iCapital: "Ostrich policy" will not solve the issues

I have written several times about iCapital (of which I am a long time shareholder), most notably here and here.

The two elephants in the room regarding iCapital's share performance are:

• Persistent underperformance relative to its benchmark (KLCI) since 2008
• Persistent discount to its NAV price since 2008

The new year report has been published, so I was interested to see how the company handles both matters. Well, the way the issues are handled is best described by the below picture:

"Underperformance, discount ...... I don't see any ...... do you?"

In the Netherlands this is called "Ostrich Policy": "to ignore obvious dangers or problems and pretend they don't exist; the expression derives from the supposed habit of ostriches to stick their head in the sand rather than face danger".

Lets start with the results for the latest year:

That is really disappointing, given that the funds cash level was a whopping 65% throughout the year. That cash is generating interest of about 3 per cent a year, so one would have thought that the fund would have performed clearly better than the KLCI.

One reason for this is the management fee (including relatively high expenses for advertisements and AGM), the total is about RM 7 Million. That translates to about 1.75% per year, which is not a problem if the fund is fully invested and outperforms. But it is a problem if 2/3rd is held in cash, earning about 3% per year on that cash, of which more than half is eaten away by fees and expenses.

Given the persistent high cash level, the board of directors should renegotiate the management fee, for instance a lower fee for the cash it is holding (one does not need a degree in rocket science to manage a fixed deposit), and a higher fee for the equity part. However, no indication is found in the year report that this is even considered.

All the outperformance of the fund came in the first few years. The last seven and a half years the fund has underperformed, especially if dividends are accounted for. The combined effects of the underperformance and discount is shown in the red column, showing that the share price has actually decreased since December 31, 2007.

One must therefore put question marks behind the comment by the Chairman:

Also puzzling is the comment regarding "shorter-term options which do not benefit share owners in the longer-term", how is it possible that company decides this for its share holders?

On December 31, 2013 the NAV was around RM 3.10 while the share price was around RM 2.47 for a discount of around 20%. Apparently the fund manager could not find enough value and decided to raise cash levels to 50%. If the fund had decided to discontinue and return back the money to shareholders, surely share holders would have been in a much better situation than currently (the share price is now RM 2.18).

iCapital continues to harp on its performance since its IPO. But which percentage of the shares is actually still held by the same persons who bought them at the IPO? If people bought their shares say 1, 3 or 5 years ago, would they not be interested in the performance over that period, instead of the performance since IPO? The performance over those intervals are simply disappointing.

Another puzzling comment is the following:

There is absolutely no need to seek for viable options to address the discount, they have been conveniently listed in iCapitals IPO brochure, as described in my previous posting:

• Shareholder activism: this is very ironic, given the way the fund and its manager have responded so far on any attempts in this direction (for instance here)
• Share repurchase: in my opinion an excellent way to decrease the discount
• Open ending
• Takeover
• Liquidation: again an excellent way to get away of the discount; after this the investors can decide themselves where they want to invest in
• Managed distribution policy

Another issue is that there seems to be an "obsession" with Warren Buffett and Berkshire Hathaway. Rather surprisingly, since Berkshire Hathaway is a US based fund (and thus accounted in USD, a currency that has performed very strongly relative to all currencies including the RM), investing a lot of money in non-listed companies, and only being interested in large acquisitions while iCapital is focused on Malaysian listed companies (which might include small caps, given its small size).

In other words, if there was ever a comparison between apples and oranges, this would be it.

Another rather interesting issue is that Warren Buffett and Charlie Munger each only charge USD 100K per year in wages, versus USD 1.5 Million (RM 6.4 Million) charged by the fund manager of iCapital, despite Berkshire Hathaway having a market cap of more than a thousand times the market cap of iCapital.

I have no idea where iCapital got these charts from, but they must be completely wrong. One of the best investors in the world has an annual compound return on its NAV of -0.39% over the last ten years?

The reality is very different according to the last year report, despite its huge size it actually was able to book very decent increases in its book value:

Another matter is that Berkshire Hathaway announced the following:

In other words, it might be better to look at the market value of Berkshires shares instead of the (understated, conservative) NAV.


[1] What iCapital should have done (instead of focus on Berkshire Hathaway) is give a clear and correct (that is based on dividends reinvested, it is not giving those at the moment) comparison of iCapitals performance versus similar funds, like the Malaysian ETF or Malaysian equity based unit trusts of reputable fund managers over the last 10, 5, 3 and 1 year periods. That would be comparing apples with apples.

[2] Next to that it should have openly discussed the persistent discount to its NAV, and why it has not taken any of the six measures as described in its IPO brochure. Those measures were listed there for a good reason, to assure potential investors that if there is a persistent discount, then there are measures (and implicitly: those measures will be taken).

[3] And lastly, it should have openly discussed the expenses and fees, which have been simply too rich in the last years given the high cash levels.


