rather difficult time to write something and feel that you are either (a) not repeating things you have said before or (b) speaking with the certainty that you are offering some genuine insight that will prove advantageous to our readers as they pursue their investment programs. For those reasons, I will endeavor to be brief, which will probably result in my being more obscure in my comments than usual. I offer thus a number of random thoughts which should Continue reading →

What Price Integrity?

By Edward A. Studzinski

“Question in a Field” by Louise Bogan

Pasture, stone wall, and steeple,
What most perturbs the mind:
The heart-rending homely people,
Or the horrible beautiful kind?

From: The Maine Poets


So we watch now the public flogging of senior officials of Wells Fargo by our esteemed members of Congress, which is not to say that the flogging is Continue reading →

Behind the Curtain

By Edward A. Studzinski

“Moon in a barrel: you never know just when the bottom will fall out.”

 Mabutsu (19th Century Japanese haiku poet)

So, August as usual is the period of the “dog days” of summer, usually a great opportunity to catch up on reading. A site I commend to you for all things investment is Hurricane Capital, recommended to me by my friend Michael Mauboussin, of Credit Suisse. Among other things Michael pointed out that the writer of this blog (from Sweden) had posted all of Michael’s strategy and thought pieces going back for years. A recent one, which I would suggest is worth a read is Continue reading →

Have We Been Here Before?

By Edward A. Studzinski

“The past is never dead. It’s not even past.”

William Faulkner

I recently had coffee with one of my former colleagues in the investment management world. He asked me if our readers understood that, in the world of mutual fund managements, it was all about assets under management and profitability to the various stakeholders in the business. Thoughts about the returns for the investor were generally secondary, or put differently, whether the investors actually got any yachts (or vacations in the Caribbean or second homes on Hilton Head Island) did not matter. Having recently reviewed some posts on our Bulletin Board, I told him that no, many of our readers were still operating under the belief that there was, somewhere in that room full of manure, a pony.

Our desire for hope and change (at least in terms of investment returns) often leads us to ignore the evidence of simple mathematics working against us. Continue reading →

The Black Swan of Brexit

By Edward A. Studzinski

“A bank is a place where they lend you an umbrella in fair weather and ask for it back when it starts to rain.”

Robert Frost

By Edward Studzinski

The title of this month’s piece probably leads one to expect that I will be writing a review of a circa-1930’s costume drama film, set in either 15th century England or France, starring Tyrone Power, etc, etc. Sadly, the time is today. And while many of the players act like fictional characters in terms of temperament and self-interest, unfortunately they are not.

I expect many of my colleagues, especially David, will have a lot more to say about BREXIT than I, but I do think the matter of it as a black swan event is critical. In recent years, many have thought about the United Kingdom as one country, especially after the Scottish secession vote was defeated, without realizing that economically it was many. You have the city state of London and southeastern England, an area that rivals Renaissance Florence as a center of commerce, trade, wealth, culture, and the arts. And then we have the rest of England, which includes the southwest as well as the impoverished former industrial north of Manchester and Yorkshire, an area of high unemployment and rather daunting poverty. Similar segmentation plays out in both Northern Ireland and Scotland. So, the surprise is not that 52% of the population, in a 70% plus voter turnout voted to leave the EU, but rather that the politicians and pollsters got it so wrong.

At this juncture I will spare you the history lesson, but suggest that some digging, especially with attention to The Hundred Years War, will give you a greater appreciation of the back and forth between England and the Continent over a thousand years. And for those who keep making a comparison between the events of today, especially the rise of economic nationalism, and the events of the 1930’s, I will suggest that a more apt comparison is the 15th and 16th centuries, where you had the continuing conflicts between England and France, France and Burgundy, and the economic rivalries of the Italian city states of Florence, Genoa, and Venice. You also had the fall of Constantinople and then Trebizond marking the end of the Byzantine Empire concurrent with the rise of the Ottoman Turks and their empire. And while politics and religion were given lip service as to the primacy of place, the real drivers of events were economics, trade, and the greed for greater personal wealth.

