Strubel Investment Management September 2013 Newsletter.
In This Issue
Ben's Notes
Get to Know Your Company
No Company Profiled
September 2013
Investor Letter


Ben's Notes

Dear Investors,

How long do you think the average investor today hold a stock? If you guessed less than a year, then you are correct. The average holding period for a stock dipped below a year sometime after 2000 and has continued to fall.
 

In the 1940s and 1960s, investors held stocks on average seven years or more. Market participants today have gone from investing to short-term trading. So why the change? Have today’s investors gone mad, or are they on to something good?

Trading
Numerous academic studies have been done regarding trading behavior and results. An study by several California and Chinese professors found that over a 15 year period only about 1% of traders are consistently profitable. Note that doesn’t mean they beat the market; it just means they actually made money. If you have been trading for 10 years and have made a grand total of $100 over that time, then congratulate yourself on being part of that 1%.

According to a 1999 NASAA study, 88% of traders lost money and 70% lost ALL their money. A separate 1992 to 2006 study found that 80% of active traders lost money. Keep in mind that this was during a bull market where the S&P 500 gained over 300%! Another paper from UC Berkeley studied 60,000 investors from 19991 to 1996 and found that the more investors traded the lower their portfolio returns were.

Why do most traders lose? Well, let me ask you a question. Would you rather face Tiger Woods on the golf course or at the bowling alley? (Are we still using him as the ultimate golfer, or is it Phil Mickelson now? Should I say an in-his-prime Jack Nicklaus?) Would you rather face LeBron James one-on-one on the basketball court or on the shuffleboard court?

When you are trading, you are going up against Wall Street in their own game. You are competing against datacenters filled with expensive computers programmed by teams of PhDs that have access to market information milliseconds before you do. Below is a graphic from the New York Times that explains how it works.

 

When you are sitting at home on your computer trading stocks and watching CNBC, you’re up against companies and hedge funds that pay hundreds of thousands of dollars for access to market information before you get it. Basically, you are playing against people who are legally cheating. It’s a no-win proposition.

Okay, so maybe you aren’t a day trader. Maybe you like to hold stocks for a few days or a few weeks to bet on things like earnings, mergers, buyouts, or acquisitions. Once again, you are up against a cadre of cheaters.

Well-connected industry insiders are aware of most of that information before you are. Take the case of SAC Capital, one of the world’s largest hedge funds, which has recently been embroiled in an insider trading scandal of epic proportions. Federal prosecutors alleged that insider trading was rampant at the firm over the past decade. So far eight analysts or portfolio managers at SAC have been charged and six have pled guilty.

But it’s not just SAC Capital. US District Attorney Preet Bharara says, “The evidence from our own office is over the course of the last three and a half years or so, we have convicted 74 different individuals of insider trading, for in some cases significant amounts of money, and it is in every sector. It’s in the health-care sector, it’s in the tech sector, it is geographically diverse, it’s on the West Coast, it’s on the East Coast. It’s people who are insiders at companies, it’s people at hedge funds, it’s people who are at expert networking firms, so it’s pervasive.”

Other recent high profile cases include Galleon Group, in which the head of the fund was found guilty and four other parties pled guilty as well. FrontPoint Partners, a hedge fund run by MorganStanley, saw one of its portfolio managers plead guilty to insider trading. Level Global, another hedge fund, is also involved in an ongoing insider trading case.

There are two basic blueprints for accessing and using inside information. The first and shrewdest way is simply to create a culture that encourages insider trading and then sit back and let natural selection work. (SAC is alleged to have used this method.) You focus on hiring traders who likely have connections to insiders. (For example, people who graduated from prestigious universities will likely have a lot of friends in high places in the corporate world.) You then create a culture in which failure to perform is ruthlessly punished and those who make money are richly rewarded. For example, at SAC, if you lost 5%, then half of your trading capital was taken away. If you lost 10%, then you were fired. Five and 10% moves in the market are not uncommon, so what is the easiest way to avoid being fired? Simply call your buddies and begin trading based on inside information you get from them. SAC had only one down year since 1992. When you cheat, making money is easy.

