I’ve read a few interesting books lately on some of the top technology visionaries of our time. They include Paul Allen (Microsoft), Larry Page & Sergey Brin (Google) and Steve Jobs (Apple). The books were all good reads (Idea Man, In the Plex, and Steve Jobs), although the Microsoft and Google tomes are a little too technical at times for those like me who know little about programming.

One thing jumped out at me about all of these trailblazers – they are/were extremely passionate about what they do. They’re geeks. They have an eccentric devotion to programming/creating/designing and are so engaged in their trade that nothing else matters to them. They don’t let traditional barriers get in their way, aren’t afraid of failure, and don’t compromise on what they believe in. Along the way, they’ve built some exceptionally cool stuff and changed the way we work and play. And there’s only more to come.

Google and Apple have been successful at developing software and products that are hugely complex at the back-end, yet simple and intuitive for the end user. This is a tremendous accomplishment. It’s something the wealth management industry should try to emulate every day.

Investing has its complexities at the back-end. Financial analysis is akin to the engineering that goes behind search algorithms or touch screen interfaces. Unlike Google and Apple, however, the industry does a poor job of making the user experience simple and efficient. There is no shortage of resources at the back-end (equity analysts, portfolio managers, etc.), but few firms put much thought or effort into making the customer experience simple and understandable.

Investing remains a complex activity to many people because the industry wants it to be perceived that way. It shouldn’t be. Investors don’t need hundreds of choices, undecipherable reporting and non-stop economic forecasts. They need a few sensible fund options, a clear investment approach, and plain-English reporting.

Allen, Page, Brin and Jobs threw out the old blueprint. They brought innovative thinking, fearlessness, simplicity, and a focus on the user experience to the table, with a touch of craziness. We could all use a little more geek in us.

I admit it. I occasionally read Vanity Fair. This month’s edition is worth picking up. Not because Lindsay Lohan is on the cover, but because there’s an interesting piece by Michael Lewis on Greece.

For those who aren’t familiar with Lewis, he’s the author of Liar's Poker, The Big Short and other bestselling books on investing and, oddly enough, sports – including Moneyball and The Blind Side.

In his latest article, he reviews a recent trip to Greece, where he traveled to learn firsthand how the small Mediterranean country sent shockwaves throughout the global economy when they came clean on their debt problems.

Lewis uncovers some scary facts and stats:

• The retirement age for Greeks who work jobs that are classified as arduous (which includes hairdressers, radio announcers and waiters) is as early as 55 for men and 50 for women;
  
• The scale of tax cheating is incredible, with an estimated two-thirds of Greek doctors reporting income under 12,000 euros a year (the amount that is tax exempt); and
  
• The easiest way to launder cash is to buy real estate, as Greece has no working national land registry.

His missive also includes a visit to a remote monastery to learn how a group of monks amassed a real estate fortune estimated at over $1 billion and are the subject of a parliamentary investigation for alleged damages to the government’s coffers.

The article, titled Beware of Greeks Bearing Bonds, is also available on Vanity Fair’s website – a good option for those who don’t want Lindsay on their coffee table.

Roger Lowenstein’s latest article in The New York Times is a must-read. In Taking Stock, Lowenstein (a financial author and journalist) draws parallels between the investment environment and mindset of individual investors today to that of the 1970s.

The most striking similarity between then and now? A disappearance in the “ethos of confidence in long-term investing.” As was the case in the ‘70s, investors are discouraged and tired today. Gloom is selling well. One needs to look no further than the rise of gold and prophecies of economic doom. As noted in the article, one investment strategist recently drew a crowd of 600 people to elaborate on his call for a “bloody, deep recession ... and a stock market crash of at least 60 percent.”

Investors in the U.S. are withdrawing money from equity funds for the third straight year. In Canada, it is no different. Money has been flowing overwhelmingly into bond and income-oriented funds for quite some time. What makes this trend more troubling is the extremely low yields and limited upside of many fixed income securities – government bonds in particular.

What many people are missing, according to Lowenstein, is an important principle of investing:

“What the herd tends to overlook is that stocks are not – except perhaps in the very short term – a bet on the odds of an apocalypse, nor are investors in securities rewarded for their prowess as macroeconomists. The real challenge of investing is so prosaic it is often forgot. Stocks are simply a claim on future corporate earnings: if you can buy those claims at a discount, you should do well.”

