My uncle happens to be a great investor. I am lucky to have someone like this in the family whose brains I can pick to develop my own philosophy on investing. This series of posts are addressed as part of letters to my uncle in an attempt to understand investing. Communication by email is superior to just talking since, when you write a letter, you need to organize your thoughts into a coherent whole. Hope you enjoy this series
I have finally decided to look at stuff other than precious metals. So to this end, I went over to both UOB and DBS (where I bank in singapore) to take a look at some of the investment products they have over there. I had a talk with the guys there and this got me thinking. What exactly am I looking for? This post is an attempt to get a handle on this.
First, you need to define the objective. What is your investing objective. My objective is very simple. My cash should keep up with inflation. They should keep up with inflation at the end of a 35 year period (when I plan to retire) after subtracting taxes and all sorts of fees.
Now the task is to define inflation. Inflation according to the layman is the rise in general prices. According to an economist it is the increase in the amount of credit in circulation. According to the government, it is whatever they say it is. The U.S. government does not include fuel and food in it’s inflation calculation. This is clearly not my definition. So to define inflation, I first need to define my basket. My basket is whatever I am spending money on now and what I expect to spend money on in 35 years. So ladies and gentlemen, I present my basket
1. Rent: 35%
2. Utilities: 5%
3. Food: 20%
4. Fuel: 7.5%
6. Clothes: 2.5%
7. Medical Bills: 10%
8. Misc: 5%
The rough portfolio
Thus whatever fund you choose must have companies that are connected to the items you defined in one form or the other. As an example
1. To cover rent invest in Real estate companies
2. Utilities: Utility companies such as Reliant in houston
3. Food: Something like cargill seeds, monsanto, tyson etc
4. Fuel: like Shell
5. Transport: Car company like toyota, insurance companies etc
So you get the general idea. There are some tweaks you can do. For instance if you purchased a house which is the inflation hedge against rent, then you do not need to have real estate companies in your holdings. Similar ideas for the rest
Dividends, Dividends, Dividends. The hell with capital Appreciation
Any fund I choose absolutely must must pay dividends. I do not give a shit about capital appreciation. All I care is that I receive a dividend of about 4%-6% year on year based on the purchase price. So the fund must focus on dividends and not on capital appreciation. When I invest in anything, at some point it must provide me an income. This income it provides must be at the rate of inflation that is currently occurring. Otherwise I am actually losing money. If the fund cannot do that, I just go back to Gold. At some time later I will post one fully explaining why I do not want to play the capital appreciation game. In my opinion, dividends are to stocks what Gold is to the monetary system. Just as a Gold standard keeps the monetary authorities honest, Dividends keep the company/fund board of directors honest.
Read the people behind the fund
This is a lost art. In the old days, investors used to keep a close watch on the person in whose company they had substantial investments. They would try to find out if he smoked or drank, had any mistresses, cheated at Golf etc etc. They wanted to make sure that who ever they entrusted their money to was trustworthy. In today’s investment climate, this is hardly ever done. The only thing anyone ever looks at is how the fund has done in the last 5 years. As if performance over the last 5 years is any indication of how it will perform over 30 years.
Some of you have the experience of buying a used car. I have. Several times. And I knew very little about cars. And the used car business is full of cheats who will sell you lemons. These guys know a lot about cars and they know how to hide it’s defects for the time that a novice takes it for a test drive or does an examination. Unless you are a car mechanic yourself, this guy can hide the defects in the car he is selling you. So how did I prevent myself from getting cheated? Simple, I studied the guy selling me the car. His tone. Does he sound honest? Is there something off about him? Why is he selling this car? How long has he had it? Is he trying to rush me into buying, etc etc. It is the same with a fund manager. You cannot look into the fund manager’s research and find errors in it. Nor can you do a better job than him. You do not have the time. You have your own job to do. So rejecting or approving a fund after going through it exhaustively is not an option for most of us. The most we can do is to see that the fund generally matches our investment philosophy and is in the general area where you want to invest. Thus it is very important for you to be able to read the fund managers themselves. But first we must ask ourselves, what are we looking for from a fund manager
The Fund managers
In short, every investor looks for just two things from his fund manager. Integrity and competence. Integrity because he will not cheat you. Competence for…….. so obvious. If you have a small amount of money to invest, you will not get a chance to even see the fund manager face to face, let alone evaluate his character. So what to do? This is where the incentive structure of the fund comes into play. If the manager has put himself in such a situation that if his fund loses money, he loses money as well, then that is the guy I am looking for.
Choosing the fund manager
1. First, get a fund manager who has been in business for a while. Examine his past record. Is his past record part of public domain? Is the company’s past performance part of public domain? See if you can find even one company like this. The longer it has been in existence, the merrier. But your job is not yet done. Remember, that old financial institutions can also crash and take you down with them. Look at Lehman brothers. They survived the U.S. civil war, the two world wars, the great depression, the 1970s hyperinflation, but they could not survive the 2008 financial crisis.
2. Look at the incentive structure of the fund: Basically the fund manager should make money if you do. And he should ideally lose money if you do. Does he himself have a substantial investment in the fund he manages? Does he buy some portion of his own fund every year? Did he ever sell recently. Ideally, he should not be allowed to sell his stake in the fund until the end. Otherwise, since he has insider information, he can always bail and leave you holding the bag. So study the incentive structure thoroughly.
The ideal structure
1. Has a substantial part of his savings in the fund he is managing
2. Buys a bit of his own fund from time to time, i.e. he keeps growing his involvement in his own fund or the other funds that he or his company is managing. He get’s an income and savings every month right? He must put some part of his savings into his own funds.
3. He must not be allowed to sell his stake in his fund unless
a. He has an emergency and needs the cash to meet it
c. He is shutting down the fund and refunding everyone the money. Kinda like the quantum fund of Jim Rogers and George Soros in the 70s.
4. He does not receive cash payments from any source other than the company he is working for.
5. A fund managers assets are a matter of record for the shareholders in the fund.
If I can find a fund manager like this, then I’ll grab him with both hands and won’t let go.
As a thought experiment, let’s say my fund manager does screw me in spite of all my precautions. The question I must ask is, What can I do about it? How can I retaliate? What recourse is available from the law? This is a real possibility given the days. Remember MF Global? So what is it that you can do?