Paul F. Miller, Jr.. The dangers of retrospective myopia

Paul F. Miller, Jr.. The dangers of retrospective myopia

Paul Mimer surprised Wall Street when he decided to leave his post high-CEO of investment bank "Drexel Harriman Ripley" (Drexel Naggiman Ripley) and open one of the first "boutique" firms on money management - "Miller Anderson Sherrerd End" (Mllleg, Anderson & Sherrerd). This innovative project, and his phenomenal investment success make him work more than worthy of attention. In 1969, they did not have a single customer and require a minimuminvestment of 20 million house. Ten years later, they had assets of about 1 billion home. Then they rose to 12 billion home. seven short years later. His striking is that very few of his customers asked for an interview, they made decisions based on past achievements Miller, who just so happens, the band included recent extraordinary profits. Realistic Miller said of himself and other money managers, "You do not have the slightest idea of ??how well they can work in the future. Do you know how many people ran out with a brilliant five-year history?"

The success can partly be attributed to the culture of the firm. Miller liked to encourage independent and creative thinking without the destructive in-house competition. "I have seen many organizations that have just broken into pieces release system facing one investment manager to another," - said on. On his style: "When you look back and analyze our successes, it is often the result of more strategic decisions, rather than making lots of money to invest in some hot stocks." What makes a person great investorom1 "First of all - Miller says - many of these people use any valuation model, so they are never tied his opinion about the stock price to intuition or flashing lights. And they never fuss - the acquisition made by long term. "

Miller absolutely believe in a "perfect market hypothesis," although it knows that the results of market movement as a whole can be overcome. Evaluating Wall Street late 80s, on commented: "In some respects the old days were better. I really think that never so many people did not do a lot of money, giving the world so slightly, as Wall Street today." In his essay, "The dangers of retrospective myopia", however, he questions the traditional thinking concerning the prediction of stock prices.
Net book value
In 1953 I first began to study the practical analysis of securities. Robert D. Hedberg and I, using an approach based on manic depressive psychosis, built a model of a declining economy, and then tested the profitability of companies in these pessimistic assumptions. As I recall, we started from a 10-percent drop of GDP and received data return; at normal P / E ratio determined the price for the "residual value", points of purchase and sale set at 20% above and below the residual value. Needless to say, we did not use the pessimistic predictions, but also missed the most important thing, namely, that economic stability will be the basis for a spectacular increase the P / E ratio.

Anyway, most investors late 40s and early 50s were doing essentially the same thing, allowing the history of the past 20 years to be the basis of their approach to investing. Everyone's attention focused on the economic instability, whereas it should have been directed to the opposite. Fortunately, we had time to make changes and do not miss the whole game, but the costs of missed opportunities the first few years were high.


TOTAL ANNUAL GROWTH RATES
By the time the 1957-58 recession. U.S. economy satisfy pent-up demand that had accumulated during the depression and war. Interests of national defense, dictated by the Cold War and the Korean conflict led to the accelerated write-off on the certificates necessary expenditures for new capacity in basic industries. Not surprisingly, the sectors of raw materials and semifinished products had excess capacity. Yet these industries have caused the boom and have become favorites of investors. By 1960, it became clear that the revenues of these companies are cyclical in nature.

In contrast, sluggish stocks, which are thought of as something associated with the widows and orphans, and by that time have built up the story of an extraordinary sequence. To investors was to realize that an increase of 10% annual growth, for example, "General Foods" or "Florida Power and Light," more attractive than a non-constant yield steel, aluminum, paper and chemical products. Growth has been more stable and can be expressed in complex terms. So opened the cumulative annual growth rate, and mathematical magic of addition was used as the basis for the great speculative surge in the stock market. Promotion of the market eagerly raised guarantors offering, we found, all that was required to the public, this five-year history of consistent growth in income from earnings, Corrie can be used for speculative extrapolation of the total annual growth boom characterized by issuing new shares of unrestrained and indiscriminate. Past growth rates dominated the estimates without the quality or size of the enterprise.

While speculation in 1960 - 62 years and failed, it has generated the concept and the outstanding investment results, compiled by some non-traditional institutional investors, have existed for quite some time. Aggregate growth rates derived mainly from old records, were in bad taste (de rigueur). They formed the basis of stock speculation, "one solution" 1971 - 73 years and remain with us today as a stronghold of the majority of assessment procedures, actions, despite the collapse of growth stocks. The usefulness of growth depends on the stability of the economy, because without a high degree of economic stability, they become useless concept, difficult to predict with some confidence and requires an approach to normalized earnings.

