NEW ORLEANS, LOUSIANA – We were not at our best. Still, we managed to give a speech to the New Orleans Investment Conference. What follows is much of what we said:
We stand before you a profoundly ignorant man. (Actually, we felt no more ignorant than any of the other speakers. And in the back of our minds we wondered who was really ignorant – the man at the podium or the people who had paid to hear him. But we pressed on)…
What we don’t know is almost everything. We don’t know which investments will go up. We don’t know what will happen in the world. We don’t know if global warming is a farce or a fact. We don’t know if Peak Oil is something to worry about or something to ignore.
As Donald Rumsfeld put it, there are known unknowns; and there are unknown unknowns; and then there are things about which we don’t have a clue.
Still, that didn’t stop the Bush Administration from launching the biggest foreign policy blunder in U.S. history…nor does it stop us from having opinions and ideas about things. In fact, as we get older, the less sure we are that we know about anything. And there are people who think we already know nothing at all. But the less we know for sure…the more important it is to have rules and principles you can follow. So as we become more ignorant about what is going on, we become more stubborn in our opinions about things.
Now, imagine that there were no Barron’s…no Dow…no financial commentators…and no one writing books such as ‘Dow 36,000.’ If that happened, you’d have to rely only on your own eyes and ears…and your own ability to put two and two together. Investing would become a private matter.
The public spectacle of the whole thing – where you get Abby Cohen telling people how much ‘The Market’ is going up – would disappear…because there wouldn’t be any public investment market – just millions of private investment transactions, each one made on its own merits.
In our private lives, by the way, that is the way we tend to do things anyway. For example, if you were in the publishing business, as we are, you would look around to see how to invest your money without much thought to ‘The Market.’ You know you can get about 5% risk-free by buying U.S. Treasury obligations. And you know you can borrow at about 7% or 8%. So, in everything you do, you have to be sure that it will give you a return of more than that. Otherwise, it’s not worth doing…unless you’re doing it merely in an effort to learn something or to gain prestige…or to accomplish something else with a non-financial purpose.
But when we look for acquisitions in the publishing field that fit this objective we see that they are hard to find. We have to spend a lot of time talking to people, researching companies, studying bits and pieces, looking at a lot of publishing projects in order to find the one or two that make sense for us. And guess what, rarely are these investments available to the public. They tend not to be listed on the public investment markets. Out there in the public – where stocks are quoted on Wall Street – publishing businesses tend to be just too expensive.
In fact, in only one case did we find a publicly traded company that was cheap enough to consider. And that was the case of TheStreet.com…but only after it crashed. And even then it was only interesting to us and to a small handful of other investors from the industry who thought they knew what to do with it. In other words, even though it was available to the public, and even though it looked cheap enough to meet our criteria, a regular public-market investor probably still should have stayed away from it, because he wouldn’t have known what to do with it to make it profitable.
Well, as it turned out, TheStreet.com (NASDAQ:TSCM) figured that out for themselves too, and their share price rose to the point where it was no longer a good investment for us.
But how could it be that a stock could be too expensive for those of us in the industry who best understand it? Why is it that public market investors believe they know more about our industry than we do and are willing to pay higher prices than we are? We’ve been in the business for thirty years. How does the casual, public-market investor think he can do better with this company than we can?
We just bring it up to be provocative. We all know there’s a big difference between what goes on in public and what goes on in private life. A guy can make a fool of himself…most do…but it takes a crowd to make a real public spectacle. Because in public…in a crowd…in a stock market, for example, a guy will do what he would never do on his own. This includes paying more for a company than it is really worth. In private, he looks at the situation as we do when we are making an acquisition; he figures out what it will cost and what it should be worth to him. But in public, he gets pushed along by slogans, headlines, collective fears and impossible dreams that he wouldn’t possibly take seriously in his private life.
So, we give you our first general rule: you will do better investing privately than you will investing along with the public. Why is that? Because, a private investor is more likely to know what he knows and what he doesn’t. And by getting close to his private investments – by really knowing the industry and the business – he is able to eliminate some of the unknowns and make a better decision. Generally, that means he pays less for his investments and works harder to get them.
And now, another rule – the further you get from the facts and from the consequences of any action, the worse the results. This is true for individuals as it is for groups.
In politics it is obvious that a town meeting in New England is a long way from the U.S. Congress. Both are collective activities; both are, broadly speaking, forms of democracy. But the folks voting on where to put the new town dump are acting on information that is very close at hand. They know the area. And they don’t want to put the dump in the wrong place, because they are the ones who will have to live with it. If they put it upwind of the town, for example, the rest of the town will regard them as idiots and probably tell them so. And they will be very attentive to the costs, too, because they are the ones that will have to pay for it.
The U.S. Congress, on the other hand, is usually far removed from both facts and consequences. Members of Congress routinely vote on legislation that they haven’t even read. Not only do they readily vote to spend other people’s money, they often spend money that hasn’t even been earned yet by taxpayers who have not yet been born. And recently, they went along with a war in a country they’d never been to, for reasons they didn’t understand, paid for with money they didn’t have, and fought by soldiers who were not their own sons and daughters.
In ancient Rome, engineers were forced to stand under the arches they had designed when the scaffolding was removed. And in ancient Greece, not only did the sons of the assemblymen go out to fight, so did the leaders themselves. Not only that, the oldest veterans were put on the front lines!
If Americans wanted to make their government more responsible, they would force congressmen to put all their wealth in U.S. dollar bonds…and serve in every war they start. How long would American troops remain in Baghdad, we wonder, if each member of Congress were forced to serve a tour of duty there?
Our general rule works for investments too. The further you get away from them… and the less you suffer the consequences… the worse your investments will be. That’s why ‘collective’ investments are usually so bad. The investor himself does not take the responsibility for making decisions – removing him entirely from the facts – and managers do not suffer the consequences. These investments – index-linked funds, mutual funds, hedge funds – are just ways of being ‘in The Market,’ – not ways of making serious investments. And since the rate of returns you will get are always reduced by the managers’ fees, you’ll always – over time and on the average – get less than the market itself. And as we pointed out, getting ‘The Market’ is not getting much. Stocks go up and down. You go through a complete cycle – paying fees, taxes, commissions and adjusting for inflation – and you are usually about where you began.
Hedge-funds are a special case. Their ‘I win, You lose’ fee structures are so aggressive that the average hedge fund investor is almost bound to lose money. Even when the fund makes money, the manager takes a large chunk of the winnings. And, of course, when it loses money, he takes none of the losses. Since the average fund is likely to get average results, the average fund investor is likely to end up with less – not more – money.
Felix Dennis, publisher of Maxim magazine among other things, has a house on St. Barts. The luxury island is a playground for the rich and famous. Felix says that when he got to know his neighbors, he found that they were almost all hedge fund managers. ‘Where are the hedge fund customers?’ he wanted to know.”
Ater we made this speech, our old friend, John Mauldin came up and corrected us:
“You’re all wrong about hedge funds,” said he. “Some of them do make a lot of money. But they’re like stocks. The best ones are not available to you. And as you pointed out, you would have to work pretty hard to find the ones that will do well. The average hedge fund is no different from the average stock. On a good day, it will probably lose money for its owners. On a bad one, it will wipe them out.”
Markets and Money