Seize the Day. This may be a strange thing for someone in my profession to say, but life is the thing you miss out on while you sit home making plans. I know: Iron Capital, like most of our competitors, does comprehensive financial planning. Our longtime readers will know that I also despise that term. I refer to the process as making financial projections, because that is what it actually is.

Projections are far less certain than plans, and there is never anything certain about the future. Did anyone plan on this never-ending reaction to a pandemic, now on its third strain? One cannot even plan on tax policy any longer because of our winner-take-all mentality with politics. Lost are the days of compromise leading to longer-term stability and the idea that winners of elections get to incrementally nudge us in the direction they wish to go. What will our tax system look like when you retire? The truth is, we don’t know.

What are we to do? These times remind me of the old legend of the tribe who lived in a cave. Every day they faced the wall at the back of the cave, and they saw shadows that scared them into not leaving the cave. Every once in a while someone would get the courage to venture out, but they never returned. The tribe, being who they were, assumed the worst. The danger outside the cave was too great. So, the tribe stayed put.

Meanwhile, those who did venture out discovered a beautiful world. They found that it was the sun rising and glowing into the cave that caused the shadows, and the figures on the wall were the shadows of the tribe itself. The outside world with all of its beauty was in fact dangerous, and some who left did indeed die. Others attempted to go back and tell the tribe that it was beautiful outside, but the tribe did not listen; fear ruled over them, and they spent their days wasting away in the cave.

Yes, there was danger outside the cave. One of the great lessons of investing, which is a universal lesson of life, is that there is no return without risk. In weightlifting they say there is no gain without pain. In the Judeo-Christian tradition of Western Civilization, the Lord told Adam and Eve that he would have to till the earth, and that she would have pain in childbearing. If one prefers Eastern philosophy, the Buddha teaches that life is suffering. To avoid risk, pain, and suffering is to avoid living.

Last year one of my cousins gave me a book entitled, “The Book of Joy.” It is written by Douglas Abrams, who records a conversation between two good friends, the Dalai Lama and Archbishop Desmond Tutu. Discussing the hardship of apartheid in South Africa, the Dalai Lama said, “You can see this in an entire generation that has experienced great difficulties like you, Archbishop. When you got your freedom, you really felt joyous. Now the new generation, who are born after, they don’t know the true joy of freedom, and complain more.” He went on to explain that it is the suffering that makes one appreciate the joy. It is the natural instinct of a parent to save their children from pain and suffering, but when we do, we rob them of their ability to grow and learn from adversity.

One of Iron Capital’s three rules of prudent investing is to be risk-averse. Are we contradicting what I just said? No. There is a huge difference between being risk-averse and being risk avoidant. Our culture today has become very black and white. We talk unthinkingly about seeing “both sides” of any issue, as if there are only two points of view – the point of view from one extreme, or that of the opposite extreme. The truth is, there is a huge area in between where most of us actually live.

Risk-avoidance means never leaving the cave: sitting there, staring at the shadows on the wall, gripped with fear. The very opposite might be jumping out of a perfectly functioning airplane, or swimming with bull and tiger sharks while a guide is feeding them. Having the courage to leave the cave and venture out in the world does not have to mean jumping off of cliffs. One could simply go for a walk in the sunshine. There are a lot more than two points of view.

We have lost our sense of balance. Seizing the day does not mean being in denial or acting carelessly. Risk should be managed – neither avoided, nor carelessly taken. This is true in investing, and it is true in life. When I was in college, I took a course to get certified to scuba dive. Scuba diving is extremely simple: breathe out of your mouth, and swim under the water. The course, however, lasted an entire semester. The reason was, we needed to learn about all the risk involved. We learned everything that could go wrong, and what to do if that happened. Then, we practiced those skills over and over in the relative safety of a deep swimming pool, while being closely monitored by instructors. By the time we made our first open-water dive, we all had good knowledge of the risks involved and how to overcome them. We did not allow the risks to stop us, nor did we simply ignore them.