But what if you didn’t graduate from a prestigious university or prep school? What if you have no friends with inside info? Never fear. Like anything else on Wall Street, “friends” are available for a price. You simply pay hundreds of thousands to subscribe to an “expert network.” If you are naïve enough to think hedge fund jockeys are willingly paying hundreds of thousands for anything but inside information, then I have some swamp land in Florida you might be interested in purchasing.

Alternatively, you can also funnel massive amounts of commissions on trades to Wall Street by always paying full price. SAC Capital did this in its early days. Wall Street will then return the favor by tipping you off before analysts’ upgrades and downgrades, mergers, acquisitions, debt or equity offerings, or other important events.

Investing
By now trading looks like a pretty bad idea. But is investing any better?

First, let’s think about what a share of stock actually is. Buying a share of stock means that you, the stockholder, are now a part owner of that business.

Since the 1940s, the business world certainly seems to be moving faster, so maybe a drop in the average holding period makes sense. With the internet, social media, clean energy, eco-friendly products, micro blogging, and Wi-Fi everywhere, things must move at lightning speed, right?

After researching this idea, it doesn’t seem that way. Despite the daily cacophony of life, the nuts and bolts of managing and running a business haven’t changed all that much. Designing, producing, and marketing new products still take years for most businesses. Here is how long it takes various businesses to perform critical tasks:

•    To develop a new pharmaceutical drug: 12 years (Pfizer, Merck, GlaxoSmithKline, etc.)

•    To develop a new car: 12 months for a minor refresh and 4-5 years for a completely new design (Ford, General Motors, Honda, Toyota, etc.)

•    For a defense contractor to design and build a new fighter aircraft: about 10 years (Boeing, Lockheed Martin, Northrop Grumman, EADS, etc.)

•    For a major film studio to produce a movie: 1-2 years (4-6 years if you include preproduction work like story and script development) (Sony, Fox, Viacom, Vivendi, etc.)

•    For a video game company to develop a new major release: 1-2 years or more (Electronic Arts, ActivisionBlizzard, Take Two Interactive, etc.)

•    To design and build a new commercial airliner: About 8 years from design to first commercial flight (Boeing, Airbus)

•    For a computer hardware company to develop a new microprocessor: 2-4 years (Intel, AMD)

•    For a software company to develop a new operating system: about 2-4 years (Microsoft, Apple)

•    To build new housing development/town: 2 – 10+ years (Lennar, DR Horton, KB Homes, Toll Brothers, St. Joe, Tejon Ranch, etc.)

•    To build one home:  4-6 months

•    To build new power plant: 1 year (for small natural gas peaking unit) and up to 15+ years (for a new nuclear plant) (Exelon, Duke, AEP, GE, Hitachi, Fluor, KBR, etc.)

•    To design, build, and ship a new video game console (e.g., Xbox, PlayStation): 3-5 years (Sony, Microsoft, Nintendo)

•    Remodel of a large department store (just one store in the chain): 1-3 years (JCPenney, Macys, Kohls, etc.)

•    Explore, discover, test, and deliver oil from new oil field: 3–10 years (ExxonMobil, Chevron, etc.)

•    For a chemical company to research and bring to market a new compound (Kevlar, Twaron, NOMEX, etc.):  5–10 years (DuPont, Akzo-Nobel, Dow, etc.)

•    For a fast food restaurant to research, test, and place a new item on the menu: about 1 year (McDonalds, Burger King, Yum! Brands)

Despite everything you hear, the business world changes only at a pace measured in years.  Sure, you’ll always have disruptive start-ups, but for most industries change takes place only over the course of years.

If you are buying a business, which is what stock represents, then shouldn’t you match your investment time horizons to the business’s operational timeline? If it takes years for things to materialize in the business world, then the day-to-day, week-to-week, month-to-month, and even year-to-year fluctuations of the stock market aren’t that important. They just give the intelligent investor a chance to pick up shares of great companies at a discount, or perhaps sell shares of a previously purchased company at a premium.

It seems like a world of opportunity is out there for investors like us with long-term horizons. We are alone. And it’s much easier to make money when there is hardly any competition for what you are doing.

