Post Taste

One of the most interesting luxury brands is—still—Prada. Unlike the tiresome antics of some other tip-top names like Louis Vuitton, and even Hermes, with their collaborations with artists, Prada is art. Full stop. Love it. Hate it. Can’t afford it. Whatevs.

Next month in Milan Muiccia Prada and her husband and business partner Patrizio Bertelli will launch Fondazione Prada that will focus on contemporary art. The café is designed by American director Wes Anderson, the creator of such indelible and delectable films as The Darjeeling Limited and, recently, The Grand Budapest Hotel. And the opening program will feature Roman Polanski discussing how a Doris Day film influenced the opening of Rosemary’s Baby.

People, what’s not to love?

Michael Rock, author of Pradasphere, writes about the ‘Prada Vision’ and how the brand plays with issues of gender, power, taste, luxury, beauty, vanity and embellishment. But why stop there? The Prada ‘experiment’ could apply to investing.

Referring to their total freedom in creating and running the foundation, Bertelli says, “Looking for consensus is a form of mediocrity, and that is one of the worst of human weaknesses.”

I suppose one could say that the rise in popularity of index-based ETFs represents our human need to cling to the median. There are many fine arguments for investing in index-based ETFs but, obviously, outperforming the index, (or standing out from the crowd), is not one of them.

You see this herd mentality play out on the investing blogs too. (I confess that I spend way too much time lurking on stockhouse.com.) This blog is full of ‘pumpers’ and ‘bashers’ and it seems to take no time at all for posters to clump around a trending narrative for what are typically small, highly speculative companies on the Canadian Venture (or, as some call it, Vulture) exchange. The value of these postings is mediocre at best because outliers, some no doubt with interesting views, are reluctant to be the object of other bloggers’ wrath.

Which brings us to the subject of clashes and conflicts. For me, one of the delights of Prada is the constant friction in the designs. The clothes and accessories are gorgeous. Or are they? They’re beautiful except when they’re ugly. They’re sexy and then not at all. They look expensive and cheap too. It’s all a crazy mash-up, not terribly unlike the markets.

Though there’s a subversive snobbery inherent in Prada, I appreciate the Prada wink. Take it seriously, or don’t. Next season there’s a whole new storyline. Gliding this idea into the markets, one can think of large caps stocks as head-to-toe Chanel. Expensive, good liquidity, universally understood, easy-to-price. Lovely, valuable, yet somewhat predictable. It takes no guts to wear a a quilted 2.55 Chanel on your arm. Good taste, absolutely.

The small caps, or micro-caps. Now that’s a different story. Good taste? Hmmm. Bad taste? Maybe. Post taste? Definitely. Investing in micro-caps is like dressing like Miuccia Prada: lime-green printed dress, short, black ankle socks, masculine shoes, no make-up, and emeralds the size of duck eggs. “What interests me, profoundly, are not certainties but doubts, clashes, and conflicts,” she has said. There is nothing patrician about micro-cap investing. It is the lime-green printed dress worn with black ankle socks—and, if you choose your ponies poorly, forget about the duck egg-sized emeralds.

Many investors cling to one group or another and in doing so miss out on potential gains (and losses too, of course.) The large cap people often hold their noses at the micro-cap types, for example. Yet small cap stocks can be terrific performers and be used to create satellite, high-growth portfolios within a more conservative framework.

Prada makes a case—fashion and otherwise—for mixing high-and-low. For the artists it means showing the rest of us where the world is going. And for investors it means making money, sometimes in “exquisite” taste, other times in “bad” taste.

Welcome to the Pradasphere!

Upstairs Downstairs

M. Agnelli in Balenciaga
Courtesy of Joao Chaves

In case you hadn’t noticed the world is bifurcating. Whether it’s income distribution or fashion, it’s an upstairs/downstairs situation. The middle is going, going, gone. It’s Balenciaga or bust. (As an aside, isn’t Agnelli’s Balenciaga satin opera coat to-die-for?)

In fashion, if you want cheap-and-cheerful—COS, H&M, Zara, Topshop, UNIQLO—are happy to provide you with glad rags: trendy clothes in fair-to-middling quality. Just don’t expect any  personal service and wardrobe consultation. It’s every shopper for herself and good luck snagging a change-room.

On the other hand, if circumstances permit, there are the luxurious ministrations of Prada, Gucci, Chanel, Dolce& Gabbana, Dior etc. Serene environments and personal attention, complete with a glass of Champagne.

The middle way, highly touted by Buddhists, is on the way out fashion-wise. Sears is toast but Wal-Mart is booming.

On the finance front, things are diverging too. Garden variety brokers—the kind that would call you with an investing idea or suggest when to take profits— are on the way out. These old-school types hand-built a unique portfolio made up of individual securities. Transactional accounts like these were a boon for buy-and-hold blue-chip investors. You paid once when you bought and once when you sold, even if the timing of those two events was decades apart.

Now banks and other financial institutions are converting clients to the “wealth-management” model. In exchange for managing a client’s portfolio, the advisor receives an annual fee. This fee ranges anywhere from one-percent of assets-under-management to several hundred basis points. The more money you have to invest, the lower your management fees.

Plunk down a minimum of $2 or 3-million and charges come in around 150-basis points or less. That’s considerably better than the typical management expense ratios on mutual funds that average 250-basis points and up. Of course, whether your advisor trades a little or a lot on your behalf, the charges stand, yea- after-year.

For those who don’t meet investment minimums, there are low-cost alternatives including ETFs, index funds and robo-advisors. With fees in the low single-digits, these are the Zara’s of the investing world. For a modest fee you participate in the capitalist zeitgeist—and benefit, or suffer, based the aggregate performance of a basket of businesses. These off-the-rack offerings are strictly for ‘downstairs’ types. Or are they?

