[The Weekend Bulletin] #130: Good and Bad Losses, Sorcerers, Behavioural Investment Opportunities,...

...Wide Moat Investing, Worldly Wisdom, $5 Challenge, A Hockey Miracle, and more.

Jul 23, 2022

A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.

Investing Wisdom

In a new short paper, Michael Mauboussin and Dan Callahan argue that not all losses are bad. They show how some losses are better than others (hint: intangibles), and how investors can make the distinction.
This article explains Morningstar's wide-moat investing framework. It makes the distinction between the three types of moats (wide, narrow, and no moats) and then goes on to explain five sources of moats. It also lists which of the five moats have worked best/least in the last 5/10 years. A good screener.
This article is a nice and easy read on our affinity for seeking fortune tellers and how that hampers our investing outcomes. A lesson in Authority Bias as well.

Mental Models & Behavioral Biases

We usually look at behavioural biases from an individual perspective - 'things I need to watch for'. But these biases are also exhibited by large groups, like the market as a whole. By building a system to identify such group behaviour, we can improve our own investment decision making, claims this article. It presents an evidence/expectation based quadrant as a model to read the market mood and then provides some strategies for dealing with each quadrant.
In his latest, Morgan Housel asserts, "If you find something that is true in more than one field, you’ve probably uncovered something particularly important. The more fields it shows up in, the more likely it is to be a fundamental and recurring driver of how the world works." He then goes on to list a number of such observations that apply across fields, in life in general. A mini-course in a number of mental models.

Personal Development

Two articles that will inspire you to think differently (power of human ingenuity):
- What would you do to earn money if all you had was five dollars and two hours? This was an assignment given to students at Stanford University. The business ideas that students came up with are really novel, and some didnt even need the starting capital.
- A narration of the 1980's US hockey team's surprising performance and how a coach approached holding a team together differently. A good example of how the best leaders think differently.

Blast From The Past

Revisiting articles from a past issue for the benefits of refreshing memory and spaced repetition, as well as for a fresh perspective. Below are articles from #55:

How old would you think that age-old advice would be? From around 1950's when Phil Fisher first published 'Common Stocks and Uncommon Profits'? Or around 1930's when Benjamin Graham and David Dodd's 'Security Analysis' was first published? How about 1888, nearly 40 years after the classic 'Extraordinary Popular Delusions and the Madness of Crowds' was first published by Charles Mackay? Published in 1888, 'The Timeless Art of Investing' carries some timeless advice for investors, some of which is summarised here. It’s interesting how some piece of advice written in 1888 sounds so much relevant even today. This goes to show how little the tenets of investing have changed despite the many advances that we have made in technology as well as in understanding human psychology.
Charles Ellis wrote a seminal paper in 1975 whereby he argued that Investing is a Loser's Game i.e. a type of game in which you win due to the mistakes made by your opponent. Winning a loser's game thus is not about winning points but losing lesser points. But how do investors ensure that they lose less than their opponents (practically the whole market)? This article provides some advice drawn from various sources.
Simple, and straightforward, this article discusses the 5 phases of a bubble drawn from the history of financial crises. It argues that these five phases can be viewed through the lens of every asset bubble in history because human nature is the one constant in the markets. It further presents some interesting anecdotes to advice you to stop worrying about bubbles.

Read-worthy Passage

Let's read together a random, but read-worthy, passage from a randomly picked book.

[Apologies, this one is more than a few passages long]