We must seize the day. Life is meant to be lived, not just survived… which brings us back to planning. Planning is a very useful function: it can provide direction in life, and we need that. Wandering aimlessly with no regard for the future is not a recipe for long-term success, yet neither is frantically planning out every detail and constantly dreaming of a future while not living in the now. Just like all forms of risk, there is a balance – living today while being mindful of tomorrow. The key is flexibility.

When we help our clients with their financial projections, we always discuss flexibility. The only certainty in projecting the future is that it will never be exactly like the projection. This does not make the projection a waste of time; on the contrary, this exercise can be extremely helpful. It gives direction, and a way to measure progress. If done correctly, it can help one achieve one’s goals even if those goals change, and having done this for nearly thirty years, I can almost assure you that they will.

The real key to success, financial or otherwise, is to create positive daily habits. In other words, seize the day for today, as it is the only day that we are ever guaranteed. There are some extraordinary people who simply do this, but they are the exception. Most of us require motivation. This is where goals come into play. Goals provide motivation: they drive us to do the things today that will lead to success tomorrow. If one’s retirement goal is to buy a house in Florida and live the good life on the beach, then the picture of doing that will help ingrain the daily habits of living within one’s means and prudently investing toward that goal of living in the “Sunshine State.”

When the day finally comes and she realizes that she actually loves her home, enjoys having four seasons and wants to see the grandkids, then that new goal is easily achieved because of the habits she formed. Goals are a good thing when they provide motivation to do the right things today. Goals can, however, be dangerous, as they can become simple daydreams. Dreaming of a house in Florida while watching the snow fall outside isn’t helpful. Dreams can have us once again staring at the wall in the back of the cave. We need to get out and live today if we truly want to have a successful tomorrow.

Once we have the motivation, we need a plan of action. The hardest step is the first step. This step is, of course, dependent on where one is starting. If he is just starting out in life, then the question is, how to save? How do I create a budget and start to invest for my future? For many of our clients the question is: Now, how do I take all of these financial assets and turn them into retirement income? Every step is like leaving the cave for the first time over again.

Financial publications are full of stories about those who hesitate to get started young; less discussed are those who hesitate to enter retirement. We have multiple clients who tell us every year that they are going to retire in three years…one has been retiring “in three years” for nearly a decade now.

Leaving the cave is hard. While the existence of simply staring at the wall is mind-numbingly oppressive, it is still more comfortable than turning around and taking that first step. It is helpful to know, however, that the step does not have to mean jumping off the cliff. Many of our clients are transitioning into retirement with consulting work, or by going part-time. There are more than two points of view; in fact, there are countless points of view, and there are countless ways to imagine retirement.

But what if we leave the cave and something bad happens? We deal with it, that is what. Life is not meant to be easy. We have never lived in a world without viruses. There has never been a time on this planet when the climate wasn’t changing. Adversity is a fact of life and part of nature. It does not mean that there is some force out to get you; it is how we choose to deal with adversity that matters.

We should remember the words of the Dalai Lama, who said, “Many people think of suffering as a problem; actually it is an opportunity destiny has given you. In spite of difficulties and suffering, you can remain firm and maintain your composure.”

When we make financial projections, we run computer simulations of thousands and thousands of bad things. We do not ignore them. We are like the instructors in my scuba diving class: we think of everything that can go wrong, and we prepare for it. Then, when it happens, we can remain firm and maintain our composure.

No financial planner ever projected that we would be living through two years in which the world has allowed itself to be held hostage by a virus; nor did they foresee the Federal Reserve ignoring their own 2 percent inflation target. If they had predicted such things, they almost certainly would have assumed this meant a selloff in equity markets, not two solid years of growth. One must remain flexible and deal with life as it comes, not as we wish it to be.

