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!

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?