The author notes that Business Week proclaimed “The Death of Equities” in 1979. A remarkable bull market arrived in 1982. Many observers are predicting a similar fate for equities today, despite the fact that businesses are profitable and stock valuations are reasonable (particularly in relation to bonds). Beware of buying into the apocalypse.

I recently finished reading False Economy – A Surprising Economic History of the World. Along with its New York Times Bestseller status and praise from all the usual suspects (The Washington Post, Financial Times, The Economist, etc.), I was intrigued by the book’s accolades from Bono and Mohamed El-Erian (CEO of PIMCO, the largest bond fund manager in the U.S.). If it appealed to a rock star and a bond geek, I figured it must be worth a read.

The book is written by Alan Beattie, the world trade editor for the Financial Times. Beattie examines the different paths that various nations have travelled in their rise to economic success or failure.

False Economy leads off with a comparison of Argentina and the United States. Beattie points out that just a short century ago, both nations were in similar places. Yet, the paths they took were very different. He explains how Argentina backed a small number of wealthy and powerful landowning families while America favoured small homesteads and settlers. American business owners invested in industrializing their country and created a nimble industrial sector, while Argentina developed a fear of the free market and sealed off its manufacturing companies behind a high wall of tariff protection. The American political system absorbed new ideas while Argentine politics were dominated by a small, self-perpetuating elite, which eventually led to a military coup and a nationalist (if not fascist) form of government. And the rest is history.

Beattie then jumps to the middle east to examine the strategic use of water and questions why Egypt doesn’t import more of its staple food. Subsequent topics include oil and diamonds (he suggests they are more trouble than they are worth), the role of religion in economic fate, and corruption (which he opines may be less damaging than it first appears).

Each of the book’s 10 chapters examines a particular nation or region and its economic history, with the author’s take on why the nation succeeded or failed and what lessons were learned along the way. His wish is that “the experience of history should lead us to hope and strive to make the world better, not to despair and resign ourselves to fate.”

While the book can be dense at times, Beattie keeps readers engaged by exploring seemingly random yet provocative topics, such as why Africa doesn’t grow cocaine, why much of America’s asparagus comes from Peru, and why giant pandas are “incompetent, inefficient piebald buffoons, and we should end their public subsidies and let them die out”.

All said, False Economy is an interesting book with good insights and lots of useful information. Yet, it reads like a text book in parts, which is why, like me, you may want to have your iPod on hand if you need a break. I found U2 to be rather appropriate.

Michael Lewis has a talent for writing about financial issues in a provocative and colorful manner. Having worked as a bond salesman for Salomon Brothers in the 1980s, he leans on his experiences and lessons learned on Wall Street to bring his readers ‘inside the tent’.

His latest work, The Big Short, is a narrative on the U.S. housing market crash. Unlike many books and articles on the topic, however, Lewis focuses his novel on a small group of investors who were on the ‘other side of the trade’ (i.e., betting that the rapidly escalating housing market would implode).

He tells the story of three groups of investors who were unwavering and obsessive in their bets against subprime mortgage bonds. And who made a whack of money because of it. He explains the birth and role of credit default swaps (CDS) and collateralized debt obligations (CDO) – those much talked about but little understood financial instruments that helped serve to bring down the likes of AIG, Bear Stearns, Citigroup and Lehman Brothers, among others. And he illustrates the colossal failure of risk management departments and rating agencies to identify and curb the risks that were growing in the system.

While the outcome is known in advance, Lewis’ take on the recent financial and housing market collapse provides many fresh and humorous (albeit dark) insights and observations. Aside from gaining a greater understanding of what was, and wasn’t, happening behind the scenes, a key takeaway is that investors who do their homework and who have a great deal of conviction in their strategies shouldn’t be afraid to run against the herd. Indeed, simply being one of the sheep can lead you to slaughter, as was the case of virtually every major Wall Street investment bank in 2008/09.