If lessons have been learned over this period, one can hope we now know that shutting down completely in the face of adversity is not a productive strategy. We cannot hide in a cave waiting for there to be no more shadows on the wall. Life is meant to be lived. We will face adversity, suffering, danger; but that just grows our appreciation for the beauty. We do not ignore risk or live in denial, but instead face it and manage it. We cannot hide in our caves; we need to seize the day, precisely because life is fragile and filled with adversity. It is a New Year, let’s make the most of it. Carpe Diem!

Warm regards,

Chuck Osborne, CFA
Managing Director

~Carpe Diem

There I was, in my living room, golf club in hand, watching a relatively new program called “Golf Academy” on the Golf Channel. A young Tiger Woods was the guest along with his then-instructor, Butch Harmon. They were discussing Tiger’s swing changes and how they went through them. They had used video analysis of Tiger’s swing and Tiger said something I’ll never forget. Discussing watching his own swing on video, he said, “There is a huge difference between feel and real.”

What Tiger felt like he was doing in his swing and what he was actually doing were two very different things. Keep in mind, this was not some unathletic weekend hacker; this was Tiger Woods. He was already the greatest golfer of his generation and on his way to being, in my opinion, the second greatest golfer of all time. In all likelihood he has more body awareness than most other professional golfers, let alone us mere mortals. Yet there he was, entering the best stretch of golf in his incredible career, admitting that even he doesn’t feel what is really happening.

What a great lesson: feel isn’t real. I’m not even going to address the enormous difference between feel and real in my golf game, but this lesson from golf carries over to investing. We monitor our investment results continuously. We have both the market and our key strategies in front of us all day long when we are in the office. Every morning we review the actual results, and I can’t tell you how many times I have asked that the results be double checked because they are not what I remembered, or should I say felt, from the previous day.

There have been times, although rare, when it turned out we did have some sort of accounting glitch in our system. There is often a delay in our system for dividend payments, and that can impact the daily numbers. However, the vast majority of the time it turns out that I was just wrong, and I have been doing this for 30 years. How could that be?

The fact is that when it comes to investing there are lots of psychological traps into which investors fall. One such trap is called anchoring. The textbook example of this is when an investor looks at a company that is currently selling for $20 per share. The stock of the company then drops to $10 per share, and the investor feels that the stock is now a bargain because the stock price was cut in half. The reality may be very different; perhaps the company was never really worth $20, even if someone was once willing to pay that amount. Perhaps it should be selling for $5. Locking onto the price at one moment in time can lead to all kinds of mistakes.

I tend to fall into that trap because on most days the relative results of our actual investments compared to the market do not change. In other words, when the market opens at 9:30 a.m. Eastern Time and all stocks trade for the first time that day, I look closely at our investments. Let’s just say that on this particular day the market opens up 0.20 percent, and our investments open up 0.50 percent. In this example we are outperforming the market by 0.30 percent. That relationship usually holds for the rest of the day, no matter what the market does from there. So, if the market ends up 1 percent, I would expect our investments to be up 1.3 percent, and if the market ends up down 0.10 percent, I would expect us to be up 0.20 percent. The 0.30 difference remains the same. Unfortunately, this is also true on days we underperform.

I am conditioned to this because for the vast majority of my career this relationship has held true, but it isn’t universal. Some days the relative action will change. Our differential will grow or shrink as the day goes on, and those tend to be the days when my feelings on the portfolio do not match the reality of the portfolio.

An even larger trap is the trap of confirmation bias. I once got into an argument with someone about the wisdom of reducing the national debt. This was right after the financial crisis of 2008 and the economy was weak. While I believe we should be concerned about the size of our national dept, I also felt that it was not a good time to prioritize it. Too many people needed help. He sent me a paper written by two Harvard economists and highlighted a sentence which warned of the dangers of too much debt. The message was something along the lines of, “take that.” He had evidently failed to read the very next sentence in which the economists went on to say that now was not the time. He was not reading economic research papers in order to gain deeper understanding; he was simply looking for confirmation of his feelings.

