Once upon a time, there was an empire ruled by a very vain emperor. The emperor took immense pride in his wardrobe. One day, two con men came to the kingdom and decided to take advantage of the emperor’s vanity. They told him they were weavers and that they could weave the finest cloth every made. It was so fine that only the most sophisticated of people could see it….Have you heard this one before? 

“The Emperor’s New Clothes” is a folktale recorded by Hans Christian Andersen. Of course, like most of his tales, this was a story that had been told long before Andersen committed it to writing in 1837. The emperor sends his most educated advisers to inspect the work of the weavers, and one after the other lies about seeing the cloth that wasn’t there because they were so afraid of being exposed for being unsophisticated. Finally, the emperor himself was shocked to not be able to see the clothes. He carried the lie so far as to parade in front of his subjects wearing nothing at all. It took a young girl who knew nothing of sophistication to finally tell the truth: The emperor wasn’t wearing any clothes. 

This folktale is the parable of our time. Stories like this were taught to children not only to entertain, but also to teach lessons. The lesson – which is as old as time – is that people who think of themselves as sophisticated can believe some ridiculous things. In fact, the truth is usually simple, and the simplest explanation is usually the truth. This is why children are sometimes wiser than the adults. 

I first thought of the connection of this story to our current age about three years ago. My daughter was in third grade and the Atlanta school system conducted a childhood safety seminar. The goal was to empower the children to report any form of abuse that they may experience. They started with a question: Are you a boy, girl, or other? The third graders laughed and shouted, “There is no other.” The emperor is naked. 

When I first thought about writing this blog, I came up with this tagline: One must be incredibly intelligent to believe something so stupid. I thought I was being original, but I guess I was really the one being stupid, as I found lots of similar quotes. Gorge Orwell put it this way, “One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

Orwell wasn’t being original either. Supposedly Cicero said, “There has never been any so outrageous and insane balderdash which some philosopher had not represented as an absolute truth.” That goes back approximately 2000 years. Turns out really intelligent people have been believing really stupid stuff for a long time. 

The list of things in this category today is too numerous to count. Like the con men in our parable, the believers of these various ideas simply say, “…if you don’t believe, then you lack sophistication.” In my world, one such stupidity is Modern Monetary Theory (MMT). It states that the government can (and should) spend whatever amount it wants because they print the money. They can do so without harming the economy or causing inflation. 

This theory has been adopted by several politicians who were instrumental in creating the spending spree that triggered the inflation we see today. One can see the attraction; they want to spend and spend, and now some economist says they can. In truth, people believe what they want to believe. The reason intelligent people take this to such ludicrous extremes is because they are mentally capable of twisting some stream of logic to explain away all of the inconvenient facts. 

When they can’t do so, they resort to bullying. They claim their intellectual superiority and then refuse to engage in a conversation. Those who disagree are spreading mis- or disinformation. They just aren’t sophisticated like the emperor and his advisers; they must at least be ignored, and at worst, be canceled. 

Who are these intelligent people who believe such stupid things? They are us. I have a liberal friend who does not hesitate to ridicule the “2020 Election Deniers,” but Russia colluding with Trump? Oh, that happened – in my friend’s mind. I have conservative friends who are the exact opposite. It sure is easy to see the silliness of others, yet it becomes harder when looking into a mirror. 

In this election week we are reminded of the polarization of our society. Everyone I know bemoans it, then points the other way and says, “It’s their fault.” Most wish our leaders would do something about it. The problem is, we are the leaders. The ones who claim to lead? They are actually our servants. That is how our system is designed to work. If we want the polarization to stop, then we need to be like that young girl and be willing to admit when our emperor is naked. Maybe we can move on to a better parable, like the one about removing the log in our eye before removing the spec in our brother’s. That would make for a better world, at least that is my perspective. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~The Parable of Our Time

For those who pay attention to financial pundits, the word “pivot” is becoming very familiar. These sources of pseudo-wisdom keep saying that the stock market cannot maintain a rally until the Federal Reserve pivots from a policy of raising interest rates to a policy of lowering interest rates. They are, as usual, wrong, but there is something bigger afoot here.

Before I get into that, I do wish to defend the word “pivot.” I coached basketball for years and believe, as legendary coach Tex Winters did, that to pivot is arguably the most important fundamental skill in basketball. To pivot is the proper movement of a player’s feet to avoid traveling. To be able to pivot in basketball is to know how to use one’s feet to protect the ball and beat one’s defender. The lack of emphasis on proper footwork is evident in the poor quality of today’s college game.

The pivot is also the engine of the golf swing. In golf, the pivot describes the proper movement of the body during the swing. Depending on the school of thought of your pro, the pivot is a proper reaction to the movement of your hand and arms, or it is the engine that actually moves your arms and by extension your hands. I prefer the description by instructor Pete Cowen who says the body is the engine, the shoulders the transmission, and the hands are the steering wheel. But we digress.