All of this raises an important question about the impact of inflation on the usefulness of aggregate growth. With only the most modest exaggeration to say that inflation has made each company to the company growth, at least with respect to the published income. Although it was done some good work in trying to remove from the published income inflation overall price level, an underestimation of depreciation and warehousing income, very little attention to the impact on the financial results of specific inflation (by product). For example, what is the impact of inflation on the "Texas Instruments" in comparison with, say, "Procter & Gamble"? The main manufactured products, "Texas Instruments" is reduced in price, while the production of "Procter & Gamble" - no, but if the price drops on semiconductors, microprocessors, minicomputers and calculators less than it would have been at a low rate of inflation? How much less?

I was lucky, my first teacher securities analysis by Professor Julius Grodinski from the Wharton School. He argued that the relatively simple to identify the growing and collapsing industries, examining price trends of their products. In this growing industry, he argued, can provide a growing income due to lower real prices for their products. Lower prices for products expand markets, and broader markets provide a lower unit cost. Mature industries need a stable real prices, collapsing industry constantly fighting for higher real rates. In my opinion, this is still a valid concept. It should no longer be used by analysts in the separation of the growth of inflation and increments poiskah.otveta the question whether there is indeed inherent in a particular company or industry aggregate rate of growth and whether the past growth rates of economically accidental.


INVESTMENT BASED ON TOTAL PROFITS
Starting with the mid-60's joint study, "Merrill Lynch" and the University of Chicago has become fashionable to evaluate an investment in shares on the basis of long-term profits, expressed as the total annual rate of total profit. This study, together with impressive profits obtained early participants in the race's 1954-64 economic indicators, formed the basis of universal revolution totals arrived mid 60s.

This explanation is no big deal. If unmanaged common stock over a long period, which included a boom, depression and war, gave 9% per annum, which could create miracles group of educated experienced and professional portfolio managers? The answer was obvious to all: some aggressive portfolios of mutual funds have accumulated a five-year history, much more productive than diversified portfolios of "blue chips" - a typical fate of traditional banks and investment advisers. It's hard to believe today, but in the days before 1965 did not provide managers, and customers do not require the statistics of economic indicators. Smooth the reason for this indifference to relative performance, I believe that absolute returns have been high enough to satisfy themselves. Traditional portfolios, however, began to look a little pale, because the post-war boom came to nothing, and the dominant sector of the economy growth was the services sector. Technological impetus as a result of the Soviet Union launch "Sputnik" is also brought to life hundreds of previously unavailable or unknown, but now the fastest growing companies who have used flow of federal dollars on space and missile programs.

Entire new industries were opened, named, for the first time generously to market their owners and investment bankers, and eagerly devoured by investors - both directly and through mutual funds. At the stock exchange first emerged leisure, textbooks, specialized retail, stewards, developers, insurance by mail, housing, semiconductors and many other industries.

Heroes on Wall Street were common, headed by Gerald Tsai mysterious. His "Manhattan Fand" in a public offering of its shares has collected as much as $ 200 million on, random walk, a perfect market, where you were in those days? "The dynamic era" was in full swing, and life was fun.

That is a huge speculative boom has attracted growing list of supporters. Players have various pension and other funds. Congress of the Federation of Financial Analysts (Financial Analysts Federation) was replaced by the Conference of institutional investors (Institutional Investor Conference). Heroes of worship at the altar of economic indicators, and were accompanied by lavish entertainment from brokerage firms, financed by inflated commissions on fixed rates.

In the late 60's only Vietnam War was between the investors and Nirvana. Investors, looking back at them for a typical manner, seized on the experience of previous decades as the basis for constructing portfolios. Inflation crept up, but thought that it is largely the result of the war, and believe that public policy can easily handle it. The only legitimate purpose was to invest on the basis of total profits, and income were not significant, in retrospect, it seems clear that the concept of gross profit - as it was used at a time - no more than an unconscious justification of low income and high estimates of investment managers in higher rates of institutional costs investors. Today, valuation levels are lowered and the concept of total return is increasingly being questioned as a time when its application the most appropriate and re-use recent history as a prescription for the future has failed miserably. There have been many studies that prove the superiority of the historical "growth stocks". The new image of economic uncertainty, born of inflation, price controls and crude unfamiliar environment, increased the attractiveness of the last trusted old reliable revenue growth of a select group of quality companies. "Shares of a solution," stocks of companies that actually do something, become an expression of growth, which carried them to the most amazing heights in our generation, with the involvement of the really big money. My friend John Neff, one of the best investors of our time, shook his head in disbelief, saying: "In my game there must be something more than just the acquisition of shares in the growth of the list, and then holding the next 20 years on the golf course." This absurd speculation institutional investors, which was attended by many of the most famous names in financial circles, came to an end in 1973 - 74 years.


