Hi Guys,
Generally I have invested in separate equities, and particularly in mutual funds, long enough to vividly remember the huge entry costs. Do you remember when the only mutual fund options were all load funds? I do. The typical upfront loads penalized the portfolio 7.5 % on average. The mutual fund industry extorted quite a high price from us amateur investors to enter the financial marketplaces. Thank goodness that onerous tax has been mostly rescinded.
Eventually commonsense defeated nonsense, and budding price sanity depressed this exorbitant cost structure. Think about how much extra excess returns these fund managers had to deliver to simply recover from the initial entry depletion of a portfolio’s value. Very few fund managers operate at this elevated skill level, especially over an extended time horizon.
But investing is more than cost containment. It is more than just assessing individual mutual fund characteristics and asset allocation. The landscape is more complex. When making fully informed investment decisions, economic and political judgments must be integrated into the decision process. The broader, big picture must be included in any investment decision.
To prematurely focus exclusively on mutual fund subject matter is not the way to investment success; it is not comprehensive enough. Too narrow a focus will not permit us to make prudent investment decisions since the criteria for that decision are not fully defined, nor data completely assembled, nor all participating factors properly assessed in a world climate context. Good decision making evolves from keeping an open mind and a keen research eye. It requires initially searching with a wide-angle lens, and pursued with a series of more powerful magnifying lenses to discover long-term investment opportunities.
That means that critical inputs from fields other than finance must be incorporated to inform our final investment decision. Those other fields include national and global politics, and worldwide economic considerations. From these supplemental inputs, a successful investor must formulate a Weltanschauung, that’s a German word for a worldview.
So any knowledge about the mutual fund industry must be underpinned with a comprehensive understanding of how the world works.
Financial decisions are intimately interwoven with both political and economic inputs. It is a complex landscape, and contributing factors are never easily isolated. So corroborative parallels between political and financial events need to be observed, evaluated, and judged for any successful investment program. For example, the Bretton Woods Agreement had a first-order impact on the US stock market for decades. It was both politically and economically inspired.
If you only study mutual fund news, you still might be a successful investor, albeit perhaps a very lucky investor. A solid investor is one who has organized a repeatable data collection and decision making process. Process matters; random success does not.
There is a natural parallel with the performance of load and no-load mutual funds and the distinction between a government controlled program and a project that is managed locally. Even if one “falsely” posits that the government can assemble a skilled set of program managers, the additional layers of offsite management absorbs resources that can not be committed to the desired output. Management costs. The government always charges a management fee; that’s a heavy headwind to overcome.
Our government is a critical factor in determining investment outcomes. Like it or not, politics not only matter, the milieu, the rules, and the regulations formulated in Washington matter greatly. The Federal Reserve is a de facto dominant market player. When a President’s popularity fizzles, the investing public’s anxiety and uncertainty temperatures sizzle. An uncertain public simply holds onto its money and does not invest.
It is not that all government projects fail. They do not. It is primarily a matter of efficiency. Government management layers, complex regulations, excessive reporting requirements, and redundant oversight cost money that subtracts from the kiddy allocated for real output.
I emphasized the qualifying term “falsely” because I will never be convinced that distant management, lacking both a vested interest in the outcome, and also devoid of practical functional experience, will ever produce a competitive end outcome when contrasted to that possible with a local entity. The failure of the USSR experiment serves as a prime illustration.
Redistribution is not the answer except in the very short-term. It detracts from long-term solutions by taking capital from strong hands, and placing those monies into weak hands who have demonstrated an inability to use those resources wisely.
The Austrian school of economics has long used the bread/baker analogy as an excellent storyline example of the issues. It is designed to illustrate the emotional and practical tradeoffs that confront an economically challenged society. It goes something like this.
A desperate population is facing a food shortage. The government reacts by buying bread from an overloaded bakery set, and distributes it to the needy, certainly a kind act that does immediately save some lives. Note that the bread comes from a fixed supply. That’s a long-term problem. However, the shortfall is not corrected, and the population remains in a critical near-starvation state. If something happens to the grain supply, or a bakery suffers an equipment failure, a tipping point is precipitated, penetrated, and the whole population is put at risk. This outline currently resembles the gasoline production scenario in the US.
A better solution would be to foster the establishment of more bakeries to relieve the shortfall in the longer-term. In a capitalistic system this objective is achieved by lowering the bakery entry level barriers: such as by reducing business taxes, by reducing regulation, by eliminating OSHA and EPA requirements, and by decreasing minimum wage laws. In an economics world a tension almost always exists between short-term and long-term goals. The Austrian school emphasizes this tension.
