Taking time and redefining risk

The Weekender offers my perspective on market developments and their potential broader implications, written most Friday afternoons. If you'd like this delivered to your inbox on Saturday mornings via Northern Trust, please sign up here .

Taking Time

Time arbitrage is a concept perhaps best expressed by Buffet when he said that the market is a mechanism for transferring money from the impatient to patient investor. A related strategy, one that involves reacting to information faster than the market, is perhaps best explained by John Henry Belville, who in 1836 started his business called "Selling Time " (h/t Mr Simons ), providing local businesses with a more accurate clock to give them a competitive edge. Another is John Harrison who in 1760 created the first Marine Chronometer which catalysed Britain’s position in naval navigation (hence Greenwich Mean Time), allowing their ships to be faster (to wars), more efficient (fewer get lost) and their explorers to sail further. Indeed Captain Cook was the first to use one.

Better still, Nathan Mayer Rothschild, who having faster and more accurate information on the war at Waterloo, walked onto the exchange in London and started selling British bonds, causing a panicked frenzy for others to do the same – thinking he was in the know – only then, to start buying the same back, at rock bottom prices ahead of the official news of Wellington’s victory.?A time arbitrage that, to this day, ranks as one of the most profitable trades ever, albeit that would breach multiple regulations in todays’ market! Now, back then such advantages were timed in hours, even days. Today traders are focused? on gaining milliseconds of advantage through HFT, focusing on improving latency in their trading and spending millions of dollars a year to do so.?

Change is a constant. Speed of change isn’t.

Why do the most patient have the least time?

To me it seems the most patient investors are often those with the least amount of time. One of my favourite clients over the years was a very successful New Zealand businessman. After a stock that I was responsible for him investing in (in a previous role) had more than halved, I called to explain why and grovel for forgiveness. He wasn’t bothered, reminding me he was ‘a long term investor’. He was aged over 80 at the time and the stock was Google. Then, after hearing my firm was involved in a pre-IPO placement in Meta (then Facebook) he called and asked if he could buy some. I asked, why? He said – ‘all the kids are using it’. No stock report, no analyst call. Just observation. The stock duly crashed on debut (from $38 to $26/sh) along with my reputation. But again, not bothered. ‘In it for the long run’ you see. One doesn’t need to be old to be observant, or young to have patience. And his paid off. In the case of Meta, 14-fold.

But what are some other traits that great investors and decision makers share? It can’t be age alone, for I know many where experience and expertise are non-corelated and many more who remain anchored to past success. I’m one of them.

Transcendent traits

So back to my friend: what other traits or tricks did he employ? Well,?he loved books (history mostly) but never read an earnings report. As mentioned, he was highly observant, a great listener and overendowed with common (oddly uncommon) sense. He seemed to love learning about new things (like DLT, crypto, gene-editing), had insatiable curiosity, obsessive focus when required, a drive to understand and to form his own opinion. And then, when ready to swing, he would ‘bring out the one-wood’, for there was ‘no point stuffing-about’ (not: buy a bit, hope it falls, buy some more: sound familiar?) Others with similar traits include the likes of Munger, Buffett, Klarman, Lynch and I would add Nicolai Tangen (Norges) and Howard Marks (Oaktree).

Now, if you do anything this weekend, listen to this interview between Tangen and Marks. It’s brilliant. Such is Tangen’s sharp and direct interview style that he gets more than most out of people. I learnt more about Marks in these few minutes than from many hours spent reading his writings.? Here are some of the key lessons that I?believe are as relevant today as when Marks first acquired them.

“AI is not a bubble”

Marks explains why the markets are not a rational science for they are controlled by humans. As Feynman quipped, ‘imagine how hard physics would be if electrons had feelings’. As a contrarian investor, his greatest success has come from taking the other side of extreme emotion. He believes it’s easier to be contrarian when markets are frothy, than fearful. Think the Internet bubble of 2000, the Housing crisis of ’07. The key is defining extreme. So when asked if AI was a bubble, his answer was instructive: We’re little bit above fair value but not so high that a fall is predictable or dependable. “If you’ve lived as long as I have you’ve seen markets get a little overpriced then more overpriced, then overpriced again and eventually form a bubble. But I think we are in the middle ground".