The Big Short is receiving some great reviews. One of my favorites is, “Michael Lewis doing what he does best, illuminating the idiocy, madness and greed of modern finance…Lewis achieves what I previously imagined impossible: He makes subprime sexy all over again.” (Andrew Leonard - Salon.com ). Canadian Capitalist also reviewed the book in a positive light in a recent blog. And who knows, we may even see it on the big screen in the future, given Lewis’ recent success with The Blind Side. It’s a fairly quick read, and last I checked it was on sale at Costco for about 40% off. So grab a 24-pack of popcorn and tuck in.

Related reading:
Book Review: Panic
Recommended Reading (The End)

If this month is like previous years, the content in the business publications and industry research will get less and less relevant as we move towards the New Year. Around Christmas the papers and on-line sources will be peppered with fluffy year-end pieces (including my own) and undoubtedly this year there will plenty of decade-ending themes.

In recognition of this content vacuum, December is a good time to make an adjustment to your investment reading habits. I would suggest you substitute time with the business section or on-line and use it to read an investment book that focuses on long-term investment principles. We have a number of recommendations:

• Unconventional Success (David Swensen)
  
• The Four Pillars of Investing (William Bernstein)
  
• Buffett: The Making of an American Capitalist (Roger Lowenstein)
  
• Winning the Loser's Game (Charles Ellis)
  

You may also want to check out some of our other must-reads, from a blog I posted a while back.  If you’ve read all of these already, you might want to go back and re-read one. After the markets we’ve experienced, a dose of religion is not a bad thing.

Happy reading.

Panic is a compilation of articles that shed light on the most severe upheavals in recent financial history – the crash of ’87, the Russian default and subsequent collapse of Long Term Capital Management, the Asian currency crisis of 1999, the Internet bubble, and the U.S. subprime mortgage crisis.

Although the book is edited by Michael Lewis (the author of Liar’s Poker and Moneyball), the articles were written by various prominent financial journalists/authors including Roger Lowenstein, Paul Krugman, Lester Thurow and Lewis himself. While many of the pieces appeared in publications such as The Wall Street Journal, The Economist, The New York Times, and Fortune, some are excerpts from books written at the time.

As taken from the inside cover, “Some of the pieces paint the mood and market factors leading up to the particular crash, or show what people thought was happening at the time. Others, with the luxury of hindsight, analyze what actually happened.”

I found it particularly interesting, not to mention entertaining, looking back at the articles written in the dot-com era. From the incredible rise and subsequent drubbing of start-ups such as Pets.com, Books-A-Million, and Egghead.com, these pieces do a good job illustrating the euphoria and emotion that can so easily overcome investors.

The last section of the book, which deals with the subprime crisis, also has several well-written articles that help explain how Americans got into the current mortgage mess, where defaults and the phenomenon of ‘negative home equity’ have become all too common. If you’re looking for a plain-English explanation of the emergence and function of complex investment vehicles such as CDOs, SIVs and credit default swaps, the collection of articles that Lewis has chosen are a good place to turn.

Panic is a great read for the patio this summer – assuming that the house connected to that patio isn’t worth less than the mortgage attached to it.

Biggs recently wrote an article for the Financial Times titled We are in for the Mother of all Bear Market Rallies.  The piece provides some perspective on the looming opportunity in the market.  For those investors tired of hearing nothing but doom and gloom, it’s a refreshing read.

But this week a friend alerted me to a treatise by Michael Lewis on Conde Nast’s Portfolio.com.  His story about the development of the sub-prime mess and the rot on Wall Street is a worthwhile read.  It has real people, drama and plenty of insight. 

The world first met Michael Lewis when he wrote Liar’s Poker, which was about his three years at Solomon Brothers.  It was an expose on the inner workings of Wall Street.  The book turned out to be a big seller and served to launch Lewis’ career as a writer.

As I remember, I didn’t much like Liar’s Poker.  I was working on the sell side of Bay Street at the time and I took it personally.  I thought Lewis exaggerated too much.  In a similar vein, I didn’t like Oliver Stone’s Wall Street either. 

As a total aside, I did love Lewis’ Moneyball, which married two of my passions - sports and business.  The book was about how Billy Bean, the General Manager of the Oakland A’s, turned baseball’s conventional thinking on its head.  It resonated with me because my ‘armchair instincts’ told me that the sports establishment’s traditional methods were too often wrong.  In football, the ‘prevent’ defense never prevented anything but unlikely comebacks.  The math behind the sacrifice bunt never made sense to me, as Lori heard too many times when we watched the Blue Jays in the 90’s.  And I always wondered why good running teams in basketball eschewed the fast break at the end of a game when easy baskets are hard to come by.