The problem is not the use of the word pivot; it is this modern idea that we have to be on one extreme or the other. In this case, the Fed must be either raising interest rates to fight inflation or lowering interest rates to fight a recession. This is absurd. The Fed can just hold steady, maybe provide some stability.

The Fed has undue influence on financial markets, but it is not clear to me at all that they have power over the actual economy. As I have mentioned before, I believe that the Fed, and central banks in general, are overrated. If monetary policy controls the fate of an economy, then explain Japan. They have been trying to stimulate their economy with monetary policy for three decades with no success.

Economists like to focus on monetary policy because they want to be seen as scientific, and the key to that is the use, often misuse, of math. Interest rates are numbers, and numbers can go into sophisticated formulas. Similarly, tax rates and government spending are numbers, and they can also be input into formulas.

Regulation, on the other hand, is not easily turned into a number. When we were fighting inflation in the 1970s and early 1980s, one little-noticed action was the breaking up of “Ma Bell” and the deregulation of the phone system. This one act allowed phone lines to be used as a world wide web of sorts (see what I did there?). No central planner, fed governor, or economic pundit could have ever dreamed of the world that this change created.

Without that one act of deregulation, there would be no Amazon, no Google, no Netflix. Apple would still be a computer company. Almost 40 years of productivity gains would be wiped out. Iron Capital wouldn’t exist. That may be less obvious because we are not an internet company, but the internet allowed the world of equity analysis to be powered by a personal computer, when previously a firm needed loads of office space for annual report storage and teams of analysts to physically go through each company’s reports.

Today we are fighting high gasoline prices, and one of the main reasons is a lack of refining capacity. Today it would be next to impossible to open a new refinery. The Fed can raise rates forever, but that will not refine a single gallon of gasoline.

The Fed is overrated, and the role of regulation is grossly underappreciated. Of course, just like with the pivot, many will read this and accuse me of wanting to live in a world with no rules. It is one extreme or the other. That is absurd and we should call it what it is. The problem with regulation is that we never update, we only keep adding. Obviously we need rules, but the rules need to make sense. There is a middle ground, and most of the time it is the best path forward. At least that is my perspective.

Warm regards,

Chuck Osborne, CFA
Managing Director

~Pivot

“You never really understand a person until you consider things from his point of view…until you climb into his skin and walk around in it.”  ~ Atticus Finch, “To Kill a Mockingbird” 

The first self-help book I ever read was Stephen Covey’s “7 Habits of Highly Effective People.” I use his weekly organizing technique to this day. Habit 5 is to seek first to understand, then to be understood. While I often fall short, this has been something I have strived to do for most of my adult life. It is one of those universal lessons. 

One can find it in literature, like this quote from Harper Lee’s “To Kill a Mockingbird.” One can find it in sales conferences, where “the client doesn’t care how much you know until they know how much you care” has been a cliché for years. One will find it in prayers such as The Prayer of Saint Francis, “O Divine Master, grant that I may not so much seek…to be understood as to understand.” It is the major theme of the Dale Carnegie classic, “How to Win Friends and Influence People.” 

Human beings are social creatures. We were made to be in fellowship with one another, and that requires the ability to empathize, otherwise society breaks down into violence. We have been losing this thread for some time now, and the reaction to the COVID pandemic has made it worse. It began in the most unlikely of places – universities – with the political correctness movement. What started out as a reminder to use good manners quickly morphed into a way of prohibiting any point of view that ran counter to the consensus. 

A few years ago, I wrote about the problem with straw man arguments. A straw man argument is when one distorts the actual argument another person is making, then responds to the distortion they created instead of the actual argument of the other person. This happens in politics all the time. A politician will promote a healthcare program as an example. Her opponent may argue that her proposal has unintended consequences that will actually make healthcare worse, not better. The politician responds by claiming her opponent is against people having healthcare. That is a straw man: the opponent isn’t against healthcare at all, but truly believes this plan will make things worse. She ignores the actual argument and runs ad after ad saying her opponent doesn’t want you to have healthcare. 

Straw man arguments have been around forever, but the difference today seems to be that we have begun to believe that the straw man is actually our opponent’s argument. This happens because our society increasingly is no longer concerned with actually trying to understand. 

We have been dealing with multiple fund families in what we have named the Mutual Fund Scandal 2.0. One fund family has sent written correspondence to multiple retirement plan sponsors, an ERISA attorney representing a plan sponsor, and us. The first paragraph of each of these states that we don’t understand what they are doing. They then go on to describe what they are doing verbatim to our description. 