I used to have a lot of sympathy for iCapital and its founder Tan Teng Boo, they have been good for Bursa in areas of educating Malaysian investors. But that sympathy is decreasing each year, at least with me.

Berkshire Hathaway: 50 years of Value Investing

Berkshire Hathaway, the conglomerate managed by Warren Buffett and Charlie Munger, published its much anticipated 2014 year report. It is the 50th since Buffett took control of the company. A true monument of value investing.

At the end of the day, the only thing that counts is the long term returns, and they are extremely impressive:

Berkshire Hathaway always uses "marked to market" for listed securities despite their limitations, Maybulk and Noble might want to take note:

It is the hallmark of the great manager to admit mistakes, Buffett does not try to hide the mistake he made regarding Tesco, about which I wrote here and here.

The last three sentences are a proof of the amazing stock picking abilities of Buffett and Munger.

Reviews about the year report can be found at Fortune, Forbes and The New York Times.

AirAsia X: is the rights issue enough?

There were many rumours going around regarding AirAsia X, quite a few of them were proven right, as so often in Malaysia.

The company (belatedly, only on January 30, 2015) responded on some of them:


"With regards to the press reports in the NST dated 28 January 2015, AAX can confirm Azran Bin Osman Rani’s cessation from the Chief Executive Officer office with effect from 30 January 2015.

The Board of Directors of AAX has appointed Datuk Kamarudin Bin Meranun (“Datuk Kamarudin”) as the Group Chief Executive Officer for AAX and Benyamin Bin Ismail (“Benyamin”) as the Acting Chief Executive Officer of the Company with immediate effect.

As to the speculation on the resignation of the Chief Financial Officer, there is no truth to this.

Datuk Kamarudin and Benyamin will spearhead with the reorganisational and turnaround exercise for the Company and to strengthen the Company’s balance sheet and to maximise profitability in ensuring the Company will be in a better financial footing."


The company also announced a rights issue to raise RM 395 Million, money that is indeed very much needed. The question is if the money is enough. The company has been bleeding lots of money (if one takes out one-off items and does not take deferred taxation into account, then AirAsia X lost money in every single year of its existence). Also, the company has large capital commitments.

Next to that, there has been a lot of selling through insider trades after the IPO, not adding to the confidence.

I think it would have been much better if all the money raised at the IPO would have been injected into the company, and shares owned by insiders would have locked up for say two years after the IPO. The authorities should consider this for future IPO's of companies, especially those that have not yet proven their business model.

With 20/20 hindsight we are all experts, but it must be noted that there were enough critical comments before AirAsia X's IPO.

"Serious Investing" wrote an interesting article here with an update here.

I wrote here on the IPO, some snippets:


"AirAsia X is offering 790 million shares, rumoured to be priced around RM 1 per share. Almost 200 million of these shares are from existing shareholders, which seems strange, AirAsia X's balance sheet is weak and this company needs money, lots of it, so why not just issue new shares?"


The exact amount paid to its existing shareholders in June 2013 would be RM 246 Million (197M shares at RM 1.25), money that would indeed have been very helpful for the company. With that money the company might not have needed a rights issue.

I also wrote about valuation:


"A company in this state, urgently needing money should not strive for a sky-high valuation. The total number of shares currently is close to 1.8 Billion, in other word pre-IPO the company is valued at about RM 1.8 Billion. Shareholders equity is 518m, which includes 247m deferred tax assets. The offer therefore looks very stretched, both from an earnings point of view (operational losses, even after six years) and a balance sheet point of view (excl. deferred tax assets).

It must also be noted that Virgin Group (Richard Branson) invested in AirAsia X in 2007, but did not participate in the subsequent rights issue in 2010, according to The Edge. Also, he sold his 10% of the company allegedly for more than USD 21M, valuing the whole company at more than RM 650m.

AirAsia had an option to increase its current shareholding in AirAsia X, but strangely enough it decided not to execute that option. Its shareholding of AirAsia X will therefore drop to only 12%, hardly meaningful and below the 20% needed to call AirAsia X its associate."


In a later post I wrote:


AirAsia X managed to book a profit over 2012, but only with the help of deferred tax accounting and gains on foreign exchange, without these 2012 would also have been a loss (like all previous years). To me, it completely hasn't proven its business model on the long haul flights.

Since the results of AirAsia X were not exactly rosy, the company also published its EBITDA numbers (Earnings Before Interest, Tax, Depreciation and Appreciation), showing profits every year.

Charles Munger has a very clear opinion about EBITDA:

"Every time you see the word EBITDA in a presentation, you should replace it with BULLSHIT EARNINGS, because that's what they are!"


Given the results of AirAsia X since the IPO, it appears that Charles Munger is indeed right about EBITDA.

AirAsia X's share price since its IPO:

Maximizing Shareholder Value is the worlds dumbest idea

James Montier tells it as it is, he is very outspoken about the financial world, the things that are very wrong in his view.