That is a long-winded introduction to Lewis’ current piece, simply titled “The End.”  Since his days at Solomon, he has been anticipating the demise of Wall Street.  “In the two decades since then, I had been waiting for the end of Wall Street.  The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management.   Over and over again, the big Wall Street investment banks would be in some narrow way, discredited.  Yet they just kept on growing...”

Lewis refers to people like me.  There were many who saw the housing crisis coming, but didn’t nearly appreciate the magnitude of the silliness (it didn’t take much time holidaying in the U.S. in 2004 and 2005 for me to understand how bad the cycle could get and the impact it would have on mortgage default rates).  Lewis’ article provides some background behind the silliness and why the value destruction has been so enormous.

It is not a short read, but I highly recommend it. 

Lowenstein is particularly critical of the industry’s imperative of putting marketing and asset gathering before the best interests of investors, not to mention the proliferation of new, often complex products.

I highlighted a few gems from the book that stuck with me:

• On the growing product shelf: “In 1970, there were 300-odd mutual funds for both stocks and bonds; there are now 4,800 equity funds alone.  But instead of providing guidance and stewardship, the fund companies are exploiting the public’s lack of patience and sophistication, recklessly breeding new variants of funds to (they hope) attract investors chasing whatever is the flavor of the day.”
• On the growing complexity of building a portfolio: “The term ‘stand-alone’ was an artfully crafted reference to the days, now past, when the goal of a fund was simply to make money and to outperform the market as a whole.  Two or three funds were commonly thought to be the right number (perhaps a couple of stock funds, plus a bond fund); taken together, they would provide all the diversification one needed.”
• On asset allocation and diversification: “All things being equal, it makes sense to invest with generalists, managers who will try to capture good values anywhere they can find them, here and abroad, in small-cap or large-cap stocks, distressed debt or spin-offs.  Since no one sector will offer good value at all times, a sector fund (such as an energy fund) has dumped back on you, the investor, the responsibility for knowing when to get in and when to get out.  The asset allocation strategies built around those style or sector funds imply that an investor needs a lot of funds in order to be adequately diversified.  That’s just plain wrong...”

In these troubling markets where investors are arguably the most susceptible to exploitation, I thought it would be interesting to apply Lowenstein’s above views to several new products that recently came across my desk.  Consider the Mackenzie Universal Africa and Middle East Fund and the Franklin MENA (Middle East and North Africa) Fund.  Do these products represent solid long-term investment solutions or a reckless attempt to gather assets?

The Bank of Montreal (BMO) and Guardian Group of Funds (GGOF) also recently announced that they are expanding their product line-up under a new brand name, the BMO Guardian Funds, with over 25 options to choose from.  Among the new funds are the BMO Guardian Sustainable Climate Fund and the BMO Guardian Sustainable Opportunities Fund.  Do all these (overlapping) options make it any easier for investors or advisors to build a portfolio?

Then there’s the new iShares Portfolio Builder Funds, offered by Barclays Global Investors (BGI).  These four funds are baskets of ETFs that are monitored by BGI and rebalanced to specific allocation parameters.  Let’s take a closer look at the iShares Growth Core Portfolio Builder Fund.  The fund’s objective is to ‘identify and optimally diversify certain fundamental sources of return through a proprietary multi-factor selection process.’  It holds 21 ETFs in varying proportions to achieve this objective.  Do investors really need 21 funds and a multi-factor selection process to be adequately diversified? 

There’s sure to be more funds launched in the coming months as fund companies attempt to recapture assets lost to redemptions and steep market declines.  Investors are well advised to be skeptical before taking the bait.  For those who have the knowledge and interest in investing in specialized new products, the first place to go looking may be last year’s latest and greatest offerings.  The energy, mining, emerging markets, China and agriculture funds have been deeply discounted.

Do you think we will learn anything from all of this turmoil?

We will learn an enormous amount in a very short time, quite a bit in the medium term and absolutely nothing in the long term.  That would be the historical precedent.

