Now What?
By Ben Carlson, CFA
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Agenda:
1. Markets Are Hard
2. How to Survive
3. How to Make Better Decisions
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My Books
Organizational A Wealth of
Alpha Common Sense
CreateSpace, 2017 John Wiley & Sons,
2015
A manual for
institutional How simplifying the
investors to improve investment process
decisions and add can improve long-
value through term investment
intelligent planning results by avoiding
and organizational complexity
structure
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Markets Are Hard
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More worried than ever
"By holding interest rates at zero, the
government is basically tricking the
population into going long on just about
every kind of security except cash, at the
price of almost certainly not getting an
adequate return for the risks they are
running. People can't stand earning 0%
on their money, so the government is
forcing everyone in the investing public
to speculate.
"I am more worried about the world,
more broadly, than I ever have been in
my career."
- Seth Klarman, Baupost Group
A Crash is Coming?
Is the Fed Out of Ammo?
Valuations & Rates, Oh My!
Predicting Bond Returns
Bond Yields
The Biggest Risk to Bonds?
CAPE Fear
Caveats on the CAPE Ratio
No SEC or Federal Reserve for much of this time frame
The U.S. was once an emerging market. As wealth rises, valuations
rise
Markets are more liquid and transaction costs have fallen substantially
Over the past 25 years CAPE was above the long-term average 95%
of the time
Through December of 2016 CAPE spent just 16 out of 309 months
below 16.8
The Four Most Dangerous Words
The investor who says, This
time is different, when in fact
its virtually a repeat of an earlier
situation, has uttered among the
four most costly words in the
annals of investing.
Every Time is Different
In 1957 the S&P 500 consisted of 425 industrials, 60 utilities & 15 railroad
stocks
Until 1988 it was 400 industrials, 40 financial & 20 transportation stocks
Americas largest company in 1902 was U.S. Steel. They generated $3,340 of
sales per employee. Today Facebook generates $2 million in revenue per
worker.
Mutual fund sales loads average 8-10% in the 1950s and 1960s
The first stock index fund was created in 1976. The first bond index fund didnt
come along until 1986
The 401(k) is ~30 years old. IRAs havent been around much longer
The entire concept of retirement is a 20th century phenomenon. In the past
most people simply worked until they died
Context on those Four Dangerous Words
The only way to avoid mistakes is not
to invest -- which is the biggest mistake
of all. So forgive yourself for your errors.
Dont become discouraged, and certainly
dont try to recoup your losses by taking
bigger risks. Instead, turn each mistake
into a learning experience. Determine
exactly what went wrong and how you
can avoid the same mistake in the
future.
The investor who says, This time is
different, when in fact its virtually a
repeat of an earlier situation, has uttered
among the four most costly words in the
annals of investing.
The big difference between those who
are successful and those who are not is
that successful people learn from their
mistakes and the mistakes of others.
How Things Have Changed
on Wall Street in 50 Years
Trading volume on the NYSE has increased from 3 million/day to 5 billion
Retail investors accounted to 90% of all trades. Today, 95% is performed by
professional investors
Trading costs have fallen 80-90% since May Day in 1975 when fixed-rate
commissions were abolished
There are more than 320,000 Bloomberg terminals with near unlimited market
& economic data available 24 hours a day
There are more than 130,000 CFA Charterholders with another 200,000
studying for the tests
Reg FD has required all corporate information be made simultaneously
available to all investors
Source: The Index Revolution by Charley Ellis
CFAs vs. Stocks
How to Survive
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Doing Nothing is a Decision
Dual Mandate
Over the long-term Over the short-term
Risk & return are related Risk & return often not related
Volatility is more consistent Volatility tends to cluster
Markets are kind of, sort of efficient Markets are inefficient
How do we grow our portfolio to How do we survive severe market
reach our goals? disruptions?
The Shiller/Fama Paradox
Marrying Tactical & Strategic
Extreme market scenarios make any reasonable asset allocation look
silly or careless at times
Portfolios should be behaviorally aware to account for the human
element
The great strategy you cant stick with will leave you worse off than
the good one you can stick with
Having a rules-based solution can eliminate the risk of making poor
decisions when emotions are running high
Most tactical approaches seek to beat the market while we look to
encourage good behavior
Stock Market Volatility Clusters
at the Extremes
30-Day Standard Deviation
Average Standard Deviation
25 Best Days
25 Worst Days
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Avoiding The Best and Worst Months
$10,279
All Days
Missing 25 Best Months
Missing 25 Worst Months
$265
Missing 25 Best & 25 Worst Months
$114
$2.95
Trend-Following
Trend-Following
Why Markets Trend
Rising prices attract buyers, falling prices attract sellers.
The Lost Decade
Growth of $1: U.S. vs. Europe
Diversify Globally
Making Better Decisions
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Are You Rational?
Unfortunate Realities of the
Investment Business
A talented sales staff will trump a
talented investment staff when
attracting $ from clients
The products that sound the best are
often the worst ones to invest in
Clients are often in search of
unrealistic solutions
Increased activity does not necessarily
lead to better results
There are no guarantees
Everyone Loves a Good Story
We prefer emotional narratives to accurate data
Stories stick with us not statistics
Your Brain on Money
The brain activity of a person making $ on their
investments is indistinguishable from a person
high on cocaine or morphine
Financial losses are processed in the same
area of the brain that responds to mortal
danger
Our brains automatically & unconsciously
expect a 3rd repetition after it sees 2 in-a-row
The anticipation of a gain evokes a much larger
response than actually receiving the gain
The bigger the potential gain the greedier you
feel (regardless of how poor the odds might be)
Institutions Chase Performance
Researchers looked at the
investment choices from consulting
firms that control roughly 90 percent
of the U.S. consulting market. They
found, no evidence that
consultants recommendations
add value to plan sponsors. In
fact, the average returns were much
worse in the funds they
recommended than non-
recommended funds.
Process > Outcomes
Organizational Alpha
Client education & improved communication efforts
Behavioral management & modification
Effective forms of communication
Setting realistic expectations
Ensuring alignment of mission & portfolio
Documenting the investment process
Saying no over and over again
Honesty, transparency and the ability to say we dont know
Providing reminders about time horizons & long-term goals
3 Ways to Make Money
1. Physically Exhausting: Work
harder than the competition
2. Mentally Exhausting: Be more
intelligent than the competition
3. Emotionally Exhausting:
Remain more rational than the
competition over the long-term
Big Ideas We Believe In
Investors are compensated for the risks they
bear & some risks pay better than others
While the future is unknowable, the past is a
decent guide and you have to always
understand the present
Asset Management has to be tied to goals to
work effectively
Less is more, costs & taxes matter,
forecasting is unreliable & performance is
mean-reverting
Client fit is everything
Behavior will determine client success or
failure
Advice That Doesnt Work
Stay the course
Think and act for the long-term
Ignore the noise
Buy low, sell high
Clients That Dont Work
Want all of the upside & none of the
downside
Always want to take part in the latest
fad investment
Pay too much attention to short-term
market events
Care about degree of difficulty &
optics
Are always fighting the last war
Advice That Does Work
Perform a Pre-Mortem Consistency & Continuity
Document the Proactive Communication
Investment Process
Set Reasonable Expectations
Scenario Analysis Ahead of Time
Checklists Be Humble
Successful Investment Advisors
manage investors more than investments.
understand that the long-term is the only
time horizon that matters but people dont
live life in the long-term.
...obsess about their clients, not their
competitors.
speak in plain English to help their clients
understand whats going on with their money.
help clients focus on those things that they
control and ignore everything else.
Questions?
