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What’s the Half-Life of Your Investment Model?

What's the Half-Life of Your Investment Model?

Long ago, when I was a child, there was a local mom and pop video rental store a couple miles from my parent’s house.  I used to rent movies there all the time, everything from horror to action to comedy and more.  It was my primary source for video rentals from my early childhood through my college years.  Shortly after I graduated college I left for Boston and for many years I didn’t think about the little video rental shop on the corner.

When I moved back near my hometown after nearly 14 years away, the topic of the local video rental store came up in casual conversation.  My parents were still using it as their primary source for renting movies.  But when the store’s ancient computer systems spontaneously crashed one day, the owners wisely decided it was time to finally close.  For the next few weeks they still rented movies to regular customers by handwriting their names and account numbers on slips of scrap paper!  This was not a sustainable way to operate however, and was only used to buy time to organize a liquidation sale.

A little more than a month later it was all over.  The small video rental store that had been a touchstone of my youth and young adulthood was gone.  The little shop had weathered the VHS-Betamax format wars.  It had survived the rapid expansion of Blockbuster Video, which had forced the closure of so many other small video stores.  And it had made it through two different physical media transitions – VHS to DVD and then DVD to Blu-ray.  In all, my local video store was in business for around 30 years, from the early 1980s until the early 2010s.

The more I thought about that small video shop, the more fascinated with it I became.  Here was a completely new kind of business model – physical video rental – that suddenly burst into being, thrived for a scant two decades and then flared out of existence just as rapidly as it had formed.  How could an entire industry come and go so quickly?  And yet here was a prime example.  If anything, my local video store did better than average, managing to stay open far longer than most of its peers.

The more I considered this imponderable the more I wondered if it applied to other industries as well.  My mind immediately focused on my time in Boston.  One of the asset management companies I had worked for there was a quantitative firm.  This simply meant that their investment model used computer algorithms to pick the best stocks to buy.  They would feed the computer a list of desirable attributes, have it search the stock market for companies with similar attributes and then buy the stocks that ranked highly on the resulting list.

The founders of this company conceived of their idea back in the 1980s.  But back then the immense computing power and massive data sets necessary to execute such a task did not exist.  And, ironically, it was probably this very inaccessibility that made their idea viable.  There was no competition for their investment model because no one, including my former employer’s founders, could easily assemble the tools necessary to implement it.

Fast forward to today, where massive computing power is plentiful and data flows like water.  The Boston quantitative asset manager in question has had great success.  Its founders persevered, painstakingly building the company client by client from the 1980s until the present.  And yet I can’t help but feel that the clock is ticking on the success of their investment model.  Other quantitative asset managers have sprung up like weeds over the last 20 years.  The investment landscape is very crowded and everyone is working with the same general evaluation criteria, i.e. dividend yield, price-to-sales ratio, net profit margins, etc.  I suspect that quantitatively driven stock investing, a darling of the investment world for many years now, is nearing the inevitable end of its period of outperformance.

And I think this concept – that a business or investment model has a finite shelf life – applies just as surely to investment management firms as it does to video rental shops.  A new idea comes into existence, but its implementation is difficult or limited in some way.  No one has ever heard of this new idea and few people are initially interested.  It is only after the innovative concept establishes a successful track record that it is slowly embraced.  Then competitors enter the space and the formerly original idea gradually becomes accepted as conventional wisdom.  Once this happens, the best days of the concept are assuredly past.

This is one of the reasons I love investing in fine art and antiques rather than traditional paper assets.  It’s an obscure investment model that is totally off the radar.  If you search the internet for investment tips related to antiques, you will find precious few with the exception of Antique Sage.  Art and antiques have been ignored and neglected for so long that no one is even aware they exist.  And yet they are an asset class unto themselves, an unexplored island of profound value sitting like jewels in an ocean of overvalued conventional assets.  And anywhere there is an underappreciated and forgotten asset there is a bargain waiting to be found.  The clock may eventually run out on every investing strategy, but fine art and antiques still have many good decades ahead.

The New Buy and Hold Investing

The New Buy and Hold Investing

Many people like to think they are buy and hold investors.  They believe in buying good quality companies at reasonable prices and then sitting back and collecting the resulting dividends for the next several decades.  Many of these investors point to the famous investor Warren Buffett as a role model for their buy and hold strategy.  The Oracle of Omaha famously proclaimed that his “favorite holding period (for investments) is forever.”  Unfortunately, buy and hold investing doesn’t work as well as it used to.

My grandparents were true believers in the buy and hold mantra.  They started regularly buying common stock a few shares at a time in the 1950s and 1960s.  They purchased shares in some of the biggest, most well-known companies of the time, like PepsiCo, General Motors and AT&T, as well as shares of local utilities and banks.  And they held them for half a century, never selling or swapping out companies.  When my grandfather passed away in 2000, my grandmother retained their existing stock portfolio.  It was only in late 2007, when my grandmother’s health was failing at age 94, that she finally sold.