Canadian Capitalist, a prominent financial blogger, recently posted a glowing book review of David Swensen’s Unconventional Success: A Fundamental Approach to Personal Investment.  CC followed up the review with another posting today (How to Pick a Winning Mutual Fund), in which he highlights some of the attributes that Swensen encourages investors to look for in a fund manager.  These include: treating investors’ money as their own, looking for managers that invest significant portions of their wealth in their own fund, concentrating their portfolio in their best ideas, and charging low fees, among others.

We couldn’t agree more.  In fact, as longstanding readers of our blog may be aware, it was Unconventional Success that was a driver for the creation of Steadyhand.  In the book, Swensen voices a lot of his ‘beefs’ about the mutual fund industry that we share.  Most notably, he criticizes bloated portfolios, high turnover, poor alignment of interests (between investor and manager) and excessive fees as being all too common. 

There are many pearls of wisdom to take from Swensen’s book, which is also at the top of our must-read list.

Mutual funds (and active management) draw plenty of criticism from a lot of industry observers, including Swensen and Canadian Capitalist.  We don’t disagree with much of this criticism; rather, we’re out to change it.  When some of Mr. Swensen’s above-mentioned concerns are addressed, active management can be a beautiful thing.

It is all good, but I particularly liked his opening theme about short termism. 

I should note that Dan has started his own firm, Lewin Capital Management, and will be managing portfolios for individual clients from his office in Vancouver. 

In his book More Than You Know – Finding Financial Wisdom In Unconventional Places, Michael Mauboussin takes a different approach to the question.  He starts by assessing the competition - the index - and what its investment approach is.

In his scouting report, he points out that the S&P 500 selection committee “does no economic forecasting, invests long-term with low portfolio turnover, and is unconstrained by sector or industry limitations, position weightings, investment-style parameters, or performance pressures.” 

That’s what an actively-managed U.S. equity fund is up against - a disciplined competitor that keeps it simple and is not bound by false constraints or short-term pressures.  The S&P 500 is also not burdened with a high management fee (investors can buy an exchange-traded fund for a fraction of 1%). 

The S&P is a tough competitor, but in his book Mr. Mauboussin discusses four attributes of managers that have beaten it for the 10-year period ending December, 2004.  They are:

1. Low turnover – The firms that beat the market had portfolio turnover of 27% per year compared to the average for all equity funds of 112%.
2. Portfolio concentration – On average, the winning funds held fewer stocks.
3. Intrinsic-value investment approach – The winning fund managers focused on buying stocks that are trading below their true value.  They were not overly influenced by the makeup of the index they were trying to beat, namely the S&P 500.
4. Diverse geographic locations – Very few of the managers that beat the index were from New York and Boston.

By no means do these attributes guarantee success, but the odds go up.  And they go up even further if you have:

5. Smart people with a good disposition for investing – The portfolio manager has to be comfortable going against the grain, which means he/she is willing to be wrong...on their own...from time to time.
6. A supportive and stable environment – An independent-thinking manager has to be working at a firm that is comfortable being different and has chosen its clients accordingly.  
7. A beatable benchmark – Some indexes are easier to beat than others.  The S&P 500 is one of the tougher ones, while our index, the S&P/TSX, has historically been much easier.  Active managers should play in an arena where they have a good chance of winning.
8. Reasonable fees – It helps a lot.

To beat the index in the long term, you need to ignore it in the short term.  This is hard for portfolio managers to do, because they are constantly being assessed (daily) against a benchmark.  And it is why the S&P 500 is so hard to beat.

If you’re a fan of our blog, you may want to check out a few of these other sites as well.  There’s something for everybody’s taste, from the insightful to the eclectic and offbeat.

As always, if you have any feedback on Cutting Through the Noise (our blog), we’re all ears.

Jonathan Chevreau’s article in Wednesday’s Financial Post highlights the latest book that bashes the mutual fund industry, The Investor’s Dilemma: How Mutual Funds are Betraying Your Trust and What to do About it, written by Louis Lowenstein.

It’s books like these that pushed us to create Steadyhand.  They often highlight the industry’s warts – high fees, bloated portfolios, poor alignment of interests, etc.  In fact, it was David Swensen’s book Unconventional Success that really gave Tom a kick in the ass to develop a better model than the status quo.  I should note that I haven’t yet read Lowenstein’s critique, but I have a good idea of where he’s going based on Chevreau’s synopsis.