In this extremely interesting presentation he argues that Maximixing Shareholders Value (MVS) is arguably the worlds dumbest idea. The presentation starts at 5:30.

One of his main arguments is wrong incentives, a subject that is also close to people like Warren Buffett and Charlie Munger, who warned about it many times. Many of the problems in the financial world stem from incentives that are either too much focused on the short term, or are misaligned.

One slide contains a collection of more dumb financial ideas, according to Montier:

Fans of Milton Friedman might want to consider skipping a few minutes from 10:00 onwards, Montier doesn't mince his words, describing the damage that Friedman has caused.

An earlier post on Montier can be found here.

IHH: profit up 60% or profit down 60%?

From The Star website:

"IHH Healthcare net profit up 60% to RM188.7m in Q2"

IHH Healthcare Bhd's net profit rose 60% to RM188.70mil in the second quarter ended June 30, 2013, excluding exceptional items and recognition of the sale of medical suites.

The company said on Tuesday the higher profit was due to the rise in earnings before interest, tax, depreciation and amortisation (EBITDA), savings in finance costs from repayment of short-term loans, and a one-off RM22.0mil tax credit this quarter relating to tax from a previous year.

IHH's revenue, excluding recognition of the sale of medical suites, grew by 14% on-year to RM1.68bil from RM1.48bil.  Earnings before interest, taxes, depreciation, amortisation, exchange differences & other non-operational items rose 20% on-year to RM419.6mil from RM349.2mil.

"The group's robust earnings were buoyed by the ramp up of new hospitals this quarter. Its newest facility in Singapore, Mount Elizabeth Novena Hospital, turned EBITDA positive for this quarter," it pointed out.

IHH Healthcare said Acibadem recorded healthy earnings and improved EBITDA from its two new hospitals - Acibadem Ankara and Acibadem Bodrum - despite a seasonal dip in inpatient admissions volumes this quarter compared to a year ago.

As for Acibadem Ankara, which opened in November 2012, turned EBITDA positive for this quarter while Acibadem Bodrum continued reducing its EBITDA losses.

The hospital group said in the six months ended June 30, 2013, excluding the recognition of the sale of medical suites, the group achieved 21% increase for both revenue and EBITDA from a year ago.

The strong performance was driven by organic growth of existing operations, ramping up of new hospitals as well as the full six months consolidation of Acibadem Holding's performance in H1, 2013 as compared to only five months consolidation in H1 2012 when the Group acquired Acibadem Holding on 24 January 2012.

The group's year-to-date 2013 PATMI excluding exceptional items and the recognition of sale of medical suites increased 39% to RM322.1mil, compared to the same period a year ago.


Shareholders of IHH who read the above surely must be very happy with their investment.

But when we look at the official announcement at the Bursa Malaysia website, we see something very different:

Earnings are hugely down, by about 60% compared to the same quarter a year ago!

Where does the difference come from? The official announcement uses the correct PBT and PAT based on time tested accounting principles, while the company's press release uses EBITDA (corrected for certain one-off items), which are simply nothing else then "Bull Shit Earnings" according to Charlie Munger.

The press release of IHH (to be found at the Bursa Malaysia website) is really disturbing in the sense that it does not mention at all the real profit numbers (PBT and PAT) in the main text (they can only be found in appendix 1 at page 4, where also EBITDA is mentioned in the same table) . 

I have no problem that the company tries to give a positive spin to the story (that is quite normal), but the correct basic numbers should be presented in a clear and transparent way, even if they look bad.

And for The Star, they should analyse press releases before they publish them, and put critical remarks alongside them. Nobody is helped by this kind of non-information, which I think is borderline misleading. Even the title is plain wrong, net profit is PAT, there is no way around it.

A much better article can be found on the website of The Sun:

"IHH Healthcare Bhd, the second largest healthcare group in the world in terms of market value, reported a net profit of RM156.76 million, or 1.93 sen a share in the second quarter ended June 30, 2013 (Q2).

The net profit was much lower compared with RM398.9 million made a year earlier".

AirAsia and AirAsia X

[1] AirAsia announced its quarterly results. They were not that great, but also not that bad, increased spending on fuel was a drag. Revenue was up by 11%, operating profit by only 3%. PBT was down since the previous gain on foreign exchange was this time reversed in a loss.

My worry, about which I have written before, is the very aggressive growth plans that this company has. Its capital commitments are simply unbelievable:

RM 64,829,008,000.00

As if this was not yet enough, "AirAsia still wants jets after record orders".

Simply unbelievable ....

Of course, when all goes well, this could work out very nicely for its shareholders.

But what if competition heats up (as is happening at this very moment), or a recession strikes, fuel prices / exchange rates or interest rates fluctuate wildly, the company runs into regulatory problems, etc. or a combination of these (when it rains it pours)?

The airline industry has not exactly been a bed of roses for its investors, it is a cutthroat industry where many companies having gone bankrupt.