AI is not a bubble. Not yet.

“But China’s cheap”

And in relation to where he sees excessive pessimism to the downside he says: ‘you have to wonder about China’. Just yesterday he said that Oaktree is bullish China, owns Chinese stocks, non-performing loans, ‘corporate loans including real estate’. Now, this is interesting. Why? Because one of Oaktree’s greatest trades was buying stocks after the Lehman collapse in late 2008. China, it seems, looks a bit like ‘one of those’. Another investor wondering about China, with similar ‘experience’ who is also a voracious reader, observant, focused when needed - and I would say highly curious - is Mark Mobius, who I met recently. I suggested to Mark that if he liked markets others loathed, but where you can also have lunch in such fine eateries as Scott’s of Mayfair, he should start investing in Britain…before the British do.

Which they will. In fact, they may soon be forced to. Not by regulation. But reputation.

No need to regulate, reputation will drive behavior

We’ve seen how effective the Tokyo Stock Exchange was when it requested companies to publish their balance-sheet plans early last year. Those who failed to, were eventually forced to, as reputations were at stake. I believe similar incentives will occur once British pension funds are required to disclose their UK investments in 2027 . Those with poorly performing schemes will be disallowed to take on new business (hat tip to the Australians for that idea). So, I suspect the current lack of patriotism, as proxied by the Government’s own Parliamentary Contributory Pension Fund’s measly 1.7% weighting to UK equities, will reverse, potentially driving prices higher in the process. Why? Because said pensions control assets some 50% bigger than the FTSE, with less than 2% of such currently invested. What if that goes to 4% (the UK’s weight in MSCI) or towards 25% like Australia, just as the selling of UK assets stops? Well, the reputational risk then becomes being underweight. A position I suspect few trustees want to find themselves in. Especially if current trends towards national interest and UK stock outperformance continues.

And so trustees may need to consider when the correct time for accounting for this might be - it may be about to get more expensive.

Killing emotion with logic

In the TV show Yellowstone, the character Beth Dutton says that if you want to go to war with someone, make them emotional first. ‘The more they feel, the less they think’. Well by this definition I sometimes feel I’m ‘at war’ with the media, given how emotive I become by the consistently gloomy picture it paints of the UK stock market. Seeing as the best way to kill my emotion (and others bias) is through logic, ?I found the following to be quite compelling.?It’s a quote from Ebin Upton, the CEO of Raspberry Pi, the mini-computer manufacturer used by NASA among others and the UK’s most recent tech IPO (yes, the UK has had an IPO and I suspect has many more to follow, including a company that could be bigger than Walmart within a year or two): “Many of the stories that people tell about the differences between the US and the UK — particularly this sort of magical multiple arbitrage — don’t seem to be real .”? The stock rallied by a third the day it opened.

Such a shame that pretty much all its early backers and current cap-table are American, not those funding UK jobs or generating retirement savings for UK pensioners. Patriotism is one thing. Profits are another.?

Redefining risk

There is a section on risk in the Marks/Tangen interview that’s essential listening (it starts from 16mins ). Sound risk management, Marks argues, is not risk avoidance (aka ‘return avoidance’). Indeed, you are paid to take risk. Risk means more things will happen than can happen and so, under any set of circumstances a variety of outcomes is possible.

As such, investors must allow for multiple outcomes in their risk modelling, a process than can’t be separated from investing itself. Risk control, therefore, shouldn’t be treated as a distinct operation but rather as a consideration in the investment process. And – as we seem to be facing new risks from drivers like deglobalisation, decarbonisation, demographics – we may need new diversifiers. Most agree the future is not in the past and yet most portfolios still are. In the past.