Lowenstein concedes that despite the industry’s flaws, mutual funds are an “intrinsically attractive and flexible vehicle.”  He recommends that investors look for the following attributes when picking a fund:

• Small size (assets under management)
• Low turnover
• Evidence of solid performance and experienced managers
• Co-investment (the manager has a siginficant portion of their own wealth invested alongside yours)
• Signs that the manager isn’t afraid to invest in out of favour companies
• Keep it general (few constraints; let managers find value wherever they can)

We couldn’t have said it better.

Just for fun, we selected a number of popular blog and Globe and Mail articles, and surprised Tom before Christmas with a hardcopy book of his writing. You can download an ebook version here (296kB, pdf, Adobe Reader 8 or higher required). We'd love to hear your thoughts on it.

1. Theory - emphasizes that investment returns are primarily a reward for risk, and provides a basic introduction to the theory behind the returns generated by various asset classes. He also provides a sound introduction to the value of portfolio diversification.
2. History - describes the historical returns generated by different asset classes, and the times when the markets have become separated from reality.
3. Psychology - explains why many of us are bad investors.
4. Business - why much of the investment industry is structured in direct conflict with investors best interests.

David Sung, from Nicola Wealth Management in Vancouver, has written an article about just this phenomenon. In it he references a Dalbar study that shows a 7% return gap between the S&P 500 index and the average U.S. investor over the 20-year period ending 2006. In the article, David reviews the reasons why this happens and outlines a "thumb sucking" strategy for preventing this shortfall from happening in the future.

It’s a good read and a good reminder. We’re all for strategies that keep us acting rationally and prevent us from blowing our portfolios up at market extremes.

Katsenelson believes that we are in a range-bound market, defined as a market that goes up and down, but ultimately ends up back where it started. He believes that this market will end around 2020, and will be characterized by a period of gradual P/E compression. Traditional value investors who buy and hold stocks for a long period of time will fare poorly in this type of market.

The book provides a sound analytical framework for evaluating stocks, the Quality, Valuation and Growth (QVG) framework, and delves into absolute valuation tools. Katsenelson advocates an active buying and selling process during range-bound markets, and emphasizes the importance of stock selection and the selling process. One of the reasons I like this book is that our managers all focus on bottom-up analysis and stock-picking.

I thoroughly enjoyed this book and feel that its ideas are relevant to investors in any market.

There has been a lot written about Canada’s asset-backed commercial paper debacle. Unfortunately, it’s not easy to sort it all out, given that everyone has an axe to grind on the issue.

Diane Urquhart is an independent analyst who I have followed for many years. I became aware of her during the mid-80s when we were both equity analysts on Bay Street and followed some of the same stocks. She got my attention because she knew way more about the insurance companies than I could ever hope to know. She was the research director at Burns Fry and, subsequently, ScotiaMcLeod. I give you this background because last week Diane published a terrific report on the ABCP issue. She titled it Another Made-in-Canada Defective Investment Product. It filled in some of the blanks for me and highlighted how difficult it is going to be to solve the problem.

For those who are interested in the topic, or have been impacted financially, I highly recommend giving this report a read.

On efficientfrontier.com, William Bernstein recently published an article titled ‘Comin’ Around Again?’ in which he made some comments on the proliferation of ETF offerings in the U.S. I think it serves as a good follow-up to our earlier postings on the subject.

As we’ve noted numerous times, we are fans of the original ETFs. These are the ones offered by Barclays that provide investors with broad market exposure at a cheap price. We have advised caution, however, in face of the numerous specialized funds that are coming to market which carry higher fees and require that buyers have more investment knowledge.

The following two paragraphs from Mr. Bernstein’s column capture our concerns perfectly.

“A few weeks ago, Jim Wiandt, the founder and publisher of Journal of Indexes, sent me, almost tongue-in-cheek, a listing of ETF issuances expected for later in the year. The list boggled the mind. Aside from the usual single country and slice-and-dice packages, there were, I kid you not, funds based on nine different NAREIT benchmarks (TB: these indexes track the REIT industry), a "Dynamic Brand-Name Products Portfolio," an Inverse Materials ETF, a Healthy Lifestyle fund, an Elliott Wave ETF, a Georgia (the state) ETF and, my favorite, an "Ultra-Short S&P 400 MidCap 400 Citigroup Growth" ETF. I began counting and lost track at 500.