So what investment conclusions can one draw from BREXIT? It is far too soon to tell. Obviously there is and will continue to be a ripple effect, which has already begun in terms of increased market volatility and dislocation. There will be winners and losers, in terms of economies and businesses. At the same time, knee-jerk reactions, either to sell investments or make new investments, are to be avoided. Those who liquidated investments in the first days of a global sell-off have probably realized losses that would not have been losses had they waited a few days longer. Those who ran in and purchased things such as European banks (thought to be undervalued before the BREXIT results) find that that they are still cheap and may become even cheaper. Over the last several months it had become clear that a number of large European banks were going to need additional help from their central bank counterparts. We see then the announcement in the last few days that one of the greatest potential sources of systemic risk to the financial system is Deutsche Bank.

In terms of real assets such as property and commodities, the fog of volatility is even thicker. I have a friend who is in the process of relocating from the UK to Switzerland, an unwinding that has been going on since the beginning of the year. The last piece was to be the sale of a home in London. The higher- end London market had already been somewhat toppy this year, with slowing sales. So, the process was dragging. This week she told me that as a result of last week’s vote, the market price that she had been expecting has dropped by 25%. In terms of commercial real estate, the short-term dislocations should be equally as great. London may appear to be a loser and locations such as Dublin, winners. Alternatively, if the British find their footing and resume being a trading and finance center for Africa and Asia, the property dislocations may be short-lived. At this point no one knows. And once again, investor time horizons matter.

A 25% move in real estate prices in one week is huge, and not easily recovered. Similarly, we saw a huge move in currencies last week, in particular the British pound sterling, by what, 15%, in a very short period? In markets which are zero sum events (for a winner there has to be a loser), we should be looking for some failures or liquidations to be announced in coming days.

And Now For a Word From …..

This brings me to a thought which will surprise many of you, given my previously expressed preferences for low cost, index products for most fund investors. This is almost the ideal environment for the active, long-term oriented value manager. The issue becomes finding that active manager who will put your interests first, above that of career and firm.

At the beginning of June, we were seeing active managers’ performance trailing the index funds (again). A friend related to me a conversation he had had with the director of equity research at an investment management firm that was seeing consistent outflows because of index-lagging performance for the year-to-date, one year, and three year periods (not surprising as most investment and financial consultants have a much shorter investment time-horizon than the one they advise their clients to have). This individual told him that even if the outflows continued and the assets under management dropped to X billions of dollars, he would not be concerned as there would be “more than enough money to go around.” So recognize the priorities here, which were on self-interest.

This is the humorous aspect of seeing presentations from investment firms about eating their own cooking, when the true focus is upon how much can be taken out of the business. For those who think these are random situations rather than episodic, I commend you to an article entitled “For the Love of Money” by Sam Polk which appears in the Sunday, January 19, 2014 Sunday Review section of the Sunday New York Times. The piece discusses the concept of “money addiction” and starts with this sentence, “In my last year on Wall Street my bonus was $3.6 million and I was angry because it wasn’t big enough.”

Think about it. The compensation of a Fortune 100 CEO is disclosed. All-in someone may get a combination of salary, bonus, benefits, and option/stock compensation tied to profitability that may come to perhaps $20 million dollars a year. This is a business with billions of dollars in revenue and profits, thousands of employees, and its performance can have a major impact on the national and global economies. Contrast that with the fund manager whose compensation all-in, for managing $40 billion of assets is $30 million dollars a year, she or he has perhaps forty employees and an economic footprint that is far less. And of course, the $30 million dollars a year is part of a shell-game that is played so that trustees of fund organizations see perhaps a $5 million dollar compensation number for the manager, with other amounts categorized as “ownership interest in the firm” or “long-term compensation pool” etc., etc. But wait, the firm is a wholly-owned subsidiary of an asset-gathering fund company? And people are surprised by how much support politicians like Sanders and Warren have garnered?