One needs to go no further than social media to see confirmation bias in full force, as our more political friends (regardless of uniform) will cherry-pick data all day long “proving” their feelings to be correct and those other people to be not only wrong but evil. Feel is not real, and this is not a political newsletter. As investors we can fall in love with a company and when we do, we are in danger of seeing only positive data. We can also feel the market should go in a certain direction based on economics or politics or who wins the Super Bowl (don’t believe that one? Google it). Then we look only for confirming signs, even when other data may point a different direction.

This can lead to another trap known as information bias. This occurs when our feelings are driven by information that may very well be correct and complete but has no actual bearing on investment decisions. Nothing is cheaper or more prevalent today than information, but most information is useless. Understanding the difference between real news and useless noise is actually one of the most important distinctions between professional investors and lay people. My personal favorite in this category is when the financial media has “Breaking News” along the lines of, “The market today is at its lowest point since last Thursday!” Oh my, panic and run, but take your smart phone so you can keep watching.

Think I’m teasing? Watch CNBC for a week and I guarantee there will be at least two such messages. This leads to two simultaneous traps. First, this is completely useless information. The media fixates on the price level of the market because it is the easiest and fastest- changing piece of data to discuss. However, it is useless when it comes to making prudent investment decisions because we don’t invest in the market; we invest in specific companies, and while their price is certainly a factor, even then it is not usually the most important factor.

Secondly, we are once again anchoring. What was so impactful about last Thursday? Why is that the benchmark for the level of the market? Of course, the media don’t care if you fall into a psychological trap and lose money; they only care about you watching the channel or clicking on that news alert.

Perhaps the most dangerous trap is the trap of loss aversion. Investors hate taking a loss. I was once sitting in a bar in O’Hare Airport getting a quick dinner before boarding my next flight and the gentleman next to me asked what I did for a living. When I told him, as is often the case he decided to impress me with his investing acumen. He said what he did was invest in stocks and if they went down, he would simply hold on until they got back to the price he paid and then he would sell. On the other hand, if they went up, he would sell immediately locking in his gain.

That is textbook loss aversion. Loss aversion is not the same as risk aversion. The latter is a rational idea that one should avoid unnecessary risk whenever possible. Loss aversion has more to do with the psychological need to be correct. The idea here is that realizing a loss on an investment is admitting a mistake and that does not feel good. The flip side leads to realizing profits quickly so that one can prove he was correct.

While this may make an investor feel smart (the gentleman at the bar certainly felt he was brilliant), it is in reality quite dumb. By quickly selling winners and holding onto the losers this investor ends up with a portfolio full of losers. Professionals attempt to do the very opposite: cut losses rapidly and let one’s winners run. It may not feel as good, but the reality will be much better.

This year we have been exploring a theme in our Perspectives blog: If one cares about people, then one has to care about the result of policy and not just the intention of policy. In other words, one must care about real more than she cares about feel. Economically many policies feel good that in reality deliver increased suffering. There are also times when a policy that feels cold may lead to the best outcome.

So how do investors and policymakers guard against psychological traps that make us feel good while doing bad? In her book, “Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts,” professional poker player Annie Duke describes many psychological traps into which poker players fall. She admits that she falls into them herself and comes to an interesting conclusion: psychological traps cannot be avoided. We are human beings, and our brains work like everyone else’s. I have already admitted to anchoring, guilty as charged. Do you think we like telling our clients we are realizing a loss because we were wrong? Nope, we have egos just like that guy in the bar.

Confirmation bias is just human. We all do it. These traps cannot be avoided. However, as Ms. Duke points out in her book, what we can do is be aware of them. Knowing that we are human and subject to all the human psychological traps can help us remain humble and self- aware. We can’t avoid the traps, but we can recognize when we are in one and think our way out of it.

We can constantly force ourselves to face reality. As professionals we are always measuring our portfolios. We run different types of analyses that force us to be honest with ourselves. Measuring the real results puts our feelings in perspective. We also rely on process; we have an investment philosophy that governs the big picture. We create specific strategies that are consistent with that philosophy and allow us to address client needs. We then create a process by which we implement these strategies. Process is key because it takes feeling out of the equation. We know the process works because it has been tested and we trust it.