One of our plan sponsor clients stated that she was taken aback by how little understanding of the plan sponsor’s point of view the fund company showed. Likewise, they have shown a misunderstanding of the investment adviser’s role and point of view, which is astonishing; plan sponsors are their end-clients. Almost all plan sponsors work with advisers who deal directly with the various fund families. How could they not understand? Even worse, how could they start a conversation by accusing their clients of not understanding? Even if that was correct, an effective person always seeks first to understand, then to be understood. 

This particular fund family is one who historically has a reputation of client service excellence, which makes this whole episode all the more puzzling. What has changed? I believe it’s long COVID-19.

This particular firm is still not back in the office full time. For two and a half years, they haven’t actually seen clients in person. They haven’t even seen each other. Sure, they can still do all the administrative tasks they need to do remotely. The job gets done, but that isn’t good enough. When dealing with human beings one needs to be effective, not efficient. Efficiency in human interactions comes across as rudeness. Working remotely and not interacting with actual human beings for two and a half years may not have reduced efficiency all that much, but it has destroyed effectiveness. 

To be understanding, one has to be in relationship. We have lost a great deal of that relationship-building over the last two and a half years. Our reaction to COVID may very well end up doing more harm to our society than the virus itself. That isn’t to say that there will not be benefits to the technology that has allowed the professional world to keep moving forward, but there must be balance. Human interaction is of utmost importance. To truly understand others, one has to follow Atticus Finch’s advice to put yourself in their skin and walk around in it. That is a hard thing to do normally; It is impossible if one never leaves the house. At least that is my perspective. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~Long COVID?

The stock of Electronic Arts, the maker of sports-related video games, is up almost 6 percent on a down day in the stock market. Why? The official news is that Amazon may be buying them, but that is misinformation. Truth be told, the Biden administration just threw a financial lifeline to the 20-something deadbeats who can now stay in their parents’ basements playing video games instead of getting a job for at least a few more months. 

Disclaimer: The above paragraph is a joke. Joke is defined by Merriam-Webster as, “something said or done to provoke laughter.” Jokes were prevalent on college campuses in the days when there were no safe spaces, trigger warnings, or student loans the size of mortgages. 

NBC recently conducted a poll in which a plurality listed “threats to democracy” as the most important issue facing the country. They made a big deal about this being the first time ever this was the case; turns out it was the first time NBC had ever asked about “threats to democracy.” If one seeks the right answer, she must ask the right question. 

Should we forgive student loans? Wrong question. What should we do about the student loan crisis in this country? Premature question. Why does college cost so much that one has to take out a mortgage-sized loan to pay for it? That is the right question. 

The student loan crisis is real, and it is causing harm to a generation, but student loans are not the disease. No, loans are the symptom. I’m no doctor, but I know enough to know that masking a symptom doesn’t cure the disease; it often makes it worse. 

The disease is the runaway cost of education. The cost of education – both higher education and private secondary school – is criminal. No other industry in the world would be able to get away with it. Education makes healthcare seem affordable. 

When we had a mortgage crisis in this country in 2008, what was the government’s response? They did not wipe out America’s mortgage debt. Instead, banking industry CEOs were forced to testify in front of Congress, specifically to answer for selling mortgage products to naive borrowers who really did not understand what they were getting into. 

Here are some good questions: How many of the student debt holders were first-generation college students? Did they borrow this money to go to college because they wanted to enrich their spirit with a better education, or because they were told they need a college degree to get a good job? If it was the latter, did anyone at the university explain that when it comes to employment, all degrees are not created equal? When borrowing hundreds of thousands of dollars to obtain a master’s degree in Russian poetry, was it explained that the degree would qualify them to be a slightly more interesting barista? 

These are questions university presidents should be forced to answer. Quality education since the time of Socrates has required just three things: a place to meet, a good teacher, and a good book. None of those things should be so expensive that it cripples the student’s financial future. 

How did this happen? Slowly over time. That is always how good people end up doing bad things. One bad decision leads to another, and then another. It is often fueled by one of the worst questions one can ever ask: What are the others doing? We raised our tuition because our peers raised theirs. Now that it costs more, that old non-airconditioned dorm that has a constant smell of stale beer isn’t quite good enough. New dorms it is. Costs are up, so we must raise tuition again. Now we need more degree programs, because a competitor offers a degree we do not; that means more professors and more classrooms. Tuition goes up again. It becomes a death spiral fueled by the most popular excuse for wrongdoing in human history, “Everyone else is doing it.” 

In the meantime, what about the quality of the actual product? Evidently with all the thousands of dollars of debt being piled on these students, no one has bothered to teach basic civics. What are the three branches of our federal government? What are their distinct roles? 

The biggest threat to our democratic form of government over the last 20 years is not a riot at the capitol, or the takeover of Seattle by radicals; it is executive action. The role of the Executive branch is to administer the law as passed by Congress. This abuse of power has been used by presidents from both parties, and it cannot continue. It has afforded Congress the luxury of not having to function, and has resulted in regulations that would have never made it through the democratic process. Perhaps most importantly, the use of executive action has created an environment in which we do a complete 180-degree turn ideologically every four to eight years. A stable nation cannot sustain that. 

