In this, the third in my series of stories on
thought-provoking presentations at my Valuex Vail conference, I
look at the importance of the investment process. (In the
previous two pieces, I wrote about
investing in WWE (yes, that's World Wrestling
Entertainment!) and the
investment opportunities in transporting shale oil.
Investing is a peculiar industry because randomness is so
deeply embedded in everything we do. I am always fascinated by
the investment processes of other successful firms. The outcome
of every decision we make results from two inputs: our skill
and our luck (randomness, whether good or bad). When you
analyze anyone's investment decisions solely based upon
outcomes, you may unknowingly be attributing successes or
failures to skill when randomness was actually responsible for
Because randomness, unlike skill, is not permanently
attached to an individual but travels where it will, results
driven by randomness are not consistently repeatable.
Therefore, in the investing industry (unlike, let's say, the
widget making industry, where one's results could be
objectively ascertained by the number of widgets produced per
hour and their quality), we should focus on how an investor
arrived at a particular decision. In short, we should focus on
the investment process. In the long run, randomness will cancel
out and the process will shine through in the results. At an
investment firm, cultivating the process is challenging because
you want the process to live in the firm and not just in its
individuals; you want the process to be transferable from one
generation of portfolio managers and analysts to the next. To
achieve this, the firm's culture and the inherent quality of
its investment process are paramount.
This is why I was extremely interested in Win Murray's
dessert talk at Valuex Vail. Win is director of research at
Chicago-based Harris Associates, an investment firm that
manages $90 billion and runs the Oakmark funds.
Harris is focusing on the sustainability of the investment
process so that it will last far beyond the current generation
of analysts and portfolio managers. The process starts with how
the firm recruits analysts. Win has interviewed more than 100
research candidates since January 2011, but he has extended
offers to only four. Asked what he looks for in analysts, he
said their math skills must be intuitive; they must have the
ability to sum up an idea succinctly; they must be able to
think creatively and employ allegory; they have to function in
some ways like investigative reporters and their
bosses must give them enough tools and rope. (As an interesting
aside, James Chanos talked last year at Valuex Vail about how
he loves to hire analysts who used to be journalists, because
they know how to dig deep for the story.)
At Harris the analyst holds a highly respected
position in fact, many senior people, including
portfolio managers, the director of research and even the
previous CEO are analysts too. It was refreshing to hear that
analysts are not evaluated on the outcomes of their ideas so
much as by the quality of their ideas. An analyst who brings an
idea that is poorly reasoned is not valued as much as the one
who brought a well-reasoned idea that happened not to work
out. That is, Harris puts more value on the process than on
immediate outcomes. Twice a year the firm's analysts have to
write a devil's advocate memo on one of their large holdings.
The holdings are debated in the open and then voted on by the
three most senior investment people in the room. If a stock
fails the vote, it is sold.
Germany, Europe and Mother Russia
I always look forward to Hendrik Leber's presentations. Hendrik
runs a value investment fund named Acatis Investment out of
Frankfurt, but he invests globally. In preparation for the
conference, I asked him if he could talk about investing from a
European perspective, so he did.
Hendrik believes that there is no immediate danger of
Europe's monetary union falling apart, but he notes that
problems in the EU go far beyond the PIIGS (Portugal, Italy,
Ireland, Greece and Spain); they are in countries that don't
recognize their problems: Belgium, France and the
He was not very bullish on Germany because it is so
dependent on exports. (German exports to China are expected to
reach $70 billion in 2013.) And Germany has an "idiotic"
energy policy, as Hendrik puts it: In 2011, after the Fukushima
Daiichi nuclear disaster, Germany decided to walk away from
nuclear energy and toward alternative sources, but it has not
found those alternatives yet. Because nuclear power plants
supplied one quarter of the country's electricity, the lack of
growth in the energy supply has been hurting the German
economy. German companies are opening factories in countries
that have stable energy policies and cheaper energy
mainly, the U.S. Ironically, by lowering its dependence on
nuclear power, Germany has increased its dependence on Russian
natural gas. If Germany were any other European country, it
would not be a big deal, but Russia has in the past used the
natural-gas spigot as a bargaining weapon in negotiations with
Hendrik also discussed Germany's own version of a social
security crisis. The country has an off-balance-sheet-debt
problem: its liabilities to the beamte, or civil servants.
However, unlike most German public employees, who are subject
to the same rules and laws as workers in the private sector,
beamte belong almost to a special class, and they usually
perform services that only the state can provide (such as
issuing official documents or teaching state-approved
curricula, for example). Like U.S. postal workers, beamte
cannot be fired. The German government pays for the bulk of
their health care, and they don't pay certain taxes, but they
give up the right to strike. (I strongly believe that all
government employees should give up their right to strike, but
that is a topic for another discussion.) Beamte are well
compensated and receive a good pension that is guaranteed by
the state, not by public insurance. You know how this story
ends: The government made promises that it will have a hard
time keeping. As the beamte get older, the German government's
liabilities to them are starting to outweigh the country's
explicit debt of 2 billion
($2.6 billion) by a factor of between two and five.
Hendrik presented three stocks in his presentation. Two of
them German chemicals company BASF and U.K.
bookmaking company William Hill looked very
interesting but only mildly undervalued. (According to Hendrik,
they had little margin of safety.) They are perfect watch-list,
buy-at-lower-price stocks. The third one, Pharmstandard, a
Russian pharmaceuticals company, looked very interesting, and
I'd be lying if I said I was not tempted to take a look at it.
But to me, after the Yukos incident, when Russia confiscated
one of its largest private oil companies and jailed its
founder, Russia became uninvestable.
P.S. After I wrote the preceding, I got an e-mail from
Hendrik, who told me that Pharmstandard had fallen victim to
Russian corporate governance. Shareholders were basically told
that if they don't agree to a proposed spin-off, the company
can buy them out at an 18 percent discount or they will get
unlisted shares of the stock. Predictably, the stock collapsed.
This is white-collar mugging; there is no other way to put it.
The company effectively says, "You are a shareholder as long as
you agree with management; otherwise we'll screw you." Now
Russia is uninvestable to me for another reason: Its corporate
governance makes Tony Soprano look angelic.