We analyze results and determine if tweaks need to be made to the process, but we do not go on feelings. Tiger Woods was also unable to will his feelings into matching reality; he simply had to accept that the correct motion did not come from what he thought was the correct feeling. Not even he could change what he felt, but he could become aware that feel and real were not the same thing. That understanding, combined with immense talent and an unrelenting work ethic, made him the second greatest golfer of all time.

Likewise, we cannot re-wire ourselves to avoid our feelings, but we can become self-aware. We can recognize a trap when we fall into it and develop a process to get ourselves back out. That is the key to having a successful investing reality.

Warm regards,

Chuck Osborne, CFA, Managing Director

~Feel vs. Real

Several weeks ago I was talking to our research director, Michael Smith. We talk all the time of course, and most of those conversations relate to the market, our clients, and the investments held in our client’s portfolios, as well as new ideas for future investment opportunities. To be more accurate, that is how most of our conversations begin; they usually end by philosophically solving one or more of our world’s problems before one of us finally says, “We have to get back to work.” These world problems could range anywhere from how Alabama will get back to playing the stiff defense for which their football team was known (Michael is a big Alabama fan), to solving the riddle that is our healthcare system, and myriad topics in between.

This particular day our conversation somehow turned to the topic of laziness. To be honest I’m not sure what turns the rabbit hole took to get us there, but it was a fruitful conversation. Sloth, after all, is one of the seven deadly sins according to Catholic teaching, and it is certainly worthy of inclusion in that list; yet it is often overshadowed by the more flashy sins like greed and wrath, which get all the glory. Nothing is more indicative of our modern society than seeing someone full of wrath over someone else’s greed.

Milton Friedman once said, “Of course, none of us are greedy, it’s only the other fellow who’s greedy.” We hear the greed thing all of the time because of our chosen profession, as investing and the accusation of greed seemingly go hand in hand. The 2008 financial crisis is a great example of this phenomenon. Books were written and movies made, and all of them had one big theme: greed was the root of the crisis. As I pointed out at the time, to believe that means that for years and years investors were not greedy and then all of a sudden became greedy, which is, of course, ridiculous. Greed could not have caused the financial crisis – not because it doesn’t exist, but because it always exists. If greedy investing decisions led to crisis, then we would always be in crisis.

The truth is that sloth had far more to do with the financial crisis than greed. Analysts got lazy. They stopped doing their jobs and were asleep at the switch. Bankers were not doing proper due diligence on mortgages they were underwriting as they figured the investors who actually provide the funds would let them know if a mortgage was too risky. Instead of thinking about what they were doing, they simply checked the box. In other words, they were slothful.

The rating agencies were slothful as well. Instead of doing real due diligence, they just assumed the bankers were doing their jobs. These securities are made up of mortgages, which are safe. They believed that a banker wouldn’t underwrite a mortgage that wasn’t safe: Check the box and rate them AAA.

Investors were slothful. Analyze the securities? Dig down into the actual mortgages themselves? The rating agencies said they are AAA, and look at the yield! What more would one need to know? Check the box, AAA security with relatively high yield: sold.

The regulators were slothful. What was there to be concerned about? They were meeting their social goal of housing for everyone: check. Banks appeared to be strong: check. After all, they had forced the banks to invest their reserves in AAA securities, so what could go wrong?

Things had been good for almost 30 years once we had gotten off the disastrous economic path of the late 1960s and 1970s and started heading in the right direction. People had gotten lazy at every level of the system. Sloth, not greed, caused the financial crisis.