Over the years, I’ve learned that disagreeing with Jack Bogle is not a good idea. I originally thought his view of ETFs was unduly alarmist: little speculative cherry bombs with which investors could blow up their savings. After all, the first Barclays products sported minuscule fees and mirrored most of Vanguard’s market-segment offerings - surely, they would be carefully assembled into efficient portfolios with a long view out to the horizon. And once again, the Sage of Valley Forge won the point: As the splinters get thinner, they grow sharper, and the odds of folks hurting themselves with these pointed objects now approach one hundred percent.”

“In the end, one strategy or style is probably as good as another...the problem for average investors is that they get pumped about a strategy at exactly the wrong time, usually because they have been sold a concept on the back of some hot performance numbers.”

Click here to read the full article.

He recently dusted off Roger Lowenstein's book, Buffett: The Making of an American Capitalist, and added it to our list of Must Reads on Investing. Here's his synopsis:

Since this is an older book, I wanted to re-read it before I put it on our reading list. Having done that, I couldn’t recommend this Buffett biography highly enough. As with the other Lowenstein book on the list (When Genius Failed: The Rise and Fall of Long-Term Capital Management), this book is an effortless read. I particularly liked the early background on Buffett after he left Ben Graham and began to forge his own way. The intellect and discipline he demonstrated at a young age helped me put his Berkshire Hathaway accomplishments in perspective. At the end of the book, Lowenstein takes the reader through how Buffett put his reputation on the line during the Salomon Brothers decline (and turnaround). It served as a spine tingling crescendo to a terrific book.

As part of his July letter, Grantham offers a buyer's guide, or perhaps it’s more of a reality check, for those looking to invest with a private equity firm. The piece is not aimed at the typical client of Steadyhand, but there are useful lessons that can be applied in a broader context and be useful for all buyers of investment management services.

So as a follow-up to my July 21st Globe & Mail column (Will Going Public Kill Private Equity?) here are a few things that I took away from Grantham’s commentary.

• He surmises that with the flood of people getting into the game, the exceptional private equity firms now make up at best 10% of the business. Ten years ago, it was 20-25%.
• Unfortunately, the average practitioners (and worse) have the same fee schedule as the elite 10%.
• If an investor hires a private equity manager, he/she is being forced to pay a steep fee on all elements of the fund’s return, each of which has a different amount of added value. For example, the 2 and 20% fee is applied to (1) the manager’s added value (great … send it in); (2) the normal market return during the term of the fund (which is available through an ETF at a fee of 0.25%); and (3) the leverage applied to the portfolio (for which you are taking the risk). TB: If we disaggregate the components of a balanced mutual fund, a mutual fund wrap (which are hugely popular right now) or principal-protected note, the same situation exists. Investors are paying a high fee on the whole product, despite the fact that only a small portion of it deserves that level of fee.
• The premium prices private equity firms are now paying to acquire assets offsets any added value the manager can provide from improving operating efficiency, focusing the company on its strengths and/or fixing the capital structure.
• Grantham notes that it is now assumed that increasing a company’s leverage increases its value. Disappeared is the ‘age old paradigm’ (my words) whereby the value of leverage is offset by increased risk. To quote Grantham - “[This] is a new idea in this cycle … [whereby] leverage is a free good not burdened by increased risk.”
• As opposed to a perfect storm, Grantham suggests that private equity has had the “perfect calm” as a result of easy credit, low risk premiums, rising profit margins and high price-earnings multiples. In the perfect calm, all funds do well (not just the best ones) and a lot of the industry’s sins are covered up. TB: I would add that this applies to all kinds of asset classes including hedge funds and good ole mutual funds.
• He thinks that few managers are assuming in their models that (1) profit margins will drop below the current record levels or (2) price-earning multiples might decline. TB: Profit growth and healthy valuations are taken for granted. But if both these factors reverse direction, look out.

Private equity provides the most illuminating canvas for Grantham’s comments, but when it comes to management dilution, fees, corporate profits and the perfect calm, they apply to all types of equity investing.