In 1964, just before its assets would peak at $2 billion, Walter Morgan said, “The name Wellington had a magical ring, a sort of indefinable air of quality about it that made it almost perfect as a name for a conservative financial organization.” The conservative financial organization would quickly lose its way. Performance sputtered, the dividend declined, and fund assets cratered to $470 million, a 75% collapse!
The fall from grace happened under Bogle's watch. He was a member of the investment committee from 1960 to 1966, and in 1965, at just 36 years old, he was handpicked by Morgan to succeed him as the president of the Wellington Group and in 1970, he was named CEO.
Performance first started to fall behind as Bogle's responsibilities grew. From 1963 to 1966, the flagship Wellington Fund gained just 5.1% annually, well below the 9.3% return of the average balanced fund. As the environment started to heat up and the conservative nature of Wall Street was transformed by the first generation of new blood to enter since the 1920s, management decided it needed to do something to keep up with the changing times. “Lured by the siren song of the Go Go years, I too mindlessly jumped on the bandwagon.”
Their decision to keep up with the times led them to merge with a young Boston firm, Thorndike, Doran, Paine & Lewis Inc. Bogle said the move was designed to achieve three goals:
Bring in managers from the “new era” who could return their performance into top results
Bring a new speculative growth fund (Ivest Fund) under the Wellington banner.
They wanted to gain access into the “rapidly growing investment counselling business.”
The merger of these two companies was an odd pairing; it would be like Vanguard purchasing a crypto currency trading firm today. The following is an excerpt from The Whiz Kids Take Over, an article that appeared in Institutional Investor in 1968: “Wellington was founded in 1928 with a balanced portfolio of common and preferred stocks and high grade bonds, with the objective of providing investors with stability, income, and a little low risk growth to keep pace with inflation...Ivest, on the other hand, was established in 1961, in effect, to make the most of those very fluctuations that Wellington was originally designed to minimize.”
The merger turned the Wellington Fund into the antithesis of what led to its long standing success. From 1929 to 1965, Wellington's equity ratio averaged 62% and its beta averaged 0.6. But with the new kids in town, turnover went from 15% in 1966 to 25% the next year, and stocks, which averaged 55% for a balanced fund, approached 80%.
Shortly after the merger, Bogle was feeling pretty smart about their shrewd business decision. In a recent interview, he said, “The first five years you would have described Bogle as a genius. And at the end of the first 10 years, roughly, you would have said: the worst merger in history, including AOL and Time Warner. It all fell apart. Their management skills were zero. They ruined the fund they started, Ivest. They started two more and ruined both. And they ruined Wellington Fund.”
Like so many other funds, Wellington got seduced and ultimately chewed up and spit out by the go go years of the 1960s:
The term “go go” came to designate a method of operating in the stock market – a method that was, to be sure, free, fast, and lively, and certainly in some cases attended by joy, merriment and hubbub. The method was characterized by rapid in and out trading of huge blocks of stock, with an eye to large profits taken very quickly, and the term was used specifically to apply to the operation of certain mutual funds, none of which had previously operated in anything like such a free, fast, or lively manner.
Investors found out how their “balanced fund” would be transformed into something completely unrecognizable in the 1967 annual report. Walter Cabot, the new portfolio manager, wrote:
“Times change. We decided we too should change to bring the portfolio more into line with modern concepts and opportunities. We have chosen “dynamic conservatism” as our philosophy, with emphasis on companies that demonstrate the ability to meet, shape and profit from change. [We have] increased our stock position from 64 percent of resources to 72 percent, with a definite emphasis on growth stocks and a reduction in traditional basic industries.... A strong offense is the best defense.”
This was written as the go go years were approaching their apex, the timing could not have been worse. John Dennis Brown, author of 101 Years on Wall Street, described 1968 as “the most speculative year since 1929.”
The go go years came to a bloody ending in 1969, with the Dow falling 36% in 18 months and individual issues falling much farther. But the stock market bounced back, and the bloody memories were quickly erased in investors' minds. The next things to take hold on Wall Street were the nifty fifty and the “one decision” stocks. Portfolio managers would no longer rapidly trade these growth stocks, instead they would invest in blue chips like IBM and Disney, and no price was too rich.
But when the air came out of the stock market, they learned the meaning of not confusing brains with a bull market. “The merger that I sought and accomplished not only failed to solve Wellington's problems, it exacerbated them.” Ivest, which is one of the reasons they sought TDP&L, lost 55% of its value, compared with a decline of 31% for the S&P 500 over the same time. But the carnage wasn't just limited to Ivest. They had started a few other funds, but they were no better off. When the markets tanked, all of them dropped far below the S&P 500. The Explorer Fund was down 52%, the Morgan Growth Fund slid 47%, and Trustees Equity Fund was down 47%. By 1978, the Trustees Equity Fund had folded and, as Bogle noted, “a speculative fund – Technivest – that we designed to ‘take advantage of technical analysis’ (I'm not kidding) folded even earlier.” You read that right, Jack Bogle, the creator of the index fund, was the CEO of a company that ran a strategy based on technical analysis.
Of all the damage that would be done, the one that cut the deepest was inflicted on their crown jewel, the Wellington Fund. It lost 40%, which was 80% of the decline in the S&P 500. Bogle described this as a “shocking excess relative to Wellington's long history. The loss would not be recouped until 1983, 11 long years later. The ‘strong offense’ proved no ‘defense’ at all.” The incredible track record and reputation they had built over the years was in jeopardy. The average balanced fund gained 23% for the decade, while Wellington's total return (including dividends) was just 2%.
Bogle looks back on this period of his career with disgust. “I can hardly find words to describe first my regret and then my anger at myself for having made so many bad choices. Associating myself – and the firm whose leadership I had been entrusted – with a group of go go managers.” The blame for the disastrous performance fell on Bogle. He was fired as CEO of Wellington Management in 1974 but convinced the board to let him stay on as chairman and president of the Wellington Fund.
Abject failure would give birth to the most important financial innovation the world has ever seen, the index fund.

- From BIG MISTAKES - THE BEST INVESTORS AND THEIR WORST INVESTMENTS by Michael Batnick.

A few lessons from the above:

Everyone, including the best, cant escape the kiss of death - a period when everything they do goes wrong;
The market's irrationality can entice even the best into doing something silly (in hindsight);
What works in the short term, may not be the best option in the long term;
From adversity, rises opportunity;