A recent study has shown that clients with investment advisors average 1.8-percent better than DIY-types. Yet these returns are gobbled up by higher fees. So it appears that, for the average investor working with an average advisor, there is no advantage to paying for advice!

There are a 3-ways around this. One, you can find a manager who charges less than 180-basis points. This way you get to keep at least some excess gains in your pocket. Two, you can do your own investing with a low-cost online brokerage. Or, three, you can blend the two approaches.

Moral of the story: We may aspire to bespoke but off-the-rack seems to work out just fine.

Scratch & Sniff

Photo Courtesy of Jônatas Cunha

A good first impression goes a long way. It can get you a good table at a popular boîte. It can give you an edge in landing a plum job. It might even get you a hotel or airline upgrade. Not surprisingly coming on like gangbusters pays off for portfolio managers too who the reap rewards for years to come—even when their performance lags.

A recent study published in Financial Analysts Journal, (eye glazing stuff to be sure), was covered this week in The Economist. After examining the performance of 1,824 managers of American mutual funds over a 12-year period it turns out that active managers do not outperform the market.

While this isn’t exactly news, it bears repeating because investors are prone to magical thinking for which they pay dearly. Most investors, even and maybe especially those who consider themselves sophisticated, desperately want to believe that paying a premium to a star fund manager is worth it. They are wrong.

For starters, the hotshot will not be able to maintain her performance record. The study showed that there is no relationship between a manager’s performance in the first five years and the subsequent five years. Now factor in the dilutive effects of the premium fees charged by active managers. Not a pretty picture.

To get a real sense of what long-term market returns will be take a glance at the risk-free rate. This is the rate of return you would get if you bought a government-secured T-bill, for example. Now look at corporate earnings. They are hovering around two or three-percent, right?

So you get the picture: Over the long haul, say, 10-15 years, it’s highly unlikely that you’ll do better than five or six-percent if you’re willing take on some risk.

Why twist yourself into a knot for five percent?

Instead, work with a low-cost portfolio manager, (or go the DIY-route if you have the time and inclination), and buy a bunch of  common shares of medium-to-large cap, dividend-paying companies in the U.S.A and Canada, and a low-cost bond index or mutual fund. Or, if you don’t want to hold individual securities, go for an all-fund portfolio of low-cost actively managed mutual funds and some ETFs. (An all ETF portfolio is suboptimal because managers must constantly trade to track an index. This herd mentality guarantees underperformance relative to the benchmark after fees.)

When I worked in the fashion biz, there was a rumour going around that certain firms would initially use high-quality ingredients for their new perfume creations. Once the punters were hooked, the formulas would be tweaked using lower-cost substitutes. The companies rightly figured that the halo effect from the initial product would keep customers coming back for more.

That’s not unlike the investment biz. Hotshot fund managers sure smell nice at first. However, the prudent investor should perform a scratch-and-sniff test a few years later. Is the aroma still so rosy?

The Umbrella Shop

Illustration courtesy of Tom Simpson

In Paris, on the charming Viaduc des Arts, there are many “one-thing shops”. There’s a perfumery, a framer, and an umbrella shop. Parasolerie Heurtault sells one thing only: umbrellas. Mind you, they are verra, verra nice umbrellas. The proprietor, one Monsieur Michel Heurtault, makes hand-stitched brollies in waterproof silk taffeta with handles made of ebony, Bakelite lacquered wood, and, gasp, antique ivory.

It’s a risk to commit to just one thing. A prolonged drought, a public distain for theatrical presentations of My Fair Lady or Mary Poppins, or some other cause of falling umbrella demand, and, poof! the business collapses.

When it comes to investing, the mantra is diversify, diversify, diversify. To risk-proof a portfolio, pundits recommend owning 4-6 asset classes and over 30 different equities. Today that’s easy enough to achieve with mutual funds and ETFs that mirror the markets.

But sometimes in the rush to diversify, something gets lost: Outsize profits.

While no rational person would ever suggest putting all your money in a fledging graphite stock trading for pennies over-the-counter, making big bets is one way top investors make big paydays.

Whales like Warren Buffett buy entire companies. Not exactly a committment-phobe, he. Further down the food chain, other investors find success by selecting asset classes they believe will do well and tilting their portfolios toward them. Again, this take a certain amount of chutzpah.

Spreading the love around, as an S&P 500 mutual fund does, divvies up the risk but it will never beat the market. And, factoring in management fees, it will always underperform the market.

Size does matter. Sizing investments is probably one of the hardest parts of being an investor. And nowhere is this more nerve-wracking than buying highly speculative stocks. Because most of these are fledging companies with no profits, they’re brittle little birds that could vanish in a blink under a strong breeze.

On the other hand, if they hit, they hit big. The rule-of-thumb is, assuming you have the appetite for them at all, to put no more than 5% of your total portfolio into high-risk stocks. Depending on the dollars this represents, you may be able to buy several of them. Ten-thousand shares might sound like a lot but if the stock is selling for 17 cents, you’re gonna want to back up the truck to get a meaningful position and the potential for a healthy return.

Once that stock starts to move, consider paring back your investment. Double-baggers do happen. (Your graphite darling might go from 17-cents to 34-cents.) But how likely is it to go from 34-cents to $3.40? Not very. If you’re still in love, keep some but play with the market’s money. Take out your original investment and find another undiscovered gem to buy, or send a kid to camp.

Sometimes betting on one-thing is a not-stupid investment. And, if you’re lucky, it can provide you with a nice, big umbrella for that rainy day.