Juggling Dynamite

Today we found a negative review of Juggling Dynamite by a new self-styled, “do-it-yourself” financial blogger. The blogger does not name himself, so I will have to call him DIY.
Of course, I don't expect that everyone will love my message.
Juggling Dynamite is a book that upsets the status quo of long-only proponents. Ideas that upset the status quo incite passionate responses. Most readers that have written to me use strong language such as “I loved your book.” A few, like DIY, dislike the message, and also respond rather passionately.
Actually it seems that there are two main groups that dislike the book’s message. The first are the do-it-yourself, self-proclaimed “experts” who are not actually money managers. This group usually cites training in other general areas to claim authority on money management. Since they do not have a management discipline themselves, they decide that passive-only is the best strategy. As I explain in Juggling Dynamite, passive strategies have worked fine in secular bull markets, and they have worked horribly during secular bear markets, with losses or no real gains even over 10- and 20-year periods. Long-only proponents naturally hope we are always in secular bull markets. History, unfortunately, does not support this hope.
To be clear, I am far from the only one expressing these concerns. Peter L. Bernstein, and other long-tenured independents, has been preaching “my sermon,” as Bernstein calls it, for the past several years. Just last week in his keynote at the CFA Forecast dinner, he alluded to the risk that we may be facing a 1970s-like cycle again.
There is a certain wisdom and risk aversion that comes from being a professional money manager. (Bernstein was one from 1951 to 1973.) As a discretionary fiduciary doing the job for a living, we managers are actually accountable and potentially liable for losses that our clients experience. I have always said that real-life responsibility for others is what separates the parents from the teenagers.
The other group that sometimes takes offense to the book are people who are long-only managers at mutual funds and other buy-and-hold firms. Since this group spend all their time selling people on buy and hold, my book tends to annoy and provoke more discussion and doubt than they care to entertain. My book explains all of these dynamics in detail for anyone who cares to learn more.
As for the criticism that Juggling Dynamite fails to include our performance numbers, I have heard this complaint from a few people now. I did not include our firm’s return numbers for a couple of reasons: One is because we are not running mutual funds, so we must model composites and every account is segregated with a different mix of fixed income and equities. The other reason is that I did not write the book as a sales pitch for our firm's approach (not everyone can be our client) nor a do-it-yourself book. The book makes the case for objective, tactical risk management, and I say that there are several valuations methods one can use to accomplish this. I also say that very few individuals will have the expertise and self-discipline to do it for his or herself. But, as I have said before, just because something requires great discipline and constant effort, it does not mean it should be avoided by those who have the foresight, system, and commitment for doing it. Admittedly excellent risk-adjusted managers are rare and valuable, but fortunately this doesn’t mean they don’t exist. I name several in the book, and I link to several more from my blog favourites.
The central point of Juggling Dynamite is to push back on the self-serving rhetoric of long-only investment sales, and to alert investors to the reality that we may well be in a different market cycle over the next several years than the one experienced over the '80s and '90s.
I am very grateful to DIY for linking us to the excellent paper by M. Faber, “A Quantitative Approach to Tactical Asset Allocation.” Although the method is simpler than the one we use, it does make the case for our approach exceedingly well. My partner and technical analyst Cory Venable published a similar paper explaining some of the basis for our methodology in the Journal of Technical Analysis, out of NY, NY in January 2005.

Nassim Taleb's new book The Black Swan has been causing quite a stir. Taleb points out that there are very few things that we can truly know about the future as human life is continually besieged by events that were unexpected. Those who believe they control their own destiny may feel unsettled by these notions, those who like to cast fate to the wind, may take comfort.
For me the story of the ant and the grasshopper comes to mind. The ant knew the winters were inevitable and so he worked everyday preparing a cushion for challenges that lay ahead. This meant giving up some of his immediate pleasure and consumption for the discipline of having reserves stored away for future needs. The grasshopper continued to dance and play today without worry for the inevitability of winter.
Many investors in the “passive long” camp have been recently citing Taleb’s work as evidence to bolster their random walk notion that financial markets are wild, unpredictable things so one is best to just spread risk around, close one’s eyes and buckle in for the ride. Their great hope is that, over one's time horizon, profits will appear like barnacles on the bottom of a floating boat.
As examples of “black swan” events, Taleb cites things like 9/11, the Internet, and the fall of the Berlin Wall. I too have had some experience with best laid plans over the years, and I fully accept that the future is full of events, good and bad, many of which we may not now foresee. Galbraith said that there are two kinds of economists: those who do not know and those who know that they do not know. So yes, I accept that there will be some black swans ahead.
But I am also committed to living like the ant and not the grasshopper. And so, I am intent on managing exposure to the risks that we can foresee—from financial markets, to health, to our environment. In fact I insist that it is the duty of those of us in positions of trust to manage the exposure of our clients to foreseeable and unforeseeable risks in every prudent way.
Was 9/11 really unforeseeable by the US administration? I do not know. I was never privy to their intelligence. Only those who were insiders will ever know the extent of their own culpability in the carnage which befell.
This comes to my point: Is the current housing recession, and the resulting pain and loss playing out worldwide, a black swan?
“The former chairman of the US Federal Reserve warned today that the danger of a US recession had risen following the turmoil in the global credit market and he denied that regulators were caught unawares by the problems which caused the global credit crunch”. In an interview with BBC Radio 4's Today programme, Mr Greenspan said it was inevitable the house price bubble would burst.
On the current financial market turmoil sparked by a collapse in the risky US mortgage sector, Greenspan said he had little sympathy for the hedge fund community which was “presumably the largest culprit” behind it. He said: “We did know what was going on and the reason we didn't stop them was that to a large extent these types of questionably egregious actions are taken by people who have their own money invested.”
He wasn't concerned at seeing these wealthy investors' net worth dwindle. He also predicted that the era of low inflation was coming to an end:

