Guidance from a Wall Street legend

Of course looking back is the easy part of investing – looking forward is more challenging. To help us do that, we thought it worthwhile to share the views of the recently deceased legendary Wall Street investor – Barton Biggs.

Barton Biggs entered the investment industry in 1961 and in 1973 joined Morgan Stanley, where he served as chief global strategist from 1985 until his retirement in 2003. He was named 10 times to the All-America research team and was voted Wall Street’s top global strategist each year from 1996 to 2000. Among his claims to fame:

• He predicted the bull market that began in 1982 and warned investors about Japanese stocks prior to their collapse in 1989.
• In an interview in July of 1999, he identified a bubble in the US market and advised investors to sell tech stocks.
• He correctly called the bottom in US stocks in March 2009.

Biggs wrote extensively on how investors can prosper in volatile markets. Three of his themes are especially relevant today:

• Why owning stocks is essential for most investors
• The challenges of investing rationally in an irrational world
• The psychological makeup of successful investors.

Why owning stocks is essential

One insight from Biggs relates to why almost all investors need to own equities at some point in their investing lives: “The history of the world is one of progress and as a congenital optimist, I believe in equities. Fundamentally, in the long run you want to be an owner, not a lender.”

Biggs also discussed the trap of making short-term safety your only investment consideration and sacrificing higher returns for lower volatility: “Warren Buffett put it best when he said he would always pick an investment strategy that over five years would give him a 12% compounded annual return, but that was volatile, over one that promised a stable 8% return annually.”

Rational investing in an irrational world

Biggs also wrote widely on the challenges of being caught up in the emotions of the market and also the tendency to root our investment outlook in what happened in the immediate past, rather than in what’s happening today and what will happen tomorrow.

This is no different than military officers who attempt to prepare for the next war by applying the lessons from the last one, without recognising that the context is entirely different. Biggs’ comment helps explain peculiarities such as massive inflows into government bonds during a period of all-time low rates, leading to the virtual certainty of capital losses when interest rates rise: “As investors, we always have to be aware of our innate and very human tendency to be fighting the last war. We forget that Mr. Market is an ingenious sadist and that he delights in torturing us in different ways …. Mr. Market is a manic depressive with huge mood swings and you should bet against him, not with him, particularly when he is raving.”

Biggs went on to refer to a comment by Warren Buffett about investing – that it is like being in business with a partner who has a bi-polar disorder: “When your partner (with a bi-polar personality) is deeply distressed, depressed and in a dark mood and offers to sell his share of the business at a huge discount, you should buy it. When he is ebullient and optimistic and wants to buy your share from you at an exorbitant premium, you should oblige him. As usual, Buffett makes it sound easier than it is because measuring the level of intensity of the mood swings of your bi-polar partner is far from an exact science.”

The psychological makeup of successful investors

As a result of the strong emotions at play, many money managers find it hard to stick to their strategies. Here’s what Biggs had to say about the importance of immunizing yourself from the psychological effects of the swings of the market: “The investment process is only half the battle. The other weighty component is struggling with yourself and immunizing yourself from the psychological effects of the swings of the market, career risk, the pressure of benchmarks, competition and the loneliness of the long distance runner.”

And Biggs offered one final piece of advice about knowing yourself and your foibles which will particularly resonate for those of you who remember the tech boom in the late 1990s – while this advice is oriented to investment professionals, it applies to individual investors as well: “At the extreme moments of fear and greed, the power of the daily price momentum and the mood and passions of ‘the crowd’ are tremendously important psychological influences on you. It takes a strong, self-confident, emotionally mature person to stand firm against disdain, mockery and repudiation when the market itself seems to be absolutely confirming that you are both mad and wrong.”

What this means for your portfolio

We apply the thoughts of Biggs to client portfolios via the following guiding principles:

• Taking the right level of risk: We spend time regularly working with you to identify not only how much risk you are prepared to take but also how much you need to take to achieve your retirement goals. We then structure a portfolio around the risk return trade-off you are prepared to accept.
• An income buffer: For retired clients, we like to have an income buffer where the portfolio has enough liquid funds to cover three years of expenses. This reduces the risk of having to sell investments at depressed levels.
• Sticking with the plan: Regardless of what happens to markets in the short term, barring a significant change in your circumstances, we should stick to the investment parameters we’ve agreed to.
• Diversifying portfolios: We cannot accurately predict the future. Market cycles will continue and different asset classes will come into and out of favour. Diversification will help increase investor comfort and insulate from downturns thereby providing a degree of investor comfort.
• Focus on cash flow: In uncertain economic times, we prefer to focus on cash yields from investments. It may not give the same return as that from capital gain but is does provide money to live on.