[2] AirAsia X filed a new IPO draft document on the SC website, I wrote before about the first draft (unfortunately it has been taken of the website).

AirAsia X managed to book a profit over 2012, but only with the help of deferred tax accounting and gains on foreign exchange, without these 2012 would also have been a loss (like all previous years). To me, it completely hasn't proven its business model on the long haul flights.

Since the results of AirAsia X were not exactly rosy, the company also published its EBITDA numbers (Earnings Before Interest, Tax, Depreciation and Appreciation), showing profits every year.

Charles Munger has a very clear opinion about EBITDA:

"Every time you see the word EBITDA in a presentation, you should replace it with BULLSHIT EARNINGS, because that's what they are!"

And Warren Buffett added:

"Yeah, why not put all expenses in the footnotes and say that "sales equals profits". Depreciation is real and it's the worst kind of expense. They will, as depreciable assets, need to be replaced."

Let's take AirAsia's as an example, the yearly depreciation is about RM 600 million, interest payments about RM 400 million, for a total of more than RM 1 billion. Not counting these huge amounts, well, let's say I full agree with what Munger said.

EBITDA is one of those financial engineering inventions from the US that better is left alone.

[3] On a side note, AirAsia X's CEO Azran Osman Rani spoke out (or rather: twittered) against racism, for which he ran into troubles. Needless to say, what he did was excellent, and it is a pity not more Malaysian VIPs speak out on important, national issues like racism, corruption and cronyism, controlled mainstream media, the persistent budget deficit, etc..

Berkshire Hathaway's year report 2012

There are two events important for followers of Berkshire Hathaway (BH), Warren Buffett and Charlie Munger:

• the AGM of BH which will be held May 4, 2013 
• the issuing of the yearly shareholder letter, which was done yesterday.

The link for the letter can be found here.

The report is very basic, no photo's, no fancy colour schemes, and the first page immediately gets down to business: the performance of the book value per share of Berkshire Hathaway versus the S&P 500.

The compounded annual gain of BH from 1965 to 2012 is 19.7% per year, the overall gain is a whopping 586,817%! Outstanding numbers.

But the outperformance versus the S&P 500 has significantly come down:

• from 1981 until 1998 BH outperformed the index every single year, often by a wide margin
• from 2004 until 2012 BH underperformed 4 years out of 9 years, and only outperformed the index by a wide margin in one single year (2008)

This was all forecasted by Warren, the sheer size of BH is such that outperformance is more and more difficult, Warren is now looking for acquisitions in the range of USD 10 Billion or more, and the universe for that kind of opportunities is not that large. His latest acquisition was H.J. Heinz, just announced in the news.

The numbers for the S&P 500 are also quite good, 9.4% per year, overall 7,433%. Yes, people who invested in US stocks over the last 4 to 5 decades would have done very well.

I estimate the comparable long-term gains for the Malaysian stock market to be much lower, and that while Malaysia's GDP has been growing much faster than the GDP of the US. A disconnect that I think has to do with the much lower corporate governance.

In plain English: majority shareholders and or management in the US have been more willing to share the spoils with the minority shareholders than in Malaysia.

Higher corporate governance standards and increased enforcement should improve this situation.

The secrets of Buffett’s success

Low beta stocks (meaning low volatility, "boring" stocks) and leverage (through the insurance business) explain some of Buffett's success, according to the below article.

I would like to add that very low expenses are also important, he is running his company with minimal staff and is only charging USD 100K yearly in wages. Furthermore, his partnership with Charley Munger, who helps with filtering investment opportunities.

And lastly, most importantly, his own stock picking ability to find wonderful companies at a relative cheap price and sticking with them.

From the Malaysian/Singaporean point of view his results are even more spectacular, since in the US one has to pay taxes on capital appreciation.


Beating the market with beta

If investors had access to a time machine and could take themselves back to 1976, which stock should they buy? For Americans, the answer is clear: the best risk-adjusted return came not from a technology stock, but from Berkshire Hathaway, the conglomerate run by Warren Buffett. Berkshire also has a better record than all the mutual funds that have survived over that long period.

Some academics have discounted Mr Buffett as a statistical outlier. Others have simply stood in awe of his stock-picking skills, which they view as unrepeatable. But a new paper* from researchers at New York University and AQR Capital Management, an investment manager, seems to have identified the main factors that have driven the extraordinary record of the sage of Omaha.

Understanding the success of Mr Buffett requires a brief detour into investment theory. Academics view stocks in terms of their sensitivity to market movements, or “beta”. Stocks that move more violently than the market (rising 10%, for instance, when the index increases by 5%) are described as having “high beta”, whereas stocks that move less violently are considered “low beta”. The model suggests that investors demand a higher return for owning more volatile—and thus higher-risk—stocks.