I must admit that before I started working at Steadyhand last year, the term blog was pretty much a foreign concept to me. ‘Blogging’ sounded more like a slang term or a new extreme sport from New Zealand (to go along with bungee jumping, river sledging and zorbing) than a form of internet communication.

Needless to say, I quickly discovered the meaning of the word (for those readers who are still unsure, it’s basically an informal web log), as Tom and Neil had already set up a blog for Steadyhand and were posting entries every couple of days. I’ve even posted a few of my own now.

I’ve learnt that blogs are a great way to communicate opinions and information and learn more about certain topics or read what others have to say about timely issues or events. In the world of investing, there are a number of articulate blogs written by Canadian investors that I enjoy reading. Below are just a few:

Canadian Capitalist
Larry MacDonald’s Investing Ideas
The Wealthy Boomer
Crunch Money
Financial Jungle
Four Pillars

While I don’t always agree with everything they have to say, these bloggers often offer well-thought opinions and analysis on financial matters.

Another site that offers a ton of information and opinions from Canadian investors is the Financial Webring. The webring forum is “an informal group of websites which promote individual financial education and empowerment.” Whenever there’s a new development in the investment industry, you can be sure that there will be a thread on it in the forum.

If you’ve got some downtime this summer, check out some of these sites. Some of them are pretty blog damn good.

The list is by no means exhaustive, and I’m always interested in hearing what other investors are reading. To this point, I was reading a blog by Canadian Capitalist the other day titled Books Recommended by William Bernstein. Towards the bottom of the list, I noticed Winning the Loser’s Game by Charles Ellis. This is another great book, albeit a little dense, on investing. One of Ellis’ quotes (from a paper that he later wrote) rings particularly true with Steadyhand’s investment philosophy, and that of our managers. In fact, you can find it on CGOV’s website:

“Increasing the number of holdings dilutes our knowledge, disperses our research efforts, distracts our attention, and diminishes our determination to act – when really called for - decisively and with dispatch. If you work hard enough and think deeply enough to know all about a very few investments, that knowledge can enable you to make and sustain each of your major investments with confidence. The more you “diversify” by increasing the number of different investments you must understand, the more you risk increasing your not knowing as much about each investment as do your best competitor investors - particularly the most expert and thus the quickest to take preemptive action.”

It has been a number of years since I last read Ellis’ book. Bernstein’s list reminded me that I should dust it off and peruse it again.

Unconventional Success: A Fundamental Approach to Personal Investment

Author: David Swensen (2005)

Comments: Steadyhand's bible. A U.S. perspective, but Swensen's principles apply in any geography.
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Straight Talk on Investing: What You Need to Know

Author: Jack Brennan (2002)

Comments: A U.S. book, but a good read on the basics of investing and mutual funds. Written by the Chairman and CEO of The Vanguard Group.
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Why Smart People Make Big Money Mistakes

Author: Gary Belsky (1999)

Comments: A fun introduction to the field of behavioral finance. It's written for the individual investor with lots of everyday examples to engage the reader. We should all read it once a year.
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The Essays of Warren Buffett: Lessons for Corporate America

Author: Lawrence Cunningham (2001)

Comments: If you're not a Buffett devotee and and haven't read all his annual reports, this compilation is an excellent way to gain from his wisdom.
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Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger

Editor: Peter Kauffman (2005)

Comments: A compilation of wisdom from Warren Buffet's sidekick. It's a huge book that extends beyond the topic of investing and has lots of repetition in it. But it is full of great pearls to keep us all well grounded.
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Fooled by Randomness

Author: Nassim Taleb (2001)

Comments: A more advanced book that challenges the way we think about investing. Taleb is quite an arrogant fellow. People either love this book or hate it. I love it.
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When Genius Failed: The Rise and Fall of Long-Term Capital Management

Author: Roger Lowenstein (2001)

Comments: The story behind the infamous bailout of Long-Term Capital Management, the largest failed hedge fund to date. While it's a few years old, it provides an inside look at the hedge fund world. Lowenstein is easy to read; to me, it read like fiction.
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Buffett: The Making of an American Capitalist

Author: Roger Lowenstein (1995)

Comments: An effortless read. The intellect and discipline that Buffett demonstrated at a young age helped me put his Berkshire Hathaway accomplishments in perspective.