Investing Success Made Simple, But not Easy

by Paul Sutherland

Posted January 8, 2010

Current Observations

January Edition

Investing Success Made Simple

by Paul Sutherland

Risk Tolerance

by Jime Frye

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"I think we are at the end of a difficult generation of business leadership, and maybe leadership in general. Tough-mindedness – a good trait – was replaced by meanness and greed – both terrible traits. Rewards became perverted. The richest people made the most mistakes with the least accountability. In too many situations, leaders divided us instead of bringing us together. As a result, the bottom 24% of the American population is poorer than they were 25 years ago. That is just wrong. At the same time, ethically, leaders do share a common responsibility to narrow the gap between the weak and the strong. The residue of the past was a more individualistic 'win-lose' game. The 21st century is about building bigger and diverse teams, teams that accomplish tough measures with a culture of respect."

– Jeffrey Immelt, CEO of GE, December 9, 2009, United States Military Academy at West Point

I have spent my career in the investment and financial services business, and I agree with Mr. Immelt. My life experience, however, has reinforced the fact that most people are ethical, honest and know the difference between right and wrong. I also am aware of the fact that some people lack ethics and virtue and want to oversimplify the complexities of life. Years ago I had the privilege of attending a lecture by an expert on "intuition." I only remember one thing he said, and I have thought of it often over the years, because it has helped us considerably here at FIM Group. He said, "Intuition is not the spontaneous [flash] thought that comes into our head; hundreds of thoughts come into our head every hour, and we don't act on them. Intuition, true intuition, comes after you know everything about a subject [are expert] – then the intuition works with your knowledge [to successful action or analysis]."

Complex Systems Systems are complex; every trend has literally a thousand counter trends. And I think societies, businesses, families and any system often get off track due to manias, fear, irrational exuberance, pessimism, recency effect or endowment behavior. Some investors still believe that investing is simple and use indexing and passive asset allocation systems. For those with the correct DNA, investing is simple, but it's not easy. As Warren Buffett said at Berkshire Hathaway's 2009's annual meeting, "If you are in the investment business and you have a high IQ, sell 30 points to the next person. You do not have to be a genius at all. But you do have to have emotional stability, and you have to have some peace about your decisions. I don't know how much is innate and how much can be taught. If you have that quality you will do very well. As I have said many times, it is simple, but not easy." My partner, Jeff Lokken, who runs our Wisconsin office, was in Omaha at the Berkshire annual meeting earlier last year. He called me from the meeting saying, "Paul, Buffett is talking about inner peace as a key to investing success." For the past 25 years, what we believe to be one of the key elements of FIM Group's success has been to maintain inner peace in terms of investing, through our rational, disciplined, common sense approach. Investors who had the inner fortitude and stuck to their discipline in 2008 and 2009 were rewarded.

2010 and 25 years This is my first letter of 2010. After 25 years in the investing business (FIM Group turned 25 in December) I am not compelled to write about what I think the future will hold, not because I can't or don't have a book's worth of thoughts on it, but because it is quite irrelevant. Forecasting is not how you succeed in the business of investing; it is merely one component and a very important part of the process, but it is not the process itself. When it comes to the future, investing has three parts: First, all investing is about the future; second, all investments are made with incomplete information (about the future); and third, the future is unknown. So after 25 years, if I had to write one sentence that summarizes what I know about successful investing, I would say, "It is best left to ethical, virtuous, experienced, mature, flexible experts who see the world as a system."

The World as a System We now know with 20/20 hindsight that many so-called "good ideas" from experts were just plain bad ideas, including: government guaranteed mortgages sold by people who gamed the system for personal profit; a "bigger and more is better than quality and integrity" mindset; and a retail-/consumer-led economic model built on credit and consumption rather than savings and investment. The world is one big system. When we oversimplify by making just a part of the world "all important," as experts often do, we can get into trouble. Creating a system based on the premise that "Everyone should own a home at any cost!" sure had a downside, as we are experiencing right now with massive unemployment, foreclosures, capital destruction, and business and bank failures. Actually, failure is a necessary and acceptable part of a healthy economy. When a business fails, we learn many lessons from its failure about management, forecasting, ethics, common sense, laziness, change and flexibility. Sadly, we often learn best through failure rather than success. I learned in high school that it is important to study successful people. I still study successful people, but I am more fascinated by studying successful companies because, after all, they are systems.

A Living System "The numbers are easy" is one of my most repeated phrases when I describe FIM Group's investment approach. Of course, stretching a great sports manager's saying, "Numbers are only 99%, the other 100% are products, people, culture, market, relationships, reputation, ethics, sustainable habits and virtue." We have companies in our client portfolios that have thrived for many generations, surviving wars, depressions, recessions, government intervention, taxes, stupid management and the most dangerous threat to a company's health: irrational exuberance and oversized, unrealistic egos. Obviously many companies are and were only financial bottom-line-oriented. They are struggling right now, and their former employees are sitting in unemployment lines or are underemployed and hoping. While pursuing my MBA my Systems and Quality Management teacher discussed the theory of "If you can't measure it – it doesn't exist." I invited him to lunch to further discuss this and asked, "So love, God and good food don't exist, since they can't be measured?" We laughed about the measure question, but to this day I encounter people who will forcefully and with much conviction maintain that, "If it can't be measured, it does not exist." To the peril of their clients, many of these folks are in the investment business. My point is that mere numbers do not accurately reflect a company's value.

Rather, value is found in a company's skills, virtue, franchise, processes, beliefs, culture, talent, reputation and management. So when we look at the world of investing, we try to understand the intangible value of a company. It is easy to add up the value of a company based on the balance sheet, but as we have seen with Merrill Lynch, UBS, AIG, Freddie and many other banks, overleveraged companies and finance companies, the balance sheet value can be destroyed in short order. Those companies seemed to disconnect from the ideas that values, virtue, ethics, long-term sustainable thinking and people matter. The Year 2020 We are long-term investors. We are not managing money market funds. We don't day trade or speculate on shortterm movements in assets. This frees us to concentrate on what matters most – keeping our retired clients retired, building our clients' wealth and serving our clients' real needs, successfully, ethically and with virtue. I think that our world will look much different in 2020 than it does today. We are a learning society, so by the year 2020 we will look back on the past decade and realize that the U.S. did little to nurture what made us great in the first place (and borrowing and spending did not make us great). We will get back on track and embrace expectations about personal responsibility, work as an ethical behavior, war as a necessary evil and government's role as a minimal part of our lives (not the pervasive influence it is now). As an American I hope we will get back to President Kennedy's ethic of being a responsible citizen illustrated by his statement, "Ask not what your country can do for you – but what you can do for your country." Of course, the investment action will be everywhere. Creative destruction and failures of systems, business and institutions will be rampant, especially over the next few years as we realize it does no one any good to keep life support on an entity, theory, belief or business that is already dead. Opportunity will also be everywhere, as wherever change exists there is opportunity for profit to be made. Silly people will, of course, hold on to the old paradigm of indexing, passive asset allocation dartthrowing, owning old, dead industries and backward-looking systems, which will leave a whole lot of opportunity for savvy forward-thinking, disciplined investors.