The problem with the model is that, over the long run, reality has turned out to be different. Low-beta stocks have performed better, on a risk-adjusted basis, than their high-beta counterparts. As a related paper† illustrates, it should in theory be possible to exploit this anomaly by buying low-beta stocks and enhancing their return by borrowing money (leveraging the portfolio, in the jargon).

But this anomaly may exist only because most investors cannot, or will not, use such a strategy. Pension schemes and mutual funds are constrained from borrowing money. So they take the alternative approach to juicing up their portfolios: buying high-beta stocks. As a result, the average mutual-fund portfolio is more volatile than the market. And the effect of ignoring low-beta stocks is that they become underpriced.

Mr Buffett has been able to exploit this anomaly. He is well-known for buying shares in high-quality companies when they are temporarily down on their luck (Coca-Cola in the 1980s after the New Coke debacle and General Electric during the financial crisis in 2008). “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” he once said. He has also steered largely clear of more volatile sectors, such as technology, where he cannot be sure that a company has a sustainable advantage.

Without leverage, however, Mr Buffett’s returns would have been unspectacular. The researchers estimate that Berkshire, on average, leveraged its capital by 60%, significantly boosting the company’s return. Better still, the firm has been able to borrow at a low cost; its debt was AAA-rated from 1989 to 2009.

Yet the underappreciated element of Berkshire’s leverage are its insurance and reinsurance operations, which provide more than a third of its funding. An insurance company takes in premiums upfront and pays out claims later on; it is, in effect, borrowing from its policyholders. This would be an expensive strategy if the company undercharged for the risks it was taking. But thanks to the profitability of its insurance operations, Berkshire’s borrowing costs from this source have averaged 2.2%, more than three percentage points below the average short-term financing cost of the American government over the same period.

A further advantage has been the stability of Berkshire’s funding. As many property developers have discovered in the past, relying on borrowed money to enhance returns can be fatal when lenders lose confidence. But the long-term nature of the insurance funding has protected Mr Buffett during periods (such as the late 1990s) when Berkshire shares have underperformed the market.

These two factors—the low-beta nature of the portfolio and leverage—pretty much explain all of Mr Buffett’s superior returns, the authors find. Of course, that is quite a different thing from saying that such a long-term performance could be easily replicated. As the authors admit, Mr Buffett recognised these principles, and started applying them, half a century before they wrote their paper.

From the website of The Economist

Warren Buffett Admits To 5 Big Mistakes

There are two big events each year for Berkshire Hathaway fans, the Annual General Meeting and the publishing of its year report with the accompanying letter of Warren Buffett. The last event happened yesterday and can be found here: here.

It is rather long (21 pages), a selection of the most important quotes can be found here.

Just a single $100 bill invested in Berkshire Hathaway in 1964 would have turned into $513,055, enough to buy a nice house in the US (especially since the recent crash in housing prices). All capital gains, since the company does not pay a dividend.

The good thing about Warren Buffett and Charlie Munger is that they openly admit their mistakes, something that is vey rare in those (and many other) circles:

HOUSING HOROSCOPE

The blunder: Buffett predicted in last year's letter that the U.S. housing recovery would begin within the next year and help fuel economic growth.

The explanation: Buffett doesn't mince words and says he was "dead wrong" about this one. But he says basic biology makes it unavoidable that the country will need more houses.

The quip: "People may postpone hitching up during uncertain times, but eventually hormones take over. And while 'doubling up' may be the initial reaction of some during a recession, living with in-laws can quickly lose its allure."

ENERGY ERROR

The blunder: Buffett spent about $2 billion buying bonds offered by Texas utility Energy Future Holdings. But those bonds are now worth about $878 million, and he conceded Saturday that even that could be wiped out.

The explanation: Buffett comes right out and admits misjudging the company's prospects and the likelihood that natural gas prices would remain depressed.

The quip: "However things turn out, I totally miscalculated the gain/loss probabilities when I purchased the bonds. In tennis parlance, this was a major unforced error by your chairman."

ACQUISITION ANGST

The blunder: Some of the companies Berkshire Hathaway has bought don't add much to the company's bottom line. Buffett didn't single out the laggards in Berkshire's manufacturing, service and retail unit, but he acknowledged that a few produce poor returns.

The explanation: Buffett says he misjudged some of these businesses before Berkshire bought them partly because he didn't always listen to curmudgeonly Vice Chairman Charlie Munger.

The quip: "I try to look out 10 or 20 years when making an acquisition, but sometimes my eyesight has been poor. Charlie's has been better; he voted 'no' more than 'present' on several of my errant purchases."

OIL OOPS

The blunder: In 2008, Buffett more than quadrupled Berkshire's stake in ConocoPhillips when oil and gas prices were near their peak. It cost the company several billion dollars.

The explanation: Buffett said he didn't anticipate the dramatic fall in energy prices that happened later in 2008.

The quip: "During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt."

TEXTILE TROUBLE

The blunder: Buffett has said that buying Berkshire Hathaway itself may have been his worst investment decision. It was a struggling New England textile mill when Buffett bought into it in the 1960s. He kept the mill running for 20 years before shutting it down.