There is another game going on here as well, and that is on the parent side of such organizations.

I recently had a conversation with someone at an asset-gathering firm where we talked about the dislocations and shut-downs in the hedge fund and mutual fund industry. This person said to me, look, it is all about leveraging our distribution platform to gather assets. If the assets under management at a subsidiary don’t grow over a five to ten year period, we are going to either offer to sell it back to the subsidiary managers or shut it down. We are not in business to not make money for our shareholders.

I related this conversation to a West Coast-based fund manager who said to me, this explains why a friend of mine at another firm was faced with the choice of mortgaging his home and signing away his life. He was presented with the choice of repurchasing his firm at the price dictated by the parent or being shut-down. Depending on the state where you are doing business, you may face rather dire choices. California of course, has made non-compete agreements illegal. Not so, New York and other jurisdictions.

This brings me to my final point this month. There is a storm brewing that will sweep over the mutual fund business as we know it. The proposed rules from the Department of Labor which will make the financial advisors, the platform companies, and the funds fiduciaries will effect drastic change. On its face, the idea that an investment should be suitable for those purchasing it and the fees disclosed for that investment would appear to make sense. And yet the rules are being fought tooth and nail by the industry.

Have you ever wondered about the economics of purchasing funds through a discount brokerage account where there is a no-transaction fee fund supermarket? Who gets paid and how? Are we talking about billions of dollars here in profits to the discount brokers? Are we talking about the ability to gather assets in funds that would not be able to so do otherwise? What do those 12(b)1 distribution fees you see in the prospectus for distribution really amount to over time? How do they impact the long-term returns on your fund investment? This is the tsunami that is coming.

All That Glitters ….

By Edward A. Studzinski

By Edward Studzinski

One should forgive one’s enemies, but not before they are hanged.

Heinrich Heine

So, we are one-third through another year, and things still continue to be not as they should be, at least to the prognosticators of the central banks, the Masters of the Universe on Wall Street, and those who make their livings reporting on same, at Bubblevision Cable and elsewhere. I am less convinced than I used to be that, for media commentators, especially on cable, the correct comparison is to The Gong Show. More often than not, I think a more appropriate comparison is to the skit performed by the late, great, and underappreciated Ernie Kovacs, “The Song of the Nairobi Trio.”

And lest I forget, this is the day after another of Uncle Warren’s Circuses, held in Omaha to capacity crowds. An interesting question there is whether, down the road some fifty years, students of financial and investing history discover after doing the appropriate first order original source research, that what Uncle Warren said he did in terms of his investment research methodology and what he in reality did, were perhaps two different things. Of course, if that were the case, one might wonder how all those who have made almost as good a living selling the teaching of the methodology, either through writing or university programs, failed to observe same before that. But what the heck, in a week where the NY Times prints an article entitled “Obama Lobbies for His Legacy” and the irony is not picked up on, it is a statement of the times.

goldThe best performing asset class in this quarter has been – gold. Actually the best performing asset class has been the gold miners, with silver not too far behind. We have had gold with a mid-teen’s total return. And depending on which previous metals vehicle you have invested in, you may have seen as much as a 60%+ total return (looking at the germane Vanguard fund). Probably the second best area generically has been energy, but again, you had to choose your spots, and also distinguish between levered and unlevered investments, as well as proven reserves versus hopes and prayers.

I think gold is worth commenting on, since it is often reviled as a “barbarous relic.” The usual argument against it that it is just a hunk of something, with a value that goes up and down according to market prices, and it throws off no cash flow.

I think gold is worth commenting on, since it is often reviled as a “barbarous relic.”

That argument changes of course in a world of negative interest rates, with central banks in Europe and one may expect shortly, parts of Asia, penalizing the holding of cash by putting a surcharge on it (the negative rate).

