These days, I spend most of my time engaged with peer to peer learning groups whose members are some of North America’s most successful former entrepreneurs and executives – men and women who retired at the top of their game after having created, built and/or sold large businesses. These are seasoned leaders who knew how to take risk. Some of these investors were senior partners of world class financial or real estate partnerships, or rose through corporate ranks to hold the top office.
These “stars,” many of whom have had 20-30 years of success and were generally perceived by others as the smartest people in the room, did not suddenly wake up dumb. But some of them are sure feeling that way now. After all the years of success, many of are now wondering “what hit them”? With the worst financial year in the past 70 years behind us, how are my fellow members faring? Did our “collective intelligence” help us to anticipate the market meltdown? How much more bad news should be anticipated? Is our brand of disciplined investing a sound strategy for bust as well as boom times? In August 2007 when the economy began to falter, many members assumed we were seeing a temporary market correction. “This ain’t my first rodeo, and it won’t be my last,” said one. Nearly 18 months later, our average member has lost 20% to 40% of the value of their investments in 2008, alone. This compares with 10 to 20 years of positive annual returns for members who have been investing their capital as passive investors with the goal of preserving and growing their wealth. A handful of members prospered by betting directly against the market, finding ways to short sub-prime and other markets. Others pulled out of the markets altogether, and preserved their capital by parking it in short term liquid investments that have held their own. Some maintained their interests in “non-correlated assets” like real estate or focused on private equity ventures. Even those sophisticates among us, who were smart enough to protect against the falling dollar for the past half dozen years with Euro holdings, have seen our hedges partially unravel this past Fall. Members pursue strategies that suit their individual risk profile, but our surveys show there was a major flight from hedge funds last year – from 11% in 2007 to under 3% in 2008. This is the biggest shift in asset allocation we have seen. Members remain focused on security, liquidity and wealth preservation. While our average member still has his largest single allocation to public equities (30.5%), this is much lower than recommended by most wealth advisors for 50-80 year olds. Many also hold a significant percentage of their assets in cash reserves (12%) — having switched to a higher level of liquidity far in advance of the advice of most wealth advisors. By our calculation this is 4 years of living expenses in reserve, where our average member lives annually on 3% of his net worth.
The Madoff fraud has been on the front pages for the last three weeks, and many of our members have been affected directly or indirectly. However, one of the most gratifying aspects of our process at TIGER 21 is that it does not appear that a single member suffered losses that will fundamentally change his or her life. Most of our lives will be affected because of the losses many have suffered in the market, but what was unique about the Madoff scandal was that so many of his investors had most or all of their assets invested with him, and many even mortgaged their homes to further invest and earn the spread. No TIGER 21 member can easily withstand the pressure from a Portfolio Defense to prudently diversify if they had such a high allocation to ANY investment, and in this sensethe value of our Portfolio Defense speaks for itself. We did have a member years ago who had most of his assets in Madoff and who left TIGER 21 after one year because he couldn’t square the feedback he got about this concentration of risk during his Portfolio Defense. He decided we “weren’t for him”. I wish he hadstayed and made the changes, but for the rest of us, I do feel proud that our process tends to minimize the damage of a fraud like this.
Our members share an entrepreneurial spirit and are resilient in tough times. They read the future in years, not minutes. Here are some of the questions I’ve heard, over the past quarter, in our member group meetings and conference calls from San Francisco to Florida, Dallas and New York:
- Is Bernie Madoff’s epic fraud the downdraft needed to reach a market bottom, or just a precursor to further economic unraveling?
- How do you preserve wealth in an environment with deflating asset values, but with so much government stimulus on the way that what is asset deflation today may suddenly become rampant inflation tomorrow?
- In what way is preserving wealth a fundamentally different challenge than simply maximizing risk adjusted returns?
- Is there a way to profit, not just survive, in this environment
- Is gold a unique repository of value, or is it just another industrial commodity, subject to the same rules of supply and demand?
