Centre Street Cambridge Corporation

Private Investment Counsel


October 2005

The truth is out: for all the money management industry’s obsession with “performance,” the variations in wealth that investors can accumulate over time by using different mutual funds really don’t amount to very much after all. Thus reported the Wall Street Journal recently in an article discussing the findings of a study sponsored by none other than one of the big fund companies. Analysts tested various strategies over a fifteen-year period in which a hypothetical investor put savings into a fund each year—much as an employee would contribute to a company retirement plan. In an account which reached an ultimate value of about $40,000, varying the fund strategy changed the ending value by no more than a couple of thousand dollars at best.

These findings complement those of other research which looked at the actual investment results achieved by real investors in funds. One study revealed, for example, that the average equity fund investor achieved only a 2.6% annual rate of return from 1984 to 2002—a period of rising security prices when stocks gained about 12.2% annually. Equity fund returns during the same span were on average lower, at about 10%. Frequent trading and the pursuit of “hot” funds—practices undoubtedly resulting from poor investor education—sapped results for many fund shareholders. It seems clear, therefore, that the actual experience of fund investors is determined not by relatively minor differences in performance among various funds, but by how the funds are used. Their proper use as vehicles for the periodic commitment of savings over the long haul makes all the difference in terms of ultimate investment success.

There is more. In news that will offer little comfort to people who may still be relying on investment returns for reaching their retirement and other financial goals, the Journal article also indicated that the biggest factor contributing to the eventual size of one’s account was the level of savings. Doubling the savings rate would double the size of that $40,000 fund. Old-fashioned thrift—a term rarely used in our modern economy—pays off in the end. But bankers, who have a vested interest in consumer debt and the fees it generates (including late payment fees), apparently have no need to fear that their customers will start living frugally. The American Bankers Association reports that the number of overdue credit card bills has reached a record 4.81% of card accounts—due in part to the low U.S. savings rate. According to recent government data, that rate is now negative.

If thrift and the stock market fail you, there is always the house. Surveys indicate that most homeowners expect their property values to continue rising for years to come: 60% foresee 5% annual increases while 25% of those surveyed are all set to enjoy 10% gains. Only 3% of owners think their homes will decline in value. Since 85% of owners experienced gains during the past few years, the survey results might be construed as “looking in the rearview mirror.” If this talk sounds familiar, it should. Before the bubble burst in 2000, many stock market participants (the incautious ones, at any rate) thought their gains would continue to mount at an unrealistic pace; rates of 20 or 30% were envisioned. As Federal Reserve Board Chairman Greenspan has pointed out, long periods of good news tend to lull people into the belief that such benign conditions will go on indefinitely. Although real estate operates differently than the stock market, nevertheless, we think the experience of the latter offers lessons applicable to all markets, including property. “Trees don’t grow to the sky,” as is sometimes said of stocks. Perhaps it would be wise not to expect rapidly-rising property values to bail one out of one’s future financial obligations, especially if one paid the high prices prevailing in recent years.

Not that it makes much difference (as our discussion above attests), but it is interesting to note that the financial markets were relatively docile during the third quarter, despite some disturbing “external shocks” in the form of soaring energy prices and natural disasters. The popular stock averages rose modestly (2–3%) aided in no small part by the companies that benefit from that expensive energy. For the year so far, average stock prices have either declined about two percent or risen about the same amount, depending on your favorite index. Bonds continued to hold their own in the face of Federal Reserve actions that have steadily lifted short-term rates for more than a year now, to about 3.5% on interbank loans. The likelihood of even heavier government borrowing to fund disaster recovery spending also seemed to go unnoticed in the fixed income realm.

Foreign equity markets showed continued strength, but the real action continues to be in commodities. Besides crude oil, everything from gold to sugar has become pricier, often setting multi-year or even multi-decade highs. Natural gas has reached records of just under $15 per million BTUs. Copper, too, is at record levels around $3900 per ton, due to anticipated reconstruction demand from the southern United States. Gold neared $475 per ounce, an eighteen-year high. Sugar reached a five-year high of 11.20 cents per pound on world markets, as more of the commodity is used to produce ethanol as a substitute for expensive gasoline. All of this has rewarded commodity traders with gains for four years running as commodity indexes have reached 25-year highs.