It was a good thing she sold too.  Her portfolio had become overly concentrated in financials just as the Great Financial Crisis of 2008-2009 was about to hit.  Out of curiosity, I updated her 2007 portfolio for bankruptcies, acquisitions and stock splits to see where it would stand today in 2016.  The results were not encouraging.  In spite of the massive rally in the broad market indices since the crash of 2008-2009, her portfolio still drifted 5.70% lower over the last 9 years.  That isn’t the worst of it though.  The income produced by her dividend-oriented account declined by an astonishing 25% during the same period.

A decade is a long time for an investor to sit on dead money.  Worse yet, there is every indication that my grandmother’s portfolio, like so many other people’s out there, will continue to have abysmal long term returns.  There may have been a time when buy and hold stock investing worked.  In fact, I firmly believe that when my grandparents began putting money into stocks over 50 years ago this was the case.  But the world has changed.  Buy and hold doesn’t work in stocks anymore.  However, that doesn’t mean the hallowed investment method doesn’t work anywhere.

There is one asset class where buy and hold investing still gives generous returns – fine art and antiques.  These often overlooked luxury goods have been coveted and hoarded by society’s elite for centuries.  Neither art nor antiques ever declare bankruptcy.  They are never beholden to the whims of an incompetent CEO or a venal board of directors.  They are always in demand.  Time and again, discerning connoisseurs seek out fine art and antiques and willingly pay premium prices for them.  They are physical wealth that you can hold in your hands in an age dominated by virtual “money”.

A well chosen collection of Gorham sterling silver tableware, ancient Greek electrum coins or vintage Montblanc fountain pens will easily grant safe, predictable returns for decades to come.  And it will do so without the risk of bankruptcy or the roller coaster boom-bust cycles that have continually plagued holders of common stock in recent years.  The old stock market buy and hold method of investing may be dead, but the new art and antiques buy and hold strategy is still alive and well.

Fungibility and Opportunistic Thinking in Art Investments

Fungibility and Opportunistic Thinking in Art Investments

Art and antiques are widely underappreciated investment vehicles that have major advantages over traditional paper assets – like beauty and historical importance.  But they do have a few drawbacks.  One of their major flaws is that, unlike stocks and bonds, art isn’t fungible.  Fungibility refers to an asset’s ability to be subdivided into units that are essentially the same.

When you buy 100 shares of Procter & Gamble stock, you know that your 100 units are just the same as everyone else’s 100 units.  They will all receive the same dividends at the same time and entitle their owners to the same voting rights.  Fungibility allows financial units to be freely interchanged with other, identical units or combined seamlessly into larger units.

The concept of fungibility has important implications for the investment industry.  For one, it allows good investment ideas to be readily scaled up to almost any size required.  For instance, let’s suppose that an investment advisor has astutely determined that the drug manufacturer Pfizer is a good buy.  He can advise all of his clients to buy Pfizer common stock without worrying that one client will accidentally receive shares that are different from another client.  One share of Pfizer stock is completely interchangeable – fungible – with another Pfizer share.   And if one client only has $1,000 to invest in Pfizer stock while another has $1,000,000 to invest, either amount can easily be accommodated by purchasing different amounts of the same, fungible, Pfizer common stock units.

Other assets besides stocks and bonds display the property of fungibility, too.  Gold and oil are just two examples of fungible commodities.  One troy ounce of gold, provided it is of comparable fineness, is just as good as another ounce of gold.  Likewise, a barrel of sweet crude oil can be interchanged with any other barrel of sweet crude oil, assuming they are both of the same grade.  This makes the trading and delivery of these fungible commodities much easier than it would be if they weren’t fungible.

Investment grade art and antiques, however, are not fungible assets.  Every painting by French impressionist Claude Monet is unique, despite the fact that he sometimes painted multiple versions of the same subject.  Even fine art that is ostensibly interchangeable really isn’t.  A copper-plate engraved print might have a run of several thousand nominally identical pieces, but that changes as soon as they leave the presses, if not before.  Some prints will invariably be damaged from being stored improperly while others will be kept almost pristine.  These prints, even though theoretically identical, will trade at radically different valuations in the secondary market due to their different conditions.  And this assumes that the printing process produced completely identical prints, something that rarely proves to be true in the real world due to plate wear and other minute printing variations.

The differences between fungible and non-fungible assets have important implications for investors in the art and antique market.  First, it should be obvious that the devil is in the details.  The success of a general recommendation like “buy medieval illuminated manuscript leaves” may hinge completely on the individual leaves chosen.  An investor who overpays for poor quality illuminated manuscript pages may suffer a loss while another investor who buys high quality leaves at a reasonable price may turn a large profit.