Democracy is slow and painful to watch, but that is by design. That need to compromise, and the slow back-and-forth nature of it, adds stability. How does the person who did all the “right things” and just finished paying off their student debt feel today? There is a lot wrong with this student loan forgiveness, but perhaps the most concerning issue is the idea that one person thinks he has the power to do it all by himself. Now that is a threat to democracy. At least that is my perspective. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~The Wrong Question

“No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other.” ~ Matthew 6:24 

When I partnered with Larry Gray to form Iron Capital in 2003, we had two driving motivations. First was the fact that the investment industry was (and still is) rife with conflicts of interest. The second was that the industry had evolved in a way that set up layers of middle people between investors and the actual investment professionals. We wanted to fix those two flaws, so we started a firm with three core values: Trust, Independence, and Service. 

The primary value, in my opinion, is independence, because it is not only important in and of itself, but also a necessary element in both of the other two. It boils down to one question: Who is the boss – is it the client, or someone else? Our industry has historically broken that distinction down by using the terms “buy side” and “sell side.”

The sell side is far more familiar to most retail investors. The traditional financial adviser (stockbroker), the big brokerage firms, and investment banks are the sell side. They develop products and then sell them to investors. I’m often accused of being unfairly harsh towards the sell side, but that really isn’t the case. The sell side is necessary, and they provide needed products and services. The issue I have is that too often they are less than forthcoming about for whom they work and what they actually do. 

This wasn’t always the case. When I first got into the industry, the distinction was clear. My first job was on the sell side, and we made it perfectly clear that we could not offer advice; we could only provide education and guidance regarding the products we offered. For much of my career my individual clients were from the “Greatest Generation.” When I would first meet someone of that generation and ask them who managed their money, they would say, “I do, and Bob is my broker at Merrill Lynch.” That is a correct statement. 

Starting with the baby boomers and especially with millennials, when we ask that same question they will answer, “Bob at Merrill Lynch.” That is not a correct statement. Merrill Lynch is a brokerage firm – a store with products to sell, not a money manager. Bob is still a salesman, but one generation understood that while others do not. In recent years I have even met young brokers who, upon meeting me and learning what I do, will say something like, “I do the same thing.” They mean it, because they don’t know any better, but they are wrong. 

I’m on the buy side and have been for most of my career. The buy-side professionals are the ones who make investments on behalf of others. We have a fiduciary relationship with our clients, and we work for the client. We are hired by the client to make investment decisions on the client’s behalf. Most on the buy side will partner with the sell side; the buy-side portfolio manager will manage a fund, and the sell-side broker will sell it. It works great for the industry – investment professionals get to spend all their time analyzing investments and managing portfolios, and sales professionals get to spend all their time in front of clients. 

That was my life before founding Iron Capital. I rarely, if ever, got to meet a client back then; if I did, it was for a quick question-and-answer session, after which the financial adviser would say, “See, we do have smart people. Now let’s make that tee time.” It works for everyone, except the client. This scenario creates extra layers of cost, and the client must settle for products which are seldom a perfect fit for what she is trying to accomplish.

One day I realized that while we on the investment team often spoke of the clients, we didn’t know them, and we didn’t really work for them. We worked for the sell side; they were the ones who sold our product, and they would only sell it if they liked it. They were the retail outlet and had basically turned us into wholesalers. This is how the industry works today. Most on the buy side manage products sold through the sell side. They don’t know the client, and either give the client little thought or assume that the sell side has the client’s best interest at heart. 

However, today’s “financial adviser” does not work for the client either; they work for the brokerage firm. Their legal title is registered representative; they represent their firm. What they can and cannot tell you is governed by a compliance department staffed with attorneys whose job it is to make sure the firm doesn’t get sued or fined by regulators. Those attorneys also do not work for client. 

Because of this, the ranks of financial advisers who have left traditional brokerage firms to become independent investment advisers have grown, which is great. Unfortunately, old habits are far harder to break than legal structures. As we recently reported, there is a mutual fund scandal happening today in which supposedly independent advisers are negotiating sweetheart deals for their book of business with mutual fund families. This may seem harmless, or even that these advisers are doing a good thing, but when an adviser accepts a sweetheart deal from one fund family, for whom is he now working? 

Independence is not as easy as just leaving a brokerage firm. One cannot serve two masters. One cannot in good conscience negotiate deals with fund families and still work solely for the client’s best interest. Independence is difficult to maintain, but for us it is a core value, and vital. At least that is my perspective. 

Warm regards,

Chuck Osborne, CFA
Managing Director

~Who’s the Boss?