A second argument against it is that is often subject to governmental intervention and political manipulation. A wonderful book that I still recommend, and the subjects of whom I met when I was involved with The Santa Fe Institute in New Mexico, is The Predictors by Thomas A. Bass. A group of physicists used chaos theory in developing a quantitative approach to investing with extensive modeling. One of the comments from that book that I have long remembered is that, as they were going through various asset and commodity classes, doing their research and modeling, they came to the conclusion that they could not apply their approach to gold. Why? Because looking at its history of price movements, they became convinced that the movements reflected almost always at some point, the hand of government intervention. An exercise of interest would be to ponder how, over the last ten years, at various points it had been in the political interests of the United States and/or its allies, that the price of gold in relation to the price of the dollar, and those commodities pegged to it, such as petroleum, had moved in such a fashion that did not make sense in terms of supply and demand, but made perfect sense in terms of economic power and the stability of the dollar. I would suggest, among other things, one follow the cases in London involving the European banks that were involved in price fixing of the gold price in London. I would also suggest following the timetable involving the mandated exit of banks such as J.P. Morgan from commodity trading and warehousing of various commodities.

Exeunt, stage left. New scenario, enter our heroes, the Chinese. Now you have to give China credit, because they really do think in terms of centuries, as opposed to when the next presidential or other election cycle begins in a country like the U.S. Faced with events around 2011 and 2012 that perhaps may have seemed to be more about keeping the price of gold and other financial metrics in synch to not impact the 2012 elections here, they moved on. We of course see that they moved on in a “fool me once fashion.” We now have a Shanghai metals exchange with, as of this May, a gold price fixing twice a day. In fact, I suspect very quickly we will see whole set of unintended consequences. China is the largest miner of gold in the world, and all of its domestic supply each year, stays there. As I have said previously in these columns, China is thought to have the largest gold reserves in the world, at in excess of 30,000 tons. Russia is thought to be second, not close, but not exactly a slouch either.

So, does the U.S. dollar continue as the single reserve currency (fiat only, tied solely to our promise to pay) in the world? Or, at some point, does the Chinese currency become its equal as a reserve currency? What happens to the U.S. economy should that come to pass? Interesting question, is it not? On the one hand, we have the view in the U.S. financial press of instability in the Chinese stock market (at least on the Shanghai stock exchange), with extreme volatility. And on the other hand, we have Chinese companies, with some degree of state involvement or ownership, with the financial resources to acquire or make bids on large pieces of arable land or natural resources companies, in Africa, Australia, and Canada. How do we reconcile these events? Actually, the better question is, do we even try and reconcile these events? If you watch the nightly network news, we are so self-centered upon what is not important or critical to our national survival, that we miss the big picture.

Which brings me to the question most of you are asking at this point – what does he really think about gold? Some years ago, at a Grant’s Interest Rate Observer conference, Seth Klarman was one of the speakers and was asked about gold. And his answer was that, at the price it was at, they wanted to have some representation, not in the physical metal itself, but in some of the gold miners as a call option. It would not be more than 5% of a portfolio so that in the event it proved a mistake, the portfolio would not be hurt too badly (the opposite of a Valeant position). If the price of gold went up accordingly, the mine stocks would perhaps achieve a 5X or 10X return, which would help the overall returns of the portfolio (given the nature of events that would trigger those kinds of price movements). Remember, Klarman above all is focused on preserving capital.

And that is how I pretty much view gold, as I view flood insurance or earthquake insurance. Which, when you study flood insurance contracts you learn does not just cover flooding but also cases of extreme rain where, the house you built on the hill or mountain goes sliding down the hill in a massive mudslide. So when the catastrophic event can be covered for a reasonable price, you cover it (everyone forgets that in southern Illinois we have the New Madrid fault, which the last time it caused a major quake, made recent California or Japanese events seem like minor things). And when the prices to cover those events become extreme, recognizing the extreme overvaluation of the underlying asset, you should reconsider the ownership (something most people with coastal property should start to think about).

