Fiduciary Responsibilities, denied

BOTH STATEMENTS ARE FROM WIKIPEDIA -A fiduciary is a legal or ethical relationship of trust between two or more parties. Typically, a fiduciary prudently takes care of money for another person. One party, for example a corporate trust company or the trust department of a bank, acts in a fiduciary capacity to the other one, who for example has funds entrusted to it for investment. In a fiduciary relationship, one person, in a position of vulnerability, justifiably vests confidence, good faith, reliance and trust in another whose aid, advice or protection is sought in some matter. In such a relation good conscience requires the fiduciary to act at all times for the sole benefit and interest of the one who trusts.

When a fiduciary duty is imposed, equity requires a different, arguably stricter, standard of behavior than the comparable tortious duty of care at common law. It is said the fiduciary has a duty not to be in a situation where personal interests and fiduciary duty conflict, a duty not to be in a situation where his fiduciary duty conflicts with another fiduciary duty, and a duty not to profit from his fiduciary position without knowledge and consent. A fiduciary ideally would not have a conflict of interest. It has been said that fiduciaries must conduct themselves "at a level higher than that trodden by the crowd"^[3] and that "[t]he distinguishing or overriding duty of a fiduciary is the obligation of undivided loyalty."^{[4] (Emphasis added in RED)}

The California Public Employee Retirement voted to divest itself of Sturm, Ruger and Smith and Wesson, both manufacturers of politically troubled, but legal products (Firearms).   The chart above presents the investment results for both companies.   Ruger is in Green and Smith and Wesson are in Blue.  Both companies have out performed the S&P over the last five years.  Ruger actually also offers a modest dividend.  I own a Ruger and so am somewhat biased on the product.   But that is not me as an investor.

The firearms companies are not ones that I follow actively.  So there may be very good reasons to sell both stocks.  Ruger is a $500 million company and Smith and Wesson are about twice that size.   Both are in high margin businesses.  But both are also in the political wilderness now.   And their long term financial viability, based on a quick look at their balance sheets suggest they are stable companies.   But this decision smells of politics of the moment.  CALPERS has some long term problems in funding the future needs of state employees.   Getting into politics is not where this major retirement system should go.

Investment Nonsense

The Investment Risk/Reward Triangle

On the weekends many radio stations offer a set of infomercials often about health or investments.  Much of what these hosts say is absolute nonsense.   For example,  today I was driving to the gym and heard one Sacramento station investment advisor claim he had figured out a way to get away from the "traditional tradeoff between risk and return."

All investments involve uncertainty.  If I invest in a stock or a piece or real estate or a work of art - will the value increase or decrease?   Generally speaking, investors demand a "risk premium" for investments that involve a higher degree of risk.  Thus, in situations like a new business, investors demand a higher rate of return than in an established and well understood business with a long history.

The diagram at the right is a good conceptual tool to explain how this works.   Think of the diagram as a bucket for projected returns.   If you put $1 into the bucket you have a chance of increasing the value of that dollar or losing it.   The two axes of the picture (horizontal and vertical) represent the dynamics of investments.  The Horizontal Axis represents the relative security of an investment.  Keep it in the green zone and you will get the expected rate of return.  Put it in the red and you will lose it.   In reality there are very few purely safe investments, even when you give up return.   The Vertical Axis represents rate of return.  At the bottom of the axis you can expect very little return but relative surety that you will get your money back; at the top a very large return.   What the diagram suggests is that if you want a very high rate of return, you have to be willing to expect that your investment will not pay off, a large percentage of the time.

The "guru's" magic bullet was time.   He yammered on that by laddering maturities you can increase yield without risk.  Well duh - but don't be so sure.  Any competent professional always includes time as one of the variables on risk.  The problem is solving the time part of the risk equation is especially complex right now.

At the right you can see what most people would call a normal yield curve - the yield increases as you stretch out to a longer maturity (thanks Investopedia!)    Note - yield curves can do all sorts of strange things including flattening (where the amount of money you receive for an investment does not vary based on the time of investment) or even inverting (where you get a higher yield for a shorter maturity).

A key challenge in today's environment is your expectations of inflation.   For the last several years the premium given to longer investments has been pretty modest.  So for example, the current returns on Treasuries give you .1% for a month and 2.91% for 30 years.    But the risk that the 30 year investor pays is huge.  If inflation begins to rear its head at all - the dollars you will get paid back with will be worth a lot less than the ones you paid in - so even though you will be getting a bit less than 3% on your investment to maturity - the value of those dollars will be less.

Pundits verus Public Shills

When Warren Buffett first started to make his claims about who pays taxes in the US I did a post which questioned whether the numbers he was using were in any way correct.   Mark Perry, an economist in DC, published the following table on his blog Carpe Diem which brings into questions Mr. Buffett's claims by using IRS data.

Buffett recently made a deal with Bank of America to create some special stock for his investment which will have an effective tax rate of 10.5% - so clearly his expertise has been in manipulating the tax system.  A lot of the success that Buffett's company has made over the time that I was a shareholder (I sold my A stock when it went to $123,000 per share) has been based on tax strategies which avoid the punitive taxation of estates before the 2001 Tax Act.

One other comment here.  According to calculations from IRS data if you established a tax rate of 100% (Take all their income) for people earning over $1 million you would yield only about half of the current deficit.

I have one other chart which tracks BRKA for the last couple of months as Buffett has made these claims.

Perhaps Buffett is a better investor than public pundit.

Selling Berkshire

In 1987 I bought Berkshire Hathaway at $3785 per share.  This week I sold the position at $120K per share.   That amounts to a bit more than a 30 bagger.  But in the last couple of years I've gotten the distinct impression that the investment potential has declined significantly.

The story of BRK.A begins with the legendary business professor Benjamin Graham who spent his career inspiring students at Columbia.  In the 1920s Graham led a movement to improve the quality of accounting information released by corporations.  His basic insight (in Security Analysis) was that when you buy a stock you are buying a set of assets.  But later on he had a group of students, including Warren Buffett and the founder of the Sequoia Fund, who figured out how to beat the market by applying some basic principles to investing.

Had you bought into Berkshire when Buffett took over the company you would be very wealthy today.  But in the last five years the stock has been a lousy proxy for the S&P.  The CEO has been caught up in becoming a public figure rather than an investor.  So while I admire the past performance of the stock, it's inspiration has been caught up in the hype of being a media figure.

What annoys me the most about Buffett's recent performances has been the hypocrisy.   Buffett has been one of the major proponents of keeping estate taxes high.  Yet, a good deal of his success over his career has been based on finding family owned business and buying them in a way that delays or denies the impact of estate taxes.  Ultimately, sound tax policy should not allow those kinds of manipulations.   We should, as the President's tax deal does, set rates for inheritance in the low range and at a high enough cap so that most taxpayers should not get caught.  One could make a case for the complete elimination of estate taxes but if there is to be a tax it should be lower than it could be next year and at a fairly high exclusion.

In all of his public statements the Sage of Omaha has never acknowledged that part of his wealth has been based on a public policy which hurts people with fewer resources than he has.