Sunday, November 13, 2011

The Most Important Thing

An investment book highly praised by Warren Buffet is not the usual finance book by people like Burton Malkiel or Jeremy Siegel , renown university professors who moonlight as investment gurus. Instead the book is written by a veteran investor- Howard Marks and lacks the academic flourish noticeable in books by professors. Aside from the usual focus on fundamentals, Marks zeroes in on value investing which Buffet is a well-known practitioner. His chapters on risk are strangely common sense but strike to the heart of the matter. Risk is basically losing your money – nothing more, nothing less. Risk is reflected in the price – the higher the price, the higher the risk. He focuses on investor psychology – the single most important aspect of value investing. Investor psychology is seen in bubbles, whether foolishly chasing the upside or in low price stock that the market has unreasonable discounted. The book is able to synthesize the various ideas of other great books by offering a realistic viewpoint for value investors. One can say the author is biased but a welcome one for someone who has been reading all sorts of financial guides.

Clearly, the market is inefficient not only because of asymmetrical information (‘insider knowledge’) but because of investor psychology, the market is a beauty contest as famously remarked by Keynes, indicating that stock fundamentals and especially technical investing is hogwash. Market sentiment is not guided by coolly efficient and rational investors but speculators who underestimate risk and are influenced by mania and emotions. It’s misguided mob throwing away money, not at all like the organized facade alluded to in television shows and advertising by brokers or investment banks. Even financial advisers may not have a clue on what they are doing, a silly pretense in trying to be a professional expert on some esoteric discipline, but just people trying their best not to lose money while sharks come in to get all the bling. People like Buffet and George Soros are the few who really know what they are doing and it’s not really an incredible skill but discipline, not being swayed by emotion and mob psychology.

The book alludes to investment success as an attitude, a certain predisposition that provides a ‘second-level thinking’ that synthesizes information from business, economics and finance, plus a conservative mentality that is not swayed by emotion and market hysteria. The key is an insightful understanding of the relationship between price and value plus a realistic assessment of the risk. Looking back to my first huge loss investing in currency, particularly on the Japanese Yen in the late 1990’s during the time Robert Rubin was treasury secretary, I was foolish. My bet was right but the execution was a mess, basically a misunderstanding between my broker and my intended plan. I was a fool who did not realize the risk despite the huge amount being invested, disregarding of my own exit plan, blinded by greed and a fear of losing money, all contributing to a disastrous loss acerbated by sweet talk of my currency broker. This sober experience, right after earning money on an early bet on Philippine banks that earned me enough to pay for my post-graduate degree, spurring me on to the reckless currency investment, thinking that I was different and smart when in fact I was just lucky, lead me to bite the bullet and borrow money from my grandmother in exchange for my stock certificates.

My failure led me to read more, eventually discovering Benjamin Graham’s books and Warren Buffet. The journey continued with Burton Malkiel and his ‘Random Walk down Wall Street’, Jeremy Siegel, Robert Kiyosaki, efficient market theory, diversification, stock allocation, George Soros and finally ending with Howard Marks  ‘The Most Important thing’ – a paean to value investing, coming full circle back to Graham and Buffet. Along the way, I have gained modest experience by investing in the Philippine, Singapore and US stock market, in common stocks, ETFs, index funds, country funds and so on. But all this experience is more about technicalities, answering the ‘How’ question, but the bigger question is on the philosophical idea, guidance on the psychology and behavior of a good investor, answering the ‘Why’ question.  The new field of behavioral economics looks into this area, something that Graham and Buffet have been talking about for decades, now an academic pillar where one’s behavior (like in all other things) is the key to success. Kiyosaki also focuses on the philosophy and not really on the technical part, not talking about the specifics of investing, but to re-orient the focus on cash flow and not traditional ‘assets’ like a large house. 

Being a contrarian is celebrated, to go against the crowd and sticking with your guns, even if it means obscurity and meager results, as long as risk is managed and one is not influenced by greed. This is the supreme lesson of Marks’ book which makes it an intriguing work from a veteran investor, being contrarian is OK while providing insights on stock cycles, risk and investment behavior. Perhaps this is the book that should end one’s study of investment – the philosophy thing is done so one follows Henry Ford’s advice to read only instruction manuals, in a specific sense, how to invest in currency or options or technical trading just to learn ‘How’ or study stocks so one is ready when the funds are available. The book transcends the financial realm into a general guide towards general living, not to aspire to live like the Joneses, but towards a more Puritan and conservative lifestyle, back in the days when one is not a ‘smart aleck’, trying to be the best and brightest, but being self-controlled, ascetic and enjoying the simple pleasures of life. Nowadays that is being contrarian.

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