Twenty-odd years ago, when I first joined Harris Associates, I was assigned to cover DeBeers, the diamond company, since we were the largest shareholders in North America. I knew nothing about mining, and I knew nothing about diamonds, but I set out to learn. I soon found myself in London and Antwerp studying the businesses and meeting managements and engineers. And one thing I learned about the extractive industries is you have to differentiate the managements. There are some for whom there is always another project to consume capital. You either must expand a mine or find another vein, regardless of what the price of the underlying commodity may be (we see this same tendency with managements in the petroleum business). And there are other managements who understand that if you know the mineral is there sitting in the ground, and you have a pretty good idea of how much of it is there, you can let it sit, assuming a politically and legally stable environment, until the return on invested capital justifies bringing it out. For those who want to develop this theme more, I suggest subscribing to Grant’s Interest Rate Observer and reading not just its current issues but its library of back issues. Just remember to always apply your own circumstances rather than accept what you read or are told.

 The Honorable Thing

By Edward A. Studzinski

“Advertising is the modern substitute for argument; its function is to make the worse appear the better.”

               George Santayana

So we find one chapter at Sequoia Fund coming to a close, and the next one about to begin.  On this subject my colleague David has more to offer. I will limit myself to saying that it was appropriate, and, the right thing to do, for Bob Goldfarb to elect to retire. After all, it happened on his watch. Whether or not he was solely to blame for Valeant, we will leave to the others to sort out in the future. Given the litigation which is sure to follow, there will be more disclosures down the road.

A different question but in line with Mr. Santayana’s observations above, is, do those responsible for portfolio miscues, always do the honorable thing? When one looks at some of the investment debacles in recent years – Fannie and Freddie, Sears, St. Joe, Valeant (and not just at Sequoia), Tyco, and of course, Washington Mutual (a serial mistake by multiple firms)  – have the right people taken responsibility? Or, do the spin doctors and public relations mavens come in to do damage control? Absent litigation and/or whistle blower complaints, one suspects that there are fall guys and girls, and the perpetrators live on for another day. Simply put, it is all about protecting the franchise (or the goose that is laying the golden eggs) on both the sell side and the buy side. Probably the right analogy is the athlete who denies using performance enhancing drugs, protected, until confronted with irrefutable evidence (like pictures and test results).

Lessons Learned

Can the example of the Sequoia Fund be a teaching moment? Yes, painfully. I have long felt that the best way to invest for the long-term was with a concentrated equity portfolio (fewer than twenty securities) and some overweight positions within that concentration. Looking at the impact Sequoia has had on the retirement and pension funds invested in it, I have to revisit that assumption. I still believe that the best way to accumulate personal wealth is to invest for the long-term in a concentrated portfolio. But as one approaches or enters retirement, it would seem the prudent thing to do is to move retirement moneys into a very diverse portfolio or fund.  That way you minimize the damage that a “torpedo” stock such as Valeant can do to one’s retirement investments, and thus to one’s standard of living, while still reaping the greater compounding effects of equities. There will still be of course, market risk. But one wants to lessen the impact of adverse security selection in a limited portfolio. 

Remember, we tend to underestimate our life expectancy in retirement, and thus underweight our equity allocations relative to cash and bonds. And in a period such as we are in, the risk free rate of return from U.S. Treasuries is not 12% or 16% as it was in the early 1980’s (although it is perhaps higher than we think it is). And for that retirement equity position, what are the choices?  Probably the easiest again, is something like the Vanguard Total Stock Market or the Vanguard S&P 500 index funds, with minimal expense ratios. We have been talking about this for some time now, but Sequoia provides a real life example of the adverse possibilities.  And, it is worth noting that almost every concentrated investment fund has underperformed dramatically in recent years (although the reasons may have more to do with too much money chasing too few and the same good ideas). Is it really worth a hundred basis points to pay someone to own Bank of America, Wells Fargo, Microsoft, Johnson & Johnson, Merck, as their top twenty holdings? Take a look sometime at the top twenty holdings of the largest actively managed funds in the respective categories of growth, growth and income, etc., and see what conclusions you draw.