These political actions would generate an immediate investment opportunity. Business friendly rule changes lower the profit hurdle for small businessmen and would thus encourage entry level bakeries to proliferate. Profit incentives are the most powerful motivating factor in a capitalistic society.
Economics has long recognized the interconnectedness of all financial actions. The complex nature of these connections defy an easy recognition and understanding. Consequently, many of our actions, especially those instigated by our government, because of its enormous scope, create unintended tensions and consequences.
I submitted a posting that touched on this topic a few days ago. It is titled “Bastiat Had It Right”. Professor Bastiat described a distinction between that which is seen, and that which is not seen. Please examine the submittal. Here is the Link to it:
http://www.mutualfundobserver.com/discuss.php#/discussion/950/-bastiat-had-it-rightOur Constitution was not constructed to grant unlimited powers to the Federal government; in fact, the powers transferred were extremely and purposely limited in both intent and scope. Our Founding Fathers truly feared Big Government. They correctly believed that entitlements dampen entrepreneurial opportunity and spirit. For example, recent government policies and actions have transferred credit eligibility from an earned privilege to an entitlement guarantee. That was the bottom-line cause of the housing meltdown.
Alexander Hamilton saw the dangers of an invasive government and the dangers of an out of control taxing structure. He said: “ If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds.”
Amen to that prescient observation. Hamilton’s axiom was correct when he originally formulated it; it is even more meaningful today.
Stay strong during these uncertain and volatile times.
Best Regards.
Comments
"For example, recent government policies and actions have transferred credit eligibility from an earned privilege to an entitlement guarantee. That was the bottom-line cause of the housing meltdown."
This is shown a number of times not to be true. In fact, it was private enterprise that jumped both feet into sub-prime mortgages as short term profitability was high and greed took over. Fannie and Freddy were large absent from this sub-prime market. They were also assisted with other private enterprises that certified the bonds based on these mortgages as AAA.
In fact, all this has been made possible with more and more withdrawal of government regulations that allowed lenders and bands to make these sort of mortgage loans available to anyone with a pulse. Not regulating derivatives also contributed to the fact. Even Greenspan, who was againt the regulation of these new financial products, admitted it did not work.
Our government debt is so large because when crisis came, private enterprise came running for help. They were not complaining of big government then! Goverment got bigger because of the irresponsible and under-regulated private sector.
In fact, the administration appointed wolfs to guard the hens. Their main purpose was not to regulate but make sure existing regulations were not administered. How quickly have we forgotten? Even last year, we have witnessed that lax and lose regulations were at the basis of millions of gallons of oil spill to the gulf.
Laissez-faire attitudes is the root of the failures that cost of dearly and than required even bigger government to clean up the mess afterwards. This is the abject failure of Austrian economics. I am sorry, the private sector's profit motives is not enough incentive for common good. Profit motives has not protected water and air from contaminated either.
If I need a big enough entity to counter these big and and powerful businesses, I find no other unit other than the government.
Sure, government is slow, inefficient but unfortunately necessary.
Hi Investor,
Thank you for both reading and responding to my missive.
After reading your reply, I’m afraid that in the end, you and I are going to agree to disagree.
I reject your argument that private enterprise was the major culprit for the housing debacle. Sure, the financial businesses that could profit from a loose, opportunistic market jumped with glee to take advantage of the situation. What business does not?
But the root causes for the debacle were a reckless and greedy population, that were encouraged by politicians essentially buying votes, engaged in excessive leverage. Did banks and loan sharks exacerbate the downfall with deceitful commercial tactics, and imprudently constructed derivative products? Indeed they did. But none of that would have been possible without the public first overextending themselves with high risk credit commitments that required a constant housing price escalation to remain viable. That never happens.
In an earlier posting, I referenced a story told by Michael Lewis in his ”The Big Short” book. In Bakersfield California, a strawberry picker with a $14,000 annual income was encouraged to purchase a $724,000 home. That was an invitation to failure; it was a story repeated thousands of times. I believe it was Warren Buffett who observed that excessive leverage is more dangerous than an Atomic bomb.
Government rules and regulations are not the answer either. The rules can always be circumvented or are never all inclusive enough. The regulations stifle initiative and are never uniformly enforced, often because of inept government watchdogs. Let me relate two personal stories here.
