Princeton University Reunions Panel

                                                                    Friday, June 1, 2012

In the fall of 1968 when I first sat in this room and tried to figure out what Prof. Burton Malkiel was talking about in his Econ 101 lectures, I had no clue about the stock market or the subject of investing.  A couple of years later, I was fortunate to secure a relatively menial job of assembling the index for the first edition of his classic book "A Random Walk Down Wall Street”.  Since there were no PCs let alone word processors, I had to read the manuscript several times and assemble the index on actual paper index cards.  The book sparked my interest in the stock market but puzzled me because on the one hand it tried to show that the average investor (or even the professionals) could not possibly hope to beat the market but on the other hand told us how he had done it successfully enough to allow him to leave Wall Street and become an academic.

Through a rather circuitous route, I ended up pursuing a career in investments partly for the challenge to prove that the impossible could indeed be accomplished.  My professional career was spent managing  well-diversified equity mutual funds using quantitative models with consistently good results.  At The Guardian Park Avenue Fund my former colleague Chuck Albers and I over 26 years were able to beat the S&P 500 by 372 basis point per year after fees and expenses[1].  We repeated this performance with the Oppenheimer Main Street Opportunity Fund where we beat the R3000 by 525 basis point annually over 8 ½ years until I retired in 2008[2].  Personally, I have pursued an entirely different style of investing with highly concentrated small cap value stocks in the energy and mining sectors with even better but admittedly much more volatile results.

The main lessons that I have learned over 40 years that are still relevant in a turbulent world are these:

1.       Although it is very difficult to beat the market, it is not impossible and the rewards can be great.

2.       Risk is in everything.  There are no risk free assets.

3.       Bonds are especially risky right now.

Jeremy Grantham, of GMO said earlier this year: "We are literally running out of superlatives to describe how much we hate bonds.  Yields are pitiful, dangers of even a slight recovery that could wreak havoc for long duration portfolios loom, and monetary policies already have added to the specter of rising yields”. http://www.cbsnews.com/8301-505123_162-57373079/jeremy-granthams-investing-strategies-for-2012/

 James Tisch, CEO of Loews this week called bonds "certificates of confiscation”. http://www.businessweek.com/news/2012-05-30/tisch-calls-bonds-certificates-of-confiscation

 Warren Buffet echoed his sentiment in his 2011  Berkshire Hathaway Annual Report letter saying: "Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits and other instrunents.  Most of these currency based investments are thought as safe.  In truth they are among the most dangerous of assets.  Their beta may be zero but their risk is huge”. http://www.berkshirehathaway.com/2011ar/2011ar.pdf

4.       This leads me to the next point which Richard Thaler, Amos Trevsky and Princeton’s Daniel Kahneman have called Myopic Loss Aversion.  Investors tend to be more sensitive to losses than gains of a given magnitude.  They also have short-term time horizons and check their results too frequently especially in today’s volatile and wired world.  This leaves them to underweight volatile investments like common stocks and prevents them from realizing the superior returns from stock ownership in the long-run.  I know that I will lose money on many of my investments and I know that I will lose money over many short time periods  but it is the risk I take to make money in the long run from my big winners.

5.       Fees, transaction costs and taxes matter.  Here I agree with Prof. Malkiel that as a default option, low cost index funds make sense for most passive long term investors.  At the risk of offending many, I would avoid hedge funds, funds of funds, limited partnerships and high turnover funds.

6.       I would also avoid leveraged investment products and leveraged companies (financials) or companies that rely on credit to sell their products (housing, autos etc)

7.       Inflation and currency depreciation is the greatest risk facing U.S. investors today.  Forty years ago, the US was a creditor nation and had the dominant economy in the world.  Today we are a debtor nation and our relative strength in the world is declining. 

Even though I am 62 years old and retired, I do not own any fixed income investments.  If I did, they would be bonds denominated in strong currencies of commodity exporting countries with small populations like Canada, Australia or Norway.

I am 100% invested in stocks primarily in energy and mining companies with an international focus.  I also own land and cattle as I believe that food and energy inflation are interconnected.  I view gold only as an insurance policy against financial collapse and as such I would only allocate 1% to 5% of my assets to physical gold.

In parting I would close with the advice of Polonius from Hamlet:

"Neither a borrower nor a lender be; for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry”.

                                            Nikolaos D. Monoyios C.F.A.