Then there was the reaction: Pundits and the media all took one look and said, “This is Wall Street, it must be because they are greedy.” All they had to do for “proof” was to find a few juicy anecdotal stories of greedy idiots, and on Wall Street those stories are never hard to find. It is a low bar, but the media whose propaganda framed the narrative may very well have been the most slothful cog in the whole wheel. Why break a sweat trying to find out what actually happened when all you have to do is write the words “Wall Street Greed” to generate clicks and likes and shares?

Sloth was everywhere in 2008 and it is still with us today. Most obviously we see it with people being slow to come back to work, which has been the big story this quarter. We were undergoing a strong recovery from the reaction to the pandemic, and then we got hit by two bad jobs reports in a row. The unemployment rate actually rose at one point. People don’t want to work, and if they don’t have to because they are making more by staying on the dole, as they used to say, then they won’t. I want to be very clear: there is absolutely no judgment in that statement, it is simply a fact. It would be slothful of me to point my finger and say, “Look how lazy those folks are.” No; the reason sloth is among the Catholic deadly sins, and is a theme in every other religion and philosophy through the history of humankind, is because it is part of the human condition. It is in every single one of us. Some may be better at overcoming it than others, but we all suffer from it.

People are complicated, so an individual may show great discipline and drive in one area of her life and still be slothful about other things. I once knew a very disciplined person who competed at a high level in triathlons. She hated doing laundry and often lived out of her laundry basket to avoid having to fold her clothes when they came out of the dryer. When it came to training and competing she was extremely disciplined, but when the subject changed to laundry, one would have a hard time finding someone lazier.

Highly successful people who are frankly lazy about their own investments are Iron Capital’s bread and butter. I am thankful they exist, otherwise I would have to find another way to make a living. Many of our clients will tell us that they rely on us because they don’t have the desire or the time to do it themselves. One really can’t be disciplined in every aspect of life because there are only 24 hours in a day. Somewhere, outsourcing is necessary.

Often today that laziness manifests in how we get our news and decide what to believe. A prime example from recent history is the Wuhan virus origination story. The New York Times recently admitted that they rejected the Wuhan lab-leak theory largely out of groupthink and partisan polarization, because it was being pushed by people they did not like. To disagree with a statement or idea simply because one does not align with the person or organization offering it is the epidemy of sloth, yet we see it all the time and from people we would never describe as slothful.

This brings me back to Michael’s and my conversations. We must get back to work. Our job is to invest our clients’ money, and our own tendency toward sloth must be overcome. We believe that prudent investing has three attributes: it is done from the bottom-up, it is absolute return-oriented, and it is risk-averse. Each one of those attributes takes discipline.

However, we can also fall into the trap of just checking a box. Good investments are always found bottom-up in our opinion, yet that does not mean one can just ignore what is happening. A tobacco company may look fantastic in isolation and may very well be fantastic for an investor seeking income, but there is no growth to be had in that industry. When analyzing a company from the bottom-up one cannot be lazy and ignore the realities of what is happening in the big picture.

We believe strongly in an absolute return orientation. The grass being greener over there is the death knell for most lay investors who always chase after the highest returns. However, if one gets lazy she can use this as an excuse to ignore investing mistakes which may have caused underperformance.

Investors must be risk-averse as it is defense which wins championships, but many in our industry use this as a lazy excuse to accept lower returns in low yielding “safe” investments. They forget that market volatility is only one form of risk, and in reality the least important. The risk of outliving one’s money is far more dangerous than a simple market correction.

The greatest example of sloth is the tendency to see what one wants to see, believe what one wants to believe, and accept only facts one wants to accept. In investing this means one who believes the market is always wrong will just go counter to the market, while one who believes it is always right will go with the market. Both are forms of sloth, and both are wrong. An investor always has to do her work and think through her investments. There is never just one simple cause for everything. There is always another point of view, and prudent investors must have the discipline to see that. This means fighting their own biases. A disciplined investor is not without sloth; he is simply aware of his unique tendency toward sloth and therefore able to fight it.