The explanation: Buffett didn't recognize immediately that the textile business was doomed to continue losing money.

The quip: "The dumbest thing I could have done was to pursue 'opportunities' to improve and expand the existing textile operation — so for years that's exactly what I did," he said last year. "And then, in a final burst of brilliance, I went out and bought another textile company. Aaaaaaargh! Eventually I came to my senses, heading first into insurance and then into other industries."

From: http://www.businessinsider.com/warren-buffett-admits-to-5-big-mistakes-2012-2

Farnam Street Blog

Just discovered an interesting blog:

http://www.farnamstreetblog.com/

Many interesting articles and also a special section on Charlie Munger's Mental Models:

http://www.farnamstreetblog.com/mental-models/

An article about Ray Dalio's Management lessons:

http://www.farnamstreetblog.com/2011/09/management-lessons-from-ray-dalio/

Ego
“Two of the biggest impediments to truth and excellence are people’s ego’s and organizational bureaucracy. Most people like compliments and agreement, and they dislike criticisms and conflict. Yet recognizing mistakes and weaknesses is essential for rapid improvement and excellence. In our culture, there is nothing embarrassing about making mistakes and having weaknesses. “
“We need and admire people who can suspend their egos to get at truth and evolve toward excellence, so we ignore ego-based impediments to truth. We have a different type of environment in which some behaviors discouraged elsewhere are rewarded here (like challenging one’s superiors), and some behaviors encouraged elsewhere are punished here (like speaking behind a subordinate’s back).”

Think and act in a principled way and expect others to as well
“all outcomes are manifestations of forces that are at work to produce them, so whenever looking at specific outcomes, think about the forces that are behind them. Constantly ask yourself, “What is this symptomatic of?”

If you don’t mind being wrong on the way to being right, you will learn a lot
“I once had a ski instructor who had taught Michael Jordan, the greatest basketball player of all time, how to ski. He explained how Jordan enjoyed his mistakes and got the most out of them. At the start of high school, Jordan was a mediocre basketball player; he became great because he loved using his mistakes to improve. I see it all the time. Intelligent people who are open to recognizing and learning from their mistakes substantially outperform people with the same abilities who aren’t open in the same way.”

Mistakes
“Create a culture in which it is OK to fail but unacceptable not to identify, analyze and learn from mistakes. … A common mistake is to depersonalize the mistake, saying “we didn’t handle this well” rather than “Harry didn’t handle this well.” Again, this is because people are often uncomfortable connecting specific mistakes to specific people because of ego sensitivities. … it is essential that the diagnosis connect the mistakes to the specific individuals by name.”

Not all opinions are equally valued
“Not all people’s opinions are equally valuable. Still that important distinction is often unacknowledged in discussions. Prevent this by looking at people’s track records, noting their credentials, and evaluating how their arguments hold up when challenged.

Debate
“Debate is generally among approximate equals; discussion is open-minded exploration among people of various levels of understanding; and teaching is between people of different levels of understanding.”

There are times when instruction is more important than debate
“Imagine if a group of us were trying to learn how to play golf with Tiger Woods, and he and a new golfer were debating how to swing the club. Would it be helpful or harmful and plain silly to treat their points of view equally, because they have different levels of believability. It is better to listen to what Tiger Woods has to say, without constant interruptions by some know-nothing arguing with him.”

Be careful not to lose personal responsibility via group decision making
“Too often groups will make a decision to do something without assigning personal responsibilities so it is not clear who is supposed to do what.”

Don’t pick your battles. Fight them all.
“If you see something wrong, even small things, deal with it. that is because 1) small things can be as symptomatic of serious underlying problems as big things, so looking into them, finding what they are symptomatic of, and resolving them will prevent big problems; 2) resolving small differences with people will prevent a more serious divergence of your views; and 3) in trying to help to train people, constant reinforcement of the desired behavior is helpful. The more battles you fight, the more opportunities you will have to get to know each other and the faster the evolutionary process will be.”

All problems are manifestations of their root causes
“Keep asking why? and don’t forget to examine problems with people. In fact, since most things are done or not done because someone decided to do them or not to do them a certain way, most root causes can be traced to specific people, especially “the responsible party.” When the problem is attributable to a person, you have to ask why the person made the mistake to get at the real root cause. For example, a root cause discovery process might go something like this: The problem was due to bad programming. Why was there bad programming? Because Harry programmed it badly. Why did Harry program it badly? Because he wasn’t well trained and because he was in a rush? Why wasn’t he well trained? Did his manger know that he wasn’t well trained and let him do the job anyway or did he not know?”

Avoid Monday-morning quarterbacking (hindsight bias)
That is “evaluating the merits of past decisions based on what you know now versus what you could have reasonably known at the time of the decision. Do this by asking the question, “what should an intelligent person have known in that situation,” as well as having a deep understanding of the person who made the decision (how do they think, what type of person are they, did they learn from the situation, etc?)”