The more difficult issue going forward will be deflation versus inflation. We have been in a deflationary world for some time now. It is increasingly apparent that the global central banks are in the process (desperately one suspects) to reflate their respective economies out of stagnant or no growth. Thus we see a variety of quantitative easing measures which tend to favor investors at the expense of savers. Should they succeed, it is unlikely that the inflation will stop at their targets (2% here), and the next crisis will be one of currency debasement. The more things change.

Gretchen Morgenson, Take Two

As should be obvious by now, I am a fan of Ms. Morgenson’s investigative reporting and her take no prisoners approach. I don’t know her from Adam, and could be standing next to her in the line for a bagel and coffee in New York and would not know it. But, she has a wonderful knack for goring many of the oxen that need to be gored.

In this Sunday’s New York Times Business Section, she raised the question of the effectiveness of share buybacks. Now, the dirty little secret for some time has been that growth of a business is not impacted by share repurchases. Yet, if you listened to many portfolio managers wax poetic about how they only invest with shareholder friendly managements (which in retrospect turn out to have not been not so shareholder friendly after they have been indicted by a grand jury). Share repurchase does increase per share metrics, such as book value and earnings.  While the pie stays the same size, the size of the pieces changes. But often in recent years, one wonders why the number of shares outstanding does not change after a repurchase of what looked to have been 5% or so of shares outstanding during the year. 

Well, that’s because management keeps awarding themselves options, which are approved by the board. And the options have the effect of selling the business incrementally to the managers over time, unless share purchases eliminate the dilution from issuing the options.  Why approve the options packages? Well, the option packages are marketed to the share owners as critical to attracting and retaining good managers, AND, aligning the interests of management with the interests of shareholders. Which is where Mr. Santayana comes in  –  the bad (for shareholders) is made to look good with the right buzzwords.

However, I think there is another reason. Obviously growing a business is one of the most important things a management can do with shareholder capital. But today, every capital allocation move of reinvesting in a business for growth and expansion directly or by acquisition, faces a barrage of criticism. The comparison is always against the choices of dividends or share repurchase. I think the real reason is somewhat more mundane. 

The quality of analysts on both the buy and sell side has been dumbed down to the point that they no longer know how to go out and evaluate the impact of an acquisition or other growth strategy. They are limited to running their spread sheet models against industry statistics that they pull off of their Bloomberg terminals. I remember the horror with which I was greeted when I suggested to an analyst that perhaps his understanding of a company and its business would improve if he would find out what bars near a company’s plants and headquarters were favorites of the company’s employees on a Friday after work and go sit there. Now actually I wasn’t serious about that (most of the analysts I knew lacked the social graces and skills to pull it off). I was serious about getting tickets to industry tradeshows and talking to the competitor salespeople at their booths.  You would be amazed about how much you can learn about a company and its products that way. And people love to talk about what they do and how it stands up against their competition. That was a stratagem that fell on deaf ears because you actually had to spend real dollars (rather than commission dollars), and you had to spend time out of the office. Horrors!  You might have to miss a few softball games.

The other part of this is managements and the boards, which also have become deficient at understanding the paths of growing and reinvesting in a business that was entrusted to them.

Sadly, what we have today is a mercenary class of professional managers who can and will flit from opportunity to opportunity, never really understanding (or loving) the business. And we also have a mercenary class of professional board members, who spend their post-management days running their own little business – a board portfolio. And if you doubt all of this, take a look again at Valeant and the people on the board and running the business. It was and is a world of consultants and financial engineers, reapplying the same case study or stratagem they had used many times before. The end result is often a hollowed-out shell of a company, looking good to appearances but rotting away on the inside.

By Edward Studzinski