October 22, 2021
By Steve Blumenthal
“Gaining an edge in investing is challenging. Traditionally, investors tackle this challenge by attempting to gain an information advantage. Investors also seek more data and information looking to confirm or deny the ‘fitness’ of an investment idea. Seeking more data makes sense; we humans don’t like uncertainty, so we do our best to reduce uncertainty at every turn. However, in public markets, which tend toward efficiency, information is ubiquitous and therefore likely already significantly in the price. Said more starkly, the very best investments will likely have the least information to support them. In addition, a more insidious relationship lurks in the way we view information. The facts are that above a relatively low threshold, obtaining more information does not increase predictive accuracy; however, additional information does increase confidence. The practical implications that flow from the above are to avoid strong consensus ideas and search for the controversial. For example, in medicine, look for ‘research frontiers’ where few competitors exist (for example, the idea that brain diseases start in the gut.) In any event, I try to adjust my confidence downward in proportion to the amount of easily available confirming evidence and seek ideas where the evidence/information set is sparse.”
― Mark T. Finn,
Chief Executive Officer, Vantage Consulting Group
Decarbonizing energy. Whichever side of the argument you find yourself on, like it or not, we are on the path to a carbon-neutral world. Europe’s goal is 2050. From an investment standpoint, there are risks and opportunities. Today, let’s skip past the market noise, the Fed, valuations, and debates around inflation. Instead, I thought I’d share with you a way of thinking about wealth creation and how to approach it thoughtfully.
At CMG, we have a particular way of thinking about wealth. We call it CORE/EXPLORE. Protect CORE wealth in a way that allows us to EXPLORE with the balance. As a general rule, we like an 80 CORE/20 EXPLORE allocation. Most of the families we work with have accumulated wealth and don’t want to lose it. Thus, an 80% allocation to CORE investing. It could be 70% for some and 100% for others depending on goals, needs, etc.
Here’s the idea: if you have a $2 million portfolio and allocate 80% or $1.6 million to CORE, the objective is to carefully grow your $1.6 million back to $2 million in four to six years. Ideally, we aim for 7% growth per year, which gets us back to even in approximately four years. Of course, risk exists in all investments and no guarantees can be made. The following chart shows what returns are needed to hit our four to six year back-to-even targets.
How do you earn 4% or 5.5% or 7%? First, avoid most forms of leverage. It’s not necessary, and it’s dangerous. We favor a diverse mix of well collateralized short-term private credit funds, certain closed-end funds, high and growing dividend stocks, and risk-managed liquid trading strategies. The point with the CORE is to get it back to even in four to six years. With your wealth intact, this then enables you to EXPLORE with the 20%. It is in the EXPLORE bucket that you look for asymmetric reward opportunities.
This is where it gets fun and sometimes not so fun, but that is the nature of investing. Investing involves risk. EXPLORE is about wealth creation; it’s not easy and to be successful requires a certain mindset.
Recently I was on a call with my dear friend and mentor, Mark Finn. We were talking about several companies in his venture capital fund. To be completely transparent, I’m invested in his firm’s 2006 venture fund, the 2019 venture fund, and invested directly in several companies in those funds. One of my clients is considering an investment and was seeking certainty. He pressed Mark for assurance. Mark is a wealth of wisdom.
Mark paused and said, “I am never certain. The more certain I am, and the more certain the others around me are, the more uncertain I become.”
Gaining an edge in investing is challenging. Traditionally, investors tackle this challenge by attempting to gain an information advantage. Investors also seek more data and information looking to confirm or deny the ‘fitness’ of an investment idea. Seeking more data makes sense; we humans don’t like uncertainty, so we do our best to reduce uncertainty at every turn.
However, in public markets, which tend toward efficiency, information is ubiquitous and therefore likely already significantly in the price. Said more starkly, the very best investments will likely have the least information to support them. In addition, a more insidious relationship lurks in the way we view information. The facts are that above a relatively low threshold, obtaining more information does not increase predictive accuracy; however, additional information does increase confidence.
The practical implications that flow from the above are to avoid strong consensus ideas and search for the controversial. For example, in medicine, look for ‘research frontiers’ where few competitors exist (for example, the idea that brain diseases start in the gut.) In any event, I try to adjust my confidence downward in proportion to the amount of easily available confirming evidence and seek ideas where the evidence/information set is sparse.
If an idea is well drawn out and well understood, it will draw a lot of competitors to the space. At that point, the idea is priced into the market. That’s the nature of public stock markets.
The bottom line is this: You can’t know all the facts. There is always a risk. What you look for are two things: First, is there edge? Second, is the size of the business opportunity enormous? The best ideas are the most rewarded, and investors will find the least amount of information because others are not yet drawn to the space.
In the EXPLORE bucket, seek disruptive opportunities in healthcare, biotech, gene editing, agriculture, decarbonization, and technology. Is there an edge, are there few competitors, and is the economic opportunity large? That’s what you can know. You won’t be able to get to certainty. Get comfortable with being uncomfortable. And establish a network that allows you to source and vet ideas.
The motivation behind today’s OMR letter comes from an article in The Telegraph entitled, “Technology saves us: Oxford sees a $26 trillion gain from net zero,” written by Ambrose Evans-Pritchard. Think EXPLORE bucket… The movement towards a carbon-neutral world is unstoppable, the size of the disruption is massive, and the opportunities that will present are worth our attention.
Eliminate the word ‘cost’ from the net-zero lexicon. The relevant concept is how much we gain.
A team of mathematicians at Oxford University has carried out the world’s best study so far of the economic windfall to be had from a turbo-charged decarbonization based on unstoppable leaps and bounds in known technology.
It concluded that the net gain is $26 trillion (£19 trillion), or $14 trillion under cautious assumptions. The faster it happens, the bigger the benefit. It can be achieved in 25 years, beating the global target of 2050. Most changes do not require lavish state funding anymore than public money is needed to make mobile phones.
I know it’s easy for us to dive into a painful political discussion. Whichever side of the carbon-neutral movement you sit on, let’s table political debate. Instead, channel your inner Mark Finn. Is there an edge, and is the opportunity large? I suspect the decarbonization movement may turn out to be a bonanza for those quick who seize it. My lights are on; I’ll be spending more time learning about this space.
Happy to share and exchange ideas. Email me at email@example.com and tell me a bit about you.
Trade Signals is next. No significant changes since last week’s post. Don’t Fight the Tape and the Fed remains bullish, as do most of our equity market indicators. The risk is high. Hedge.
Trade Signals – Probability of Two Fed Rate Hikes in 2022 at 93.75%
October 20, 2021
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Notable this week:
Short-term rates are rising while long-term rates are declining. To be watched as a continuation of this trend is an excellent predictor of recession.
Inflation is driving the betting markets. The probability of two Fed rate hikes by the end of 2022 is now at 93.75%.
The Trade Signals Dashboard follows next. The Zweig Bond Model moved to a “Sell” signal. Signaling rising rates and declining bond prices. All of the Trade Signal bond indicators are in sell signals.
Click HERE to read to the balance of Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Personal Note – The Flying Pig
Short note this week as I’m rushing to hit the send button and meet a friend at the Flying Pig for a quick pregame IPA. My friend’s son played soccer for my wife Susan years ago, and we would meet up with several other parents at the “Pig” before and sometimes after the soccer games. Today’s game is a big one: Malvern Prep vs. The Haverford School. Susan coaches MP. Pretty much a must-win. Go Friars!
I hope your calendar is full of fun things that make you happy. Best to you and your family.
All the best,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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