One might have expected to see a more vigorous response on the part of the financial markets to such things as booming energy prices or catastrophic hurricanes. But nature’s wrath is fleeting, and the reconstruction effort afterwards provides economic stimulus. In addition, those high energy prices may in fact be playing a role in keeping security prices (especially long-term bonds) elevated and steady, as a significant portion of those “petro dollars” is recycled into U.S. financial assets. Oil money contributes to the sea of liquidity that, by buoying all financial asset values and narrowing the differences in rewards offered by the safest and riskiest instruments, is making for a seemingly benign environment. When abundant liquidity is keeping security prices elevated, it is probably a good idea to stay liquid yourself. Market liquidity has a way of drying up quickly under certain conditions—conditions that are usually not very comfortable for security owners.

The Overwhelming Indifference of Nature

Once in a while something comes our way—usually completely unrelated to the financial sphere—which gives us interesting and useful insights into how the peculiar little world of Wall Street operates. This was true of the recent film Grizzly Man. German director Werner Herzog examines the life of n’ere-do-well Timothy Treadwell who spent thirteen summers among the grizzly bear of Alaska in their natural habitat, seeing himself as the bears’ protector against human encroachment and poachers. Using Treadwell’s own videos of his life among potentially deadly neighbors, Herzog paints a picture of a man who, having rejected human society, finds identity and meaning among wild animals and nature, in which he sees good and harmony. The film’s director will have nothing of this, however, asserting that in nature there is only chaos and indifference and the order and harmony Treadwell perceives is merely a human fiction. For Herzog, there is no “secret world of the bears;” in the eyes of the bears appearing in the videos he finds only a “half bored interest in food,” which, in the end, is what Treadwell becomes. Beyond some extraordinary cinematography, Herzog maintains that Treadwell’s work is valuable not so much for its view of wild nature, but for its revealing insights into our own, human nature, and its tendency to conceptualize the universe according to human referents.

Human nature being what it is, it should not surprise us that our penchant for imagining “secret worlds” is apparent in many places, including Wall Street. Personification of the markets is commonplace—how often do we hear such phrases as “the market is looking for direction,” or “the market wants to go up”—as if a mere trading locale had a consciousness of its own and operated according to some half-mysterious purpose which can be divined through the use of proper market analysis techniques. Long periods of seeming conformity with these notions reinforces the animistic spirit in us. In the same way that the thirteen seasons Treadwell spent successfully living amongst predators reinforced his feeling that he had established a relationship—even kinship—with the bears in which he was in control, extended periods of good or poor markets reinforces our “personification” of them as having benign or evil qualities, engendering feelings of trust or fear.

In fact, they are neither benign nor evil, and trust is not a proper attitude to have toward them, nor is fear. Markets (like nature) are indifferent to our experience of them, and the idea that they somehow have a will of their own is just nonsense. As J.P. Morgan once said: “The markets will fluctuate.” That is really all we as investors need to know. The challenge is to avoid falling into the trap of trying to anticipate which direction the markets will take, as if they had a mind of their own, and not to view positive or negative trends and volatility emotionally, in terms of good and evil. It is important to accept the markets for what they are and prepare for the inevitable fluctuations that will take place.

While this perspective and the discipline it entails may elude and discomfit Wall Street seers and perhaps most of the investing public, we believe the state of mind it represents holds significant advantages for the securities buyer and owner. Most importantly, it promotes a healthy respect for the financial marketplace by accepting it on its own terms. Like Treadwell’s bears, it can be dangerous and there is an unseen line which we cross only at our peril; we are not in control. Our agnostic viewpoint also makes it easier to focus on the elements that we can control—measurement and the analysis of data—which permit us to take advantage of markets’ “irrational” fluctuations (to employ an anthropomorphic term). The central tenet of investing—the protection of capital—is too important a duty and challenge to entrust to the divination of market intentions, just as, in wild nature, preserving one’s life is not something to be left to the goodwill of predators.


Dennis Butler, MBA, CFA