I'm not really able to pinpoint the time but I'm reasonably confident that the inflation tranquility that we have experienced throughout the world actually for the last 20 years is not something we can hope to readily replicate as we move into the future.

Financial market participants today are super-levered—from consumers, to hedge funds, and many western world governments. It is not just the net worth of “wealthy hedge funds investors” at risk here. These issues are now broad and endemic, certain to effect the fate of future decades to come. All responsible insiders saw these issues coming. They ought to have seen them coming. And they ought to have structured risk management plans accordingly. Pleading ignorance can be no excuse. This is no black swan.

Yesterday I was re-reading Capital Ideas: The Improbable Origins of Modern Wall Street by Peter Bernstein. For anyone that has not read this book lately, I strongly recommend it as an exceptional overview of how capital market theory, as we know it, has evolved over the past 100 years.
From the 50's to the 70's Bernstein worked as a portfolio manager at the investment counsel firm his father had founded in the 30's. During his first 20 years in practice, markets enjoyed a strong bull cycle a little like the more recent cycle of 1982–1999. Then came the Bear of 1973–1974, where “the entire rise in stock prices since 1954 had been erased. At the same time, the bond market, the traditional haven of the risk-adverse suffered a 35 percent loss of purchasing power.” (p.3)
Many industry advisors who had only known the previous 20 years of market experience were completely shocked by the extent of the capital devastation done. They had read about previous crashes in market history of course, but somehow the unusually long period of economic prosperity in the 50's and 60's had convinced most that times were much safer and that such large market losses were the things of a distant past. When the Bear of 1973–1974 hit many, Bernstein included, left investment management, horrified by how few risk controls they had actually had in place to protect their clients. As we have witnessed throughout human history, periods of smooth sailing do not build the best sailors.
I was one of 4 on an expert “voice of experience” panel yesterday at a conference on indexing and ETFs. The other 3 panellists were all explaining how they use passive ETFs since clients are looking for lower fee structures. I agree with this premise for picking index units over individual stocks as we also use ETFs in practice for our equity tool. But it really struck me that so much of what we as a profession or business “know” about risk management has come to us from the world of theory and the infinite time horizons of institutional pensions and foundations, and in particular from the Bull market of 1982–1999.
As I write in Juggling Dynamite, people however are not pensions. In other words, this whole idea of no need to time markets or take profits because passive investment in a broad basket or index is the most efficient over 50 year + time frames, is really rather irrelevant to real life people. My clients are all 40, 50, 60, 70. They get the bulk of their capital in lumpy deposits as they sell businesses, or assets, and receive inheritance. Most of their life savings come into being in their last say 10 years of working. So isn't it nuts then that the buy and hold mantra keeps saying no need to time, just invest for the long haul? Most clients don't have 50 years for it to work out and in reality if they lose money over 1 or 2 years in bad markets they are likely to be very psychologically injured by the decline.
The trouble is that investment advice is largely populated by well-meaning salespeople who have really just downloaded a general understanding of investment theory from the academics after the theory has been filtered through a “how to get people to buy” filter from the big firms. The academics are writing about very long term horizons and the “advisors” are sort of blindly applying these “infinite” notions to the “finite” clients they are servicing. And so, little critical thought is going on from anybody about the end user individual investor.
I guess it’s a bit like medical research being performed primarily for one patient group such as white males and then trying to apply those general concepts to other disparate groups without taking into account the unique characteristics of those other patients. The theorists may be right in the institutional large, but the front line advisors are then trying to treat individual patients without accounting for their dramatically different fact sets.
One of the questions yesterday to the panel was: “Is there anything that you worry about, that keeps you up at night sometimes?” All three broker/advisors said no, nothing worried them, and one said he lost sleep over his golf score.
I said that I was a professional worrier. I worry about everything that could go wrong and hurt my clients. As a discretionary, fiduciary manager working for “finite” clients, I believe that my clients pay me to worry about them. Why else would they hire a portfolio manager? Is our job to slap them on the back and take them golfing once in a while? Or is our job to look out for their best interests and take every possible step to protect them from the next big decline?
What keeps me up at night sometimes? I am worried that complacency has set back in. I am worried that after 4 strong market years (where investors have not yet recovered all of their painful losses in the 2000–2002 Bear), investors and their advisors are once again blindly over-exposed to market risk while feebly citing half-understood and misapplied institutional concepts to bolster their courage.
Sometimes I wish I knew less about the risks or could take my fiduciary duty less seriously. I would no doubt get more sleep and play more golf.