- How did so many economists miss the signals and even today continue to suggest this may “just” be a longer than average recession instead of sending alarms to batten down the hatches for the coming storm (Many of our members take comfort in consulting NYU economist Nouriel Roubini’s blog, Global Economy Monitor, www.rgemonitor.com).
- If the stock market is a leading indicator of recession (and future recovery, when it truly bottoms out), is real estate a lagging indicator? All real estate or just particular sectors?
- At a recent meeting in New York, one member remarked: “The whole world is for sale.” The question is: “What is worth buying?” Here are a few random strategies members have considered or acted upon:
Look for patterns in the chaos. Members see the long term promise in emerging markets, clean technologies and distressed debt. Some still favor basic companies that are not cyclical such as P&G, J&J and others whose products will be bought in good times and bad. - There are many corporations whose businesses and balance sheets are strong. These firms may be able to take advantage and grow at the expense of their weaker competitors. A few did in the Great Depression of 1871 and built franchises that lasted a century.
- Bank debt – recently trading at about 70 cents on the dollar – may be grossly undervalued, since corporate debt is only trading at the same discount. We are told it is just the temporary “supply and demand” conditions in the markets today but the basic insight of the relation between bank debt and corporate debt, makes some believe this anomaly is the opportunity of a lifetime (to buy the bank debt). Once the idea surfaced, members found they could invest with select bank debt funds, instead of just going through expensive private equity and hedge funds.
- A member who is a former senior Wall Street executive commented on a members only conference call in November that the discrepancy between the 7 year rates in the TIPS (Treasury Inflation Protected Securities) market and the then 4.5% rate on the 10-year treasury provided a unique arbitrage opportunity. Within days, the market corrected and the 10-year treasuries “rallied” to 2.5%, delivering one of the swiftest appreciations in T-Bond prices in history.
- In October, due to the heavy liquidation by hedge funds, one of our members noted on a regular conference call the historic opportunity in the pipeline MLP’s, which had dropped over 40%. Within a few weeks, prices for this subset of the MLP market had rallied 15-20%, although prices have still remained volatile since then.
- Some members see opportunity in municipal bonds. The difference between a rating based on insurance from “monoline” insurers like AMBAC and MBIA, whose coverage is now largely discounted or just worthless, versus Municipals which are fundamentally sound because of the issuers’ revenue or taxing authority is something they are focusing on. We have also learned how the “pre-refunded” sector of the municipal market works, where Treasury bills provide full collateral, but you still earn attractive tax-free returns in the current market.
- Special Purpose Acquisition Companies (SPACs) may offer unusually high returns. This is because most SPACs, which have yet to make an acquisition, trade today at a discount to the value of the actual treasury bills they are holding.
- A member with a large restaurant franchise noted that people who work longer hours eat out less frequently to save money. This opinion was supported by another member, who recently sold a high-end whole foods supermarket chain and noted that his business was “steady or better in most locations.” Do these comments validate the insights about Wal Mart as the largest grocer benefiting from this downturn? Conversely, a Washington, D.C.-based member observed that in an Obama Administration, union sympathies will impact Wal-Mart most because it will either empower the union assault on the giant retailer or at the very least, increase labor costs.
Our members have benefited from the collective intelligence of the group in pairing risk from their portfolios well in advance of advisors’ warnings. When the fallout from the sub-prime mortgage crisis began to take its toll, the peer group dynamic provided ballast to a suddenly rudderless ship. Though we may have drifted for a while, we didn’t go down. Being part of the TIGER 21 network helped some avoid panic selling while providing others with the courage to get back in the game selectively to try to recoup some of their losses.
So, what is the smart money doing in the face of unprecedented turbulence? I actually think the smart money is reacting slower to events and in measured steps. With discipline it is repositioning continually, at its own pace, to defend against the crisis. Some are clearly doing better than just holding their own- they are profiting by trading the market, a strategy nonetheless deemed too risky for most members. Paraphrasing one of our members, “We don’t know how to prevent a flood, and in a storm, everyone is likely to get soaked, but I think together, we can build a better ark.”