HISTORICALLY INFORMED AND SIMULATION OF THE POSSIBILITY OF
Using historical probabilities to model the future profitability of portfolio investments, so fashionable these days, is the embodiment of a tool relying on past experience. The problem with this approach is not so much that the future does not look like the past, like us in that neither was assured. The point rather is that these probabilities are used without regard to the starting point. Obviously, it is ridiculous to assume that future earnings and the likelihood of achieving them are identical with the beginning levels of ratings that are significantly different. Such an approach would imply that the future has the same probability of these levels of income through, say, five or ten years from today's levels of evaluation actions, as in 1972. A statement that the optimal portfolios can be constructed using probabilities derived based on historical data, to be pure nonsense, if we do not recalculate the probability of re-evaluation of the different levels of stock or if not in use so long periods of time, it makes them meaningless in terms of timing investment activities or careers of individuals. Long before the story can express themselves, come new people with new recipes decision-making.


MRI, index funds, etc.
The latest in a parade of solutions based on history - modern portfolio theory (Modern Portfolio Theogu, MPT).

In fact, MRI gives some quantitative measurement tools for certain portfolio characteristics, which are known for generation of sophisticated investors. If we omit the details, MRI provides: In bull and bear markets, some stocks rise and fall more than others.

We should expect that portfolios carrying out large fluctuations, revenue yield is higher than the more stable portfolios. Fluctuations in the portfolio tend to reflect the fluctuations of the total market. Diversification reduces the risk of non-market risk can be, and probably should be diversified. We can control the volatility of income, but not the actual income. Nransaktsionnye costs and expenses for investment management consume a significant portion of the proceeds. The choice of asset mix most strongly affect the future earnings and future risk.

While all of this valuable investment concepts, many users of MRI appears to provide their quantitative manipulation of some implied accuracy, gives them comfort that can be dangerous. Ego threat occurs primarily because that distracts too much attention from the important issue of whether it is necessary to have stocks or bonds, and if "yes", in what relative quantities. I'm not talking here about the decisions regarding the timing of market entry or decisions regarding the theoretically optimal combination of long-term assets. This is a much more important question: are we or not in one of those "critical periods of decision-making, only a very rare occurrence in the life of the investor.

Looking back on his roughly 30-year career, I can recall three of these decision-making period. The first occurred in the late 40s - early 50s. Then the shares were valued low because of the postwar depressive psychosis, while at the same time interest rates are artificially maintained. The second was in late 50s - early 60s, the end of the post-war recovery and postdepressionnogo, the skin was necessary to recognize a new generation of investment in an industry very different from the major sectors, led the postwar boom. The third was in the late 60s - early 70s, when it was critically important to recognize that the ranges of the shares are generally quite high, and the investor was not disappointed by the growth of savings and / or its stability. Each of these cases involved a period of three - five years, during which the urine to be taken the right decisions that determined the longer levels of portfolio income.

We know, of course, that few investors have taken these decisions properly. The reason is that most of the experience of the previous period can dominate their thinking. This is what happens now. Poor profit we get from stocks, combined with economic, monetary, social and political unevenness of the past decade is responsible for significant reductions in the proportion of shares in the assets, shares redirect From a cash flow of pension funds and, consequently, lower levels of evaluation of common stock. True to historical form, investors justified these levels of evaluation difficult places estimates that include current levels of interest rates and premiums of historical risk. Thus they avoid the important question of whether we are in a period of general and significant underestimation of the shares, which can create a very, very great opportunity, or are entering a period of serious economic decline and chaos, which will convert an apparent underestimation of re-evaluation.

Index funds, funds with a "fixed income" passive portfolios, or the inclusion of foreign securities in domestic portfolios, one way or another based on historical experience and did not answer the question of optimization of future income. In this sense, nothing seems so wrong to me, as indexed portfolios, which may be just as wrong as the timing of the formula in 1951.

I say this for two reasons. First, they do not help to avoid a final decision on the allocation of resources - ie you want to be on the market or not? If the market is in a tailspin, investors owning securities index fund, receive a small consolation because the reduction is on par with the market or know that many other investors, the situation is even worse. Further, there is a risk that such investors are disappointed to turn their assets into cash at the base of the market, which only further evidence that indexing does not save you the trouble of asset allocation.

Second, they obviously do not do anything to ensure that you will succeed more than the market, on the way up.