The Diversification Deficit

Oxford Economics have written an interesting paper suggesting there is a Diversification Deficit in many portfolios, and that it’s time to consider alternatives to address such. No, not PE – for it doesn’t diversify risk?(the key is in the name). Additionally, its perceived role as a return diversifier (via smoothing) could soon vanish as regulators are pushing for greater transparency and more frequent valuations. The paper suggests that trend-following strategies and CTAs are likely to be better diversifiers, which I have sympathy with – albeit that dispersion of returns is significant, suggesting manager access/selection is key to deploying these successfully. We’ve also discussed alternative diversifiers in the past, such as balance sheet optimisation, hard assets (gold) and factors like quality and dividends and allocators moving towards more holistic, total portfolio views.

So I won’t go on. Much. But if you are prepared to ignore the insiders, like Apollo’s President, who reckons things "are not going to be okay" in PE, and you’re still fine with single digit sector returns that offer less diversification than they once did, but still suffer liquidity limitations and have lots of leverage...then you are going to LOVE dividend stocks with starting yields +5%, lower valuations, the ability to $-cost average and compound returns through buy-backs, not to mention ample liquidity. Why not consider adding some ‘accelerant’ – ?namely debt – which you are clearly comfortable with elsewhere? Your 5% could become 10% quite quickly.

And that’s assuming no capital appreciation. Which is highly unlikely?–?see above...

I wish I’d become a spot-welder….

Source: ADP Research

...at least then I would have abundant travel opportunities, and a well-paying job in pretty much any western country. And wage growth. If you don’t believe me, you might believe those smart folks at Oxford . By the way, even smarter folks, at Cambridge, have now generated more tech value than Italy and Spain’s combined . What if a little of the money used to buy Gilts yielding 50bps was used instead to buy these start-ups?

It may have annoyed the accountants. But at least the pensioners would be happy.?You know, the folks they work for...

Talking of time

In 1703, 2000 sailors died off the Scilly Isles after getting lost at sea. Ships could navigate latitude using a sextant but needed to know time for longitude. As conventional clocks couldn’t work at sea, the government introduced the Longitude Act, offering a King’s Ransom to solve the problem. John Harrison, a carpenter from Grimsby, answered the call and in 1760 created the first Marine Chronometer.

To bring us full circle to the start of this week’s edition, this catalyzed Britain’s position in naval navigation (hence Greenwich Mean Time) and positioned the UK as the world leader in watchmaking – bringing the benefits outlined mentioned earlier – and with the first recipient of Harrison’s invention being a certain Captain James Cook. He not only discovered the country of my birth, New Zealand, but lit the fuse on exploration, leading the Brits to controlling a quarter of the globe by the end of the 19C. A great example of how necessity breads innovation and what humans can do with the right incentives.

NEITHER THE INFORMATION NOR ANY VIEWS EXPRESSED CONSTITUTES INVESTMENT ADVICE AND IT DOES NOT TAKE INTO ACCOUNT THE SPECIFIC INVESTMENT OBJECTIVES, FINANCIAL SITUATION AND THE PARTICULAR NEEDS OF ANY SPECIFIC PERSON WHO MAY VIEW THIS MATERIAL.

These are my own personal views, not those of my employer. This report is not intended for retail customers. Any further disclosure, use, distribution, dissemination or copying of this report or any of the information herein is strictly prohibited. The information in this report has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Any opinions expressed herein are subject to change at any time without notice. Any person relying upon information in this report shall be solely responsible for the consequences of such reliance. This report is provided for informational purposes only and does not constitute legal, tax or other advice nor does it constitute an offer or solicitation to purchase or sell any security, commodity, currency or other product. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining advice from their own advisors. Internet communications are susceptible to alteration and Northern Trust shall not be liable for the message if it has been altered, changed or falsified.

Under no circumstances should you rely upon this information as a substitute for obtaining specific legal or tax advice from your own professional legal or tax advisors. Information is subject to change based on market or other conditions and is not intended to influence your investment decisions.

?2024 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the U.S. Products and services provided by subsidiaries of Northern Trust Corporation may vary in different markets and are offered in accordance with local regulation. For legal and regulatory information about individual market offices, visit northerntrust.com/terms-and-conditions .