An Investing Lesson from Greek Mythology

There is one ancient Greeks myth that we investors would do well to heed even today thousands of years later. Like Odysseus, we must resist the seductive songs of the investment Sirens luring us to financial destruction.

A case in point is mutual funds. Many times has the disappointing truth been told that most mutual funds' investment returns are worse than their reference index. Worse, far worse in fact, than this are the investment returns of the actual investors in mutual funds. Vanguard fund founder John Bogle recently wrote in his Bogle's Corner May/June issue (thanks to the Bylo where I found this link) of evidence of shocking under-performance of investors in a group of 200 US mutual funds.

"... the 200 funds with the largest cash inflows during the five-year period 1996–2000—essentially the duration of the late, great bull market—reported an average return of 8.9 percent for the 10 years from 1996 to 2005. But the dollar-weighted return of those 200 funds— the return actually earned by their shareholders—was just 2.4 percent, only 25 percent of the annual returns reported by the funds themselves."
After inflation and taxes, that wouldn't be much!

To continue the analogy, the Siren song was the advertising of the mutual fund companies touting their recent past investment performance. Sadly, the cash inflows are evidence that the investing public listened. (Others call this chasing returns but I like the Greek analogy.)

The way to resist is to do as Odysseus instructed his sailors - build a plan, stick some wax in the ear and don't deviate when the temptation is strongest.

Financial Risks Can Be Health Risks Too

The BBC reports in Bank Crises 'deadly for health' that researchers have determined that financial crises and runs on banks, such as that occurring this past autumn at the Northern Rock, can cause a spike in heart attacks among the population. The article interestingly notes that older people are especially susceptible to heart attacks; perhaps a higher than expected risk aversion amongst older people is an instinctive adjustment for self-preservation? How often does one hear people say, "I don't want the stress of equity investment", or "I cannot take the stress anymore"? Maybe they are reacting to internal health messages from their body?

Another issue is that a proper appreciation of the relative real risk of various assets and holdings is essential. Do people need to be told that even banks are not perfectly safe and that low probability of failure is not equal to zero probability? Various politicians and business leaders who say that things are "perfectly safe" are actually doing everyone a dis-service. It is easier to face a known hazard than to deal with a nasty surprise when it was thought there was no chance of the bad thing happening.

To me this is another reminder that diversification - spreading investments and assets around so that if one fails others prevent calamity - is an essential protection.

Bloggers tell institutional investors to stay calm and stick with plan as market weakens

In light of the recent article on the CBC website, titled "Advisers tell investors to stay calm and stick with plan as market weakens", a reply from the blogosphere is called for.

The CBC says:
"After a nearly five-year run, investment advisers say it's time to stay calm, review your investment plan and look to defensive plays such as utilities, health care and consumer stocks to wait out the slowdown."

... Bloggers say it's time time to stay calm, stick with your investment plan, look for stock bargains among long-term high-quality companies and wait out the slowdown.
"Me? I’m sticking to my plan and giving this all some time to settle out." Canadian Dream: Free at 45
"During Monday’s panic, I actually went out and bought more banks." CanajunFinances
"Often the best thing to do is nothing, especially when our emotions are getting the better of us." Michael James on Money
"At times like these, amidst breathless front-page coverage of every gyration in the stock market, you can dust off your copy of The Intelligent Investor and find solace in the counsel of Benjamin Graham." and goes on to quote words saying to stay calm. Canadian Capitalist

Let us also note the results of a small informal poll conducted on this very website regarding the severe market slide of January 15-17. In answer to the question about what they did in response, 39% of readers said they bought stocks they considered a bargain, 71% said they did nothing and were going to wait things out, 0% said they sold to pay for Christmas expenses or for other expenses and 0% (yes, that's a big fat ZERO) said they sold equities! Yes, sir, the average person on the street sure was panic selling!

In contrast, the CBC article quotes mutual fund managers saying, "I think you have to continually look at your portfolio and make sure you're focused on quality and to the extent that you have more speculative or lower quality investments, you may have to have make a decision to exit some of those securities," Pym said." ... and ... "Watson said defensive stocks like utilities, health care and the consumer sector will be areas investors will want to look to." Ah yes, sector rotation, tactical asset allocation, market timing, those discredited and disproved strategies. Now we know who was doing all that panic selling in the last little while.

Stock Markets and Multi-Vehicle Pile-Ups

Today's CBC web headline included a report about a monster multi-vehicle pile-up on highway 400. Thankfully, no one seems to have died. Having been in the middle of one such pile-up on the 401 a few years ago, I extend my sympathies to those involved. I remember the feeling of helpless foreboding in the brief moments after I had stopped safely - watching in the rear-view mirror while vehicles approached, hoping none was a semi-trailer going too fast, trying to guess whether I should move into the gap between vehicles ahead or stay where we were, or jump out and head to the ditch, though that would mean we were even more exposed. There was no long time to think, only seconds. As it was, we stayed put and sure enough, someone in an SUV couldn't quite stop and banged into our rear, smashing our plastic bumper, but we were ok and so were they. Not so lucky was the guy in a large pick-up a few hundred meters back, killed in the sandwich between two semis.