Don’t undermine personal accountability with vagueness
“Use specific names. For example, don’t say “we” or “they” handled it badly. Also avoid: “We should…” or “We are…” Who is we? Exactly who should, who made a mistake, or who did a great job? Use specific names.

Efficiency
“Try to equip departments to be as self-sufficient as possible to enhance efficiency. We do this because we don’t want to create a bureaucracy that forces departments to requisition resources from a pool that lacks the focus to do the job. For example, while people often argue that we should have a technology department, I am against that because building technology is a task, not a goal in and of itself. You build technology to…(fill in the blank, e.g., help service clients, help market, etc.). Keeping the tech resources outside the department means you would have people from various departments arguing about whether their project is more important than someone else’s in order to get resources, which isn’t good for efficiency. The tech people would be evaluated and managed by bureaucrats rather than the people they do the work for.”

Constantly worry about what you are missing
“Even if you acknowledge you are a dumb shit and are following the principles and are designing around your weaknesses, understand that you still might be missing things. You will get better and be safer this way.”

Remember the 80/20 rule and know what the key 20% is
“Distinguish the important things from the unimportant things and deal with the important things first. Get the important things done very well, but not perfectly, because that’s all you have time for. Chances are you won’t have to deal with the unimportant things, which is better than not having time to deal with the important things. I often hear people say “wouldn’t it be good to do this or that,” referring to nice-to-do rather than important things: they must be wary of those nice-to-do’s distracting them far more important things that need to be done.”

Use the phrase, “by and large”
“Too often I hear discussions fail to progress when a statement is made and the person to whom it is made to replies “not always,” leading to a discussion of the exceptions rather than the rule. For example, a statement like “the people in the XYZ Department are working too many hours” might lead to a response like “not all of them are; Sally and Bill are working normal hours,” which could lead to a discussion of whether Sally and Bill are working too long, which derails the discussion. Because nothing is 100% true, conversations can get off track if they turn to whether exceptions exist, which is especially foolish if both parties agree that the statement is by and large true. To avoid this problem, the person making such statements might use the term “by and large,” like “by and large, the people in the XYZ Department are working too many hours.” People hearing that should consider whether it is a “by and large” statement and treat it accordingly.”

Most importantly
“a) build the organization around goals rather than around tasks;
b) make people personally responsible for achieving these goals;
c) make departments as self-sufficient as possible so that they have control over the resources they need to achieve the goals;
d) have the clearest possible delineation of responsibilities and reporting lines;
e) have agreed-upon goals and tasks that everyone knows (from the people in the departments to the people outside the departments who oversee them);
f) hold people accountable for achieving the goals and doing the tasks.”

More about Dalio: http://www.newyorker.com/reporting/2011/07/25/110725fa_fact_cassidy

Munger's models and his best (Business) Books

Charlie Munger often refers to his mental models which help him in decision taking. Rob Kelly lists 12 of them on his website:

http://robdkelly.com/blog/models-frameworks/munger-mental-models/

Books related to Munger:

http://futile.free.fr/bibliocm.html

Kelly's favorite list of business books:

http://robdkelly.com/blog/personal-development/best-business-books-of-all-time/

Moody's: Fraud, Corruption, Greed

I blogged before about the non-event that S&P downgraded the AAA status of the US:

http://cgmalaysia.blogspot.com/2011/08/non-event-s-downgrades-us-to-aa.html

".. as usual, the rating agencies in the US have been hopelessly slow to adapt to reality. Similar to the enormous disservice they did a few years ago rating packaged mortgages as AAA while the collatoral was dubious to say the least. A huge bias due to the wrong incentive: if the agencies would offer high (unrealistic) ratings they would receive more work and thus more money."

There is more support for this:

"A former senior analyst at Moody's has gone public with his story of how one of the country's most important rating agencies is corrupted to the core."

"The primary conflict of interest at Moody's is well known: The company is paid by the same "issuers" (banks and companies) whose securities it is supposed to objectively rate. This conflict pervades every aspect of Moody's operations, Harrington says. It incentivizes everyone at the company, including analysts, to give Moody's clients the ratings they want, lest the clients fire Moody's and take their business to other ratings agencies. In short, Harrington describes a culture of conflict that is so pervasive that it often renders Moody's ratings useless at best and harmful at worst. "
Here are some key points:
 

Moody's ratings often do not reflect its analysts' private conclusions. Instead, rating committees privately conclude that certain securities deserve certain ratings--and then vote with management to give the securities the higher ratings that issuer clients want.

Moody's management and "compliance" officers do everything possible to make issuer clients happy--and they view analysts who do not do the same as "troublesome." Management employs a variety of tactics to transform these troublesome analysts into "pliant corporate citizens" who have Moody's best interests at heart.