When attempting to sell cutting edge military programs to the government, I frequently gave presentations to government employees trusted to make critical fund/not fund decisions. These employees often had no engineering or scientific training that would have permitted them to make an informed decision. Yet they accepted some propose projects and rejected others for totally unfathomable reasons. Only the devil knows why. By their faulty questions, I can guarantee you that these defective decision makers didn’t understand the presentations, their merits nor their deficiencies. These folks were useless parasites.
After retiring, I was hired by several defense contractors to formulate and document proposals. Over time, I was shocked by the expanded time scale needed to submit, and if accepted, to execute a project. Avalanching government regulations and rules simply slowed everything to a snail’s pace. During earlier years, I worked on complex programs that were designed and successfully executed in a single year. When I last participated on similar projects, it took a year just to secure the contract; it took several years to complete the design phase, and a few years more to complete the testing. Now that’s a dreadful regression that should not be tolerated, but is. The primary contributor to that extended timeframe is an ever growing set of meaningless rules and regulations.
We constantly talk about the government deficit. That’s bad, but did you know that the sum of private debt within the United States is much larger than the public debt? That is the case.
Regardless, crushing leverage is the downfall of both private citizens, whole Nations, and even historical Empires. Leverage caused the failure of the Roman empire in the 5th century, it prompted the demise of the Spanish empire in the 16th century, the maritime Dutch empire several centuries later, and the British empire in the 20th century.
If you define an economics scale with the Austrian school anchoring one side and the Keynesian school anchoring the other side, I suppose I find myself closer to the Austrian end. I expect that you are likely closer to the Keynesian end cap. I really do not believe that it is an either/or choice however. In real world scenarios, I suspect that valid techniques can be deployed using a mix from both camps.
I trust the noninterventionist Austrian policy more than those recommended by Keynes. Historical evidence has largely discredited his approach. It did not work in our Great Depression of the 1930s, and it surely failed to stimulate our economy under QE1 and QE2. I understand that Keynesian True Believers hold that the efforts were insufficiently funded. I do not share that belief.
Government institutions do not have the wisdom nor the talent to properly execute these huge, multidimensional programs with almost boundless scope. It is simply too complex an undertaking.
I prefer less ambitious projects that are designed and governed more locally. A single social experiment on a national level is far more risky than 50 statewide experiments. I fear central control. Big government is a Big loser; bigger government is an even bigger loser.
I place my trust in an independent marketplace. Any bad experiments, just like inferior investments, will be quickly identified and abandoned. More successful experiments will be rapidly recognized and will be eagerly adapted by all. That’s the way of a competitive marketplace. That’s the United States.
A single dominant decision maker is a great hero while he is making the right moves. But what happens if his wisdom falters? He tends to remain true to his philosophy, ignores the failing system, and governs into a disaster.
History provides many illustrations of a truculent leader. Centuries ago, the Chinese were global sailors with superior ships. They ruled the seas until a lone Emperor decided that he favored isolationism. He ordered the burning of all ocean-going ships. Thereafter, China became a second-class nation for centuries. Central control is not sustainable. Just ask the Russians in the late 1990s.
Thank you once again for your careful comments; they provide yet another dimension to the debate. Easy solutions do not exist. If they did, the issues would resolve themselves.
Good luck and best wishes.
I am not going to rebut your submission although I am more than able to do so. I will sum up to one simple paragraph:
First, Austrian economics did not work in 1930s as attempt to cut debt too fast brought on 1937 recession. Secondly, the big government everyone is talking about is actually the smallest government in recent times. The non-defense discretionary budget has shrunk the smallest level (17% in 2011). Irresponsible tax cuts has gutted the capability of government doing anything without borrowing more. Just watch the History Channel program about the awaiting national disasters due to failed infrastructure. The national highway infrastructure, the space program, the electrification of the rural USA were all government initiatives. Under today's ideology we could not build these. We are not even able to properly repair them. So, I would not put that much trust in the marketplace that is left to its own devices. Some of its bad experiments did cost us dearly and produced the complete meltdown and bigger government which was not by choice. When it comes to marketplace, profits are always private and losses are public. Under crisis, champions of free enterprise and marketplace rush to mother government. Their mistakes hurt average Joe should government recuses or not. In other times, just like a teenager, they would like to break free the rules and regulations. We have seen this many many times and yet in just 2 years, the same old is put in front of us as a new way. I am not against fully developed marketplace. I am against, wild west capitalism and anarchy that it generates. There is a role for government to play.