Don’t Buy What Wall Street Is Selling
Investing is boring, but the biggest problem is it doesn’t make Wall Street any money. For example we bought Omnicom stock back in 2008. We still own it. Wall Street made a commission on the trade back in 2008, but after that the position hasn’t been profitable to them. They want nothing more than for me to sell it and buy something else. The more I trade, the more money they make.

That’s why you see ads all over the internet, TV, magazines, and so forth (e-Trade and Schwab are prime offenders). They hide what they really want by using sexy sound bites: “Take control of your future” and “we give you the tools you need to succeed.” Such ads rarely just pitch stocks (since handling those trades is a low-profit-margin business now). Ads hawk the “savvy” need to trade options, futures, currencies, commodities, and more!

So why do people continue to trade? A New York Times article asked a professor of behavioral finance at Santa Clara University and this is what he said:

“The technical term is thrill-seeking,” says Hersh Shefrin, a professor of behavioral finance at Santa Clara University in California and author of “Beyond Greed and Fear,” an exploration of investors’ mindscapes. “There’s an adrenaline rush. And the thing about day trading is that it gives you pretty quick feedback. If you buy and hold, a lot of things need to happen before you see a result, and much of what happens relates to external factors that are beyond your control. With day trading, you’re in charge.” Also, he says, “people enjoy trading.”

Trading can be great as a hobby if you have some extra money to just play around with. But when it comes to building a nest egg for retirement or generating income to live off of investing is the far superior choice.

Normally, I encourage you to forward my newsletters to those who may be interested. Maybe this time is different. Maybe we shouldn’t let them in on our little secret. Let’s allow everyone else to keep day trading their money away. ; )


P.S.  Here is a fun exercise. Below is the performance of our Dividend Fund since inception (2/14/2011 until mid September). The dark blue line is our fund, the light blue is the S&P 500. We did very well, we made almost 50% over that period while the S&P 500 only gained a little over 34%. I would say that counts as a very successful stretch of investing.

Now, count how many times I would have been fired or had my capital cut if I worked at SAC. I circled in green some areas where the fund dropped in value and in yellow some areas where the fund lagged the market but didn’t lose any money. (I assume the latter is an offense worthy of being firing if I worked at SAC.)

 

By my count, I would have had my capital cut in half five times and I would have been fired twice (or five times if you count the times I lagged the market which I'm assuming is a fire-able offense at SAC)!





No Company Profiled

No Company Profiled This Month.

About Our Portfolios

The American Renaissance Fund (our Capital Appreciation Portfolio) and the American Renaissance Dividend Fund (our Dividend Portfolio) are innovative, investor friendly alternative to traditional actively managed mutual funds called a Spoke Fund ®. We can also customize portfolios for clients seeking less risk and volatility by including allocations to other asset classes such as bonds and real estate.

Spoke Funds are significantly less expensive and more transparent than a large majority of mutual funds. Both portfolios are managed for the long term using value investing principles. Fees for both portfolios are 1.25% of assets annually. That figure includes both our management fee and all trading costs. We try to minimize turnover and taxes as well in both funds.

Investor accounts are held in your name (we never take investor money) at FOLIOfn or Interactive Brokers*.

For more information visit our website.

*Some older accounts may be custodied at TradePMR.


Disclaimer

Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and investing may cause capital loss.
 
The performance data presented prior to 2011:
  •  Represents a composite of all discretionary equity investments in accounts that have been open for at least one year. Any accounts open for less than one year are excluded from the composite performance shown. From time to time clients have made special requests that SIM hold securities in their account that are not included in SIMs recommended equity portfolio, those investments are excluded from the composite results shown.
  • Performance is calculated using a holding period return formula.
  • Reflect the deduction of a management fee of 1% of assets per year.
  • Reflect the reinvestment of capital gains and dividends.
Performance data presented for 2011 and after:
  • Represents the performance of the model portfolio that client accounts are linked too.
  • Reflect the deduction of management fees of 1% of assets per year.
  • Reflect the reinvestment of capital gains and dividends.
 
The S&P 500, used for comparison purposes may have a significantly different volatility than the portfolios used for the presentation of SIM’s composite returns.

The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.

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