As an investor, I now feel much like that moment. The world financial pile-up has started, courtesy of financial institutions guilty of driving too fast with credit in conditions they should have seen were dicey. It started with the sub-prime mortgages in the US and the damage to many banks, hedge funds and investment houses has been in the news for months. The chain reaction continues, the latest crash of a semi being the downgrading of bond insurer Ambac and its follow-on effect on US municipal bonds. Ambac may be a blameless motorist on the financial highway yet it inflicts much destruction when it loses control. (btw, Credit to financial editor Robert Peston of the BBC for consistently exposing the consequences of the sub-prime induced meltdown in the UK and farther afield as his post on Ambac and MBIA attests). It just goes to show that one can follow all the safety procedures with a good vehicle (i.e. diversified portfolio) and behave cautiously yet still suffer collateral damage and be caught in a big mess that will take a while to clean up once the collisions have stopped, which obviously is still not the case. There's more market crashing going on today in Asia and throughout Europe. The market has shifted from greed to fear with good reason.

Unlike for my mini-van, I don't have portfolio insurance. Hmm, maybe I should get some, though it's a little late for this episode of financial highway mayhem.

Of course, we could all just stay home and invest in GICs, never taking the risks of travel, but then we wouldn't get anywhere interesting, would we?

New Survey: Your Reaction to Market Drop

Well, the TSX is down 900 points in three days and if you are internationally diversified and watching other stock markets, you are seeing that in times of crisis, positive correlation reigns, with the S&P 500 down, the FTSE down, the DAX down, the Hang Seng down and so on. The only positive note is that the Canadian dollar has been sliding too so the foreign holdings are not dropping quite as much in C$ terms as they would have with a constant exchange rate. That's a diversification value.

Along with the slide there is the predictable article that accompanies all bear markets - a piece on the CBC website that tells small retail investors like you and me not to panic and sell out. Hmm, most of my friends and family are too busy going to work, watching hockey games, helping kids with homework etc to do more than watch in puzzlement and helplessness as the indexes plummet. Could it possibly be someone else who is doing all the selling, possibly the big boys of the investment houses, the hedge funds, the pension plans who have the vast majority of the money in the market? In order to test this hypothesis I am launching another mini survey for my blog readers to see how many of us small investors are bailing out and how many are hanging tough. If you are reading this and have $100 million or more under your control, please don't answer as the survey results will get skewed and unscientific.

Beat This as Worst Investment Ever

It was a doozy indeed, minus 100% return! Yup, I managed to invest a bundle in a TSX-listed company that went bankrupt. In the hopes that someone out there might avoid the same mistake, here's the story of Intelligent Detection Systems.

Once upon a time there was an ultra-aggressive entrepreneur named Mariusz Rybak, whose nickname, I have since learned, was the Baltic Barracuda. That alone might be some cause for concern, though one suspects other ruthless business tycoons have acquired colourful sobriquets from employees, associates and competitors. In retrospect, familiar problems appear to have sunk the company such as overly ambitious expansion, including into areas where management had little or no knowledge. The epitome of this was the plan to launch an online eCommerce portal to trade in mining equipment and services ... at the height of the Internet frenzy in early 2000. A dash of nepotism, in the form of Mr. Rybak's brother Andy as a top manager, could also have provided a warning sign. Yet the company actually had as its core a useful and successful product - bomb detection systems for airports - so it was easy to fool oneself. In fact, the detection product was acquired by another company and it still being sold today, six and a half years after the downfall. Again in retrospect, a strong-willed and aggressive CEO founder, was likely able to bend the board of directors to his unwise plans when the company was public. On top of that, the CEO liked to live high and well, with corporate offices in the big towers on Bay Street. And finally, in retrospect as well, a CEO who did not pay too much attention to "accounting details", as he said (see Bagnall article links below) when improprieties were uncovered by auditors.

Mr. Rybak did not lose his shirt however, as he now lives in a luxury condo in Monaco. And he did not lose his self-confidence or his talent for wreaking financial mayhem (or worse?), being subsequently one of the main protagonists in the even larger Langbar scandal that has garnered much attention over here in the UK. James Bagnall of the Ottawa Citizen wrote a couple of extended articles about the man and his exploits - in December 2005, December 2006. Is it an accident that the old IDS weblink points to a website about law enforcement?

The ancient Romans invented the appropriate expressions in Latin, MEA CULPA and CAVEAT EMPTOR. Every time I open my online account listing, I see that line with IDS and $0.00 market value beside the $xx,xxx book value to remind me.