The second ramification of art’s non-fungibility is that it is difficult to scale purchases, even if you do have the knowledge necessary to choose good examples.  For example, it may be easy enough for a small art investor to quickly put $1,000 to work in vintage fountain pens.  But another investor with $100,000 to invest may find it impossible to deploy that amount of money in desirable pieces quickly.  He may have to wait for several months in order to successfully establish his desired position at fair prices.

Despite these drawbacks, I don’t think that the best approach to art and antiques is to avoid them because they are non-fungible.  Instead I believe it is necessary to invest in them opportunistically.  In other words, when you see a good deal in the antique world, jump on it.  Chances are it won’t be there for long.  If you wait until you are “ready” to deploy funds, you’ll likely be disappointed.

I speak from personal experience on this point.  I have lost many excellent pieces because I didn’t feel like I was in a position to buy yet.  I regret each and every one of those masterpieces that I passed up.  The corollary to investing opportunistically is that sometimes you must have patience.  Don’t invest in mediocre or subpar antiques just because you feel compelled to deploy your funds today.  Better items are sure to come along eventually and missed opportunities are recouped more easily than losses.

1919 – The Disastrous Year before the Great German Hyperinflation

1919 - The Disastrous Year before the Great German Hyperinflation

There has been a tremendous amount of chatter recently in the financial press about the possibility of hyperinflation in the developed world.  Hyperinflation is a period of runaway inflation, typically defined as an inflation rate in excess of 50% per month (12,875% annualized).  Understandably, the thought of hyperinflation strikes horror into the hearts of investors, economists and policymakers everywhere – and with good reason.  Hyperinflation renders bonds and savings accounts worthless while bringing the economy as a whole to a grinding halt.

It isn’t surprising that financial commentators are wary of the possibility of hyperinflation, given that central banks all over the world have resorted to unprecedented amounts of quantitative easing (money printing) in a futile attempt to reinvigorate the global economy.  The most famous historical episode of hyperinflation took place immediately after World War I, during the early years of the ill-fated German Weimar Republic.  Pundits will often compare some aspects of the present situation with that foreboding period leading up to the early 1920s German hyperinflation.

The articles practically write themselves.  And, if your success as a journalist is determined by how many clicks you can generate, then it is no wonder the German hyperinflation is a popular topic.  It was an utterly horrifying experience for the German people.  Their currency, the mark, ultimately depreciated from 4.23 marks to the dollar before World War I in 1914 to 4.2 trillion marks to the dollar in late 1923!  This financial dislocation gutted the already war-torn German economy, leading to widespread unemployment, starvation and social unrest.  So it is understandable why we should be aware of the possibility of hyperinflation and strive to avoid a repeat of the Weimar experience.

There is, however, a little known lesson buried in all the abject terror of the German hyperinflation.  Quite simply, a nation doesn’t need to experience a preposterously excessive hyperinflation to mortally wound itself economically and destroy its middle class.  While most financial writers concentrate on 1922 and 1923 when the German hyperinflation moved from devastating financial crisis to ridiculous tragicomedy, it was really the year 1919 that broke the back of the German middle class.

From January 1919 to January 1920, the German wholesale price index increased by a factor of five.  This effectively amounted to an 80% depreciation of the German mark over the course of a single year.  What originally cost 1 German mark at the beginning of 1919 ended up costing about 5 German marks by the end of the same year.  This massive devaluation was an economic disaster of the highest order for the German people.

An 80% loss in purchasing power over a scant 12 months is bad enough for cash and savings accounts, but mark denominated bonds, whole life insurance policies and other fixed denomination financial instruments did even worse.  These financial assets were promises to pay a fixed amount of marks in the distant future when those marks would be almost assuredly worthless.  Consequently, bonds and similar financial instruments lost far more than 80% of their market value during 1919.

The German stock market was no safe haven either.  Although it rose from 97 in January 1919 to 166 in January 1920, this increase was an illusion.  While it was technically a nominal price gain, once adjusted for the precipitous decline in the German mark over the same time, it turned into a loss of 66% in real terms.

Given these statistics, it is obvious that it wasn’t the hyperinflation of 1922 and 1923 that really bankrupted the average Weimar Republic household.  Instead, it was the rather pedestrian currency crisis of 1919 that did most of the damage.  The middle class had their net worth decimated by the 80% depreciation that occurred in that year.  Their long-dated bonds and whole life insurance became almost worthless while their savings and cash lost 4/5ths of its purchasing power.  Even their stock holdings lost most of its value in real terms.

While wild rants about an imminent hyperinflation in the U.S. dollar might drive clicks and sell online ads, it misses the much more prosaic, although sinister, truth.  Hyperinflations merely kick a national populace that is already down.  Most of the real financial damage is done well before the hyperinflation arrives, during the initial currency crisis phase.  And no paper asset of any kind – neither stocks, nor bonds nor nor cash – protect against such an event.  This is why tangible assets like bullion, gemstones and art and antiques are such an important part of a properly diversified investment portfolio.  They can help shield your wealth against devaluations both large and small.