Moody's product managers participate in--and vote on--ratings decisions. These product managers are the same people who are directly responsible for keeping clients happy and growing Moody's business.

At least one senior executive lied under oath at the hearings into rating agency conduct. Another executive, who Harrington says exemplified management's emphasis on giving issuers what they wanted, skipped the hearings altogether

http://globaleconomicanalysis.blogspot.com/2011/08/former-moodys-senior-vice-president.html

Munger and Buffett have often warned about giving people/institutions the wrong incentives, it will lead to highly biased situations (ironically, they did invest themselves in Moody's, one of the big three rating agencies).

In Malaysia we have exactly the same situation regarding the "independent" reports. It is in the benefit of the writers to follow the majority shareholders, writers who are critical of them will not be asked again for their services. It is therefore no surprise that these reports are so biased that they are completely useless.

Recommendation: Independent reports should be abolished and the Securities Commission and Bursa Malaysia should really have come down hard at the writers a long, long time ago. By not doing so they have done Malaysia a big disservice, credibility has suffered and Minority Investors had no chance to fight for their cause.

Charlie Munger 175 Quotes

http://wealthymatters.com/2011/02/12/charlie-mungers-quotes-mungerisms/

Charlie Munger is a pretty outspoken person: "If you mix raisins with turds, they're still turds".

Some other quotes:

”Most people are too fretful, they worry to much.  Success means being very patient, but aggressive when it’s time.”

”I think that, every time you saw the word EBITDA [earnings], you should substitute the word “bullshit” earnings.”

"If you buy something because it’s undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That’s hard. But if you buy a few great companies, then you can sit on your ass. That’s a good thing.”

”It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

”In my whole life, I have known no wise people who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads, at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”

”Well, the questioner came from Singapore which has perhaps the best economic record in the history of any developing economy and therefore he referred to 15% per annum as modest. It’s not modest–it’s arrogant. Only someone from Singapore would call it modest.”

”Everywhere there is a large commission, there is a high probability of a ripoff.”

”Acknowledging what you don’t know is the dawning of wisdom.”

”Beta and modern portfolio theory and the like – none of it makes any sense to me."

Gold: a Buy or a Sell?

Gold trades currently above USD 1,600 per ounce. The previous bull run ended in 1980 at around USD 850 per ounce, after which a 26(!) year bear market followed. The following chart is not adjusted for inflation:

There are four people I admire.

Warren Buffett:

“Gold gets dug out of the ground in Africa, or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

“Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything.”

Charlie Munger:

“I don’t have the slightest interest in gold. I like understanding what works and what doesn’t in human systems. To me that’s not optional; that’s a moral obligation. If you’re capable of understanding the world, you have a moral obligation to become rational. And I don’t see how you become rational hoarding gold. Even if it works, you’re a jerk.”

Jim Rogers:
"I own gold and silver, because paper money all over the world is being debased.  In a few years we will probably all have our money in physical assets, because nearly all paper money is being debased at a rapid rate by politicians who have learned how to buy votes.  It is the wrong thing to do, but they don't care.  They're worried about the next election."

Marc Faber:

“And so the question is, you know, where do you put your money if you and I go away to an island or to jail for ten years and we can’t make any transactions and we come back in ten years’ time? I think if the objective is the maintenance of purchasing power, in other words, you just don’t want to wake up in ten years’ time when you come out of jail and what you have is worthless, then I would say that probably gold is the best alternative. If the question is how do you maximize profit, probably there may be more profit in equities because, you know, we have abysmal performance of equities in the last ten years. And particularly in the US, as a result of the decline in the value of the US dollar, equities would seem to me to be not particularly expensive. I think what would be dangerous for you and me would be to put all our money in US dollar cash and in US government bonds for ten years and then come back and maybe find out that we can buy with a hundred thousand dollars just a cup of coffee — or not even that.”

He said that longer-term gold can only go higher because of negative real interest rates. Even a deflationary collapse is unlikely to hurt gold because the Fed will simply debase the dollar to get nominal prices higher.

"If the Fed gets it right and successfully re-inflates asset prices, then inflation will be in the double-digits, which would be bullish for gold," Faber pointed out.”

Marc Faber argued the following in his "Gloom, Boom and Doom" newsletter:

It took the US government about 80 years (between 1920 and 2000) to devalue the USD by 95%. In other words, it would take $20 in 2000 to buy the same item that cost $1 in 1920. The US government will again devalue the USD by 95%, but this time they will do it much faster. Paper currencies can be printed at will, they don’t even need a physical printer, they can add money electronically. The only money they can’t print at will is money supported by real items, like Gold.

For me, if these clever people have such a different opinion, then what can I add? I simply find it fascinating, such a difference of opinion by such clever people.

For me, I own some gold and some gold miners (through Blackrock World Gold Fund), I don’t intend to buy nor sell at this moment. Other good long-term inflation hedges are land, property and to some extend shares. The best is to spread risk by investing in different asset classes.