It would be easy to say that the lazy investor hides in index funds, follows trends, and invests in what is popular. To a large degree this is true; however, there may be times when the index makes sense. Fighting the popular trend just to be contrarian can be just as lazy. The key to overcoming one’s own sloth is to understand it. What form does it take? A prudent investor must always be questioning himself. I used to work with a senior marketing person who loved to say that he was, “often wrong but never in doubt.” I would respond, “I’m always in doubt, which is why I’m seldom wrong.”

We would laugh and then go down some rabbit hole conversation until one of us would say, “It is time to get back to work.”

Warm regards,

Chuck Osborne
CFA, Managing Director

~Sloth

I am a proud member of the “Seinfeld” generation. We can communicate in short, seemingly meaningless phrases, and we know exactly what the other person means because of the cultural phenomenon that was the “Seinfeld” TV sitcom. One such phrase is, “No Soup for You!”

A New York City chef had opened a restaurant specializing in soup, which he served himself. The only issue was that the customer had to order the soup in a specific manner. If the customer got it wrong and upset the chef, then it was, “No soup for you!” He got away with this behavior because his soup was that good. Well, Jerry and his friends came to enjoy the soup and hilarity ensued. The bit was so funny that it went on for multiple episodes. The chef was known as the “Soup Nazi.”

At Iron Capital we are often asked, “What is your minimum?” The answer to that question is technically $1 million, but we are allowed to make exceptions, and we usually respond by telling the prospective client that we have never turned anyone away because of a lack of assets. The reason is very simple: We do not view our clients as dollar signs. This is one of my pet peeves about our business. Several years ago we tried having salespeople. We hired experienced staff from our industry. When they uncovered a promising new prospect and came to tell me about it, they would habitually started with, “She has $X in her portfolio.”

I would always tell them that I didn’t care about that; what I wanted to know is, who is this prospective client? Why is she interested in working with us, who referred her, and what is she looking for in an advisor? I wanted to know about the person, but the sales mentality went immediately to the dollars.

It was not their fault. They had all come from the industry, and this is how our industry works. In the industry people think nothing of asking, “What are your assets under management?” I understand what they mean, but the truth is Iron Capital, like every other firm out there, has no assets under management. Our clients collectively have more than $5 billion that they have entrusted to us to advise or manage, but not a dime of that belongs to Iron Capital. Those assets belong to our clients, who have largely entrusted us with the bulk of their assets, which they rely upon to provide for their various financial goals.

We tell our staff all the time: It does not matter how small a portfolio may be compared to others we manage, it is all the money in the world to that client, and he is just as important as every other client. Our responsibility to him is just as great – and perhaps even greater because he has less of a margin for error. This is our culture and it is why, for several years now, we have no salespeople. We are entirely referral-only, so people must come to us, as we have no one whose job it is to seek them out.

Once a prospective client understands that we are not concerned with their level of wealth, they usually ask the next logical question: “So have you turned people away for other reasons?” The answer is yes. If we feel that a prospective client is not a fit with us culturally, then we will politely tell them that we do not believe this is a fit, and we wish them the best of luck.

That is right – sometimes we say, “No soup for you!” (Much more kindly, to be clear.) Why would we do that? It is not because we are some form of financial advice Nazis; it actually has to do with the fact that we have no salespeople and we do not make any effort to seek out new clients in the first place.

When people from the industry hear that we don’t market ourselves to new clients, at first they often just don’t believe it because, to my knowledge, it is completely unique. They will ask, Aren’t you concerned with growth? Of course I am – people, plants and firms are all either growing or decaying. Growth is necessary for life; this is something the capitalism-haters simply do not understand, but that is a topic for another day.

Iron Capital is a living, breathing firm, and it must grow so that its employees can grow. People need raises, healthcare costs rise – everything is always going up, so we as a firm must grow as well. How do we do so if we don’t have salespeople? We rely on our clients. I have always believed that if we take care of our clients, then they will take care of us. So we focus entirely on taking care of our clients.

How do I get everyone on board with this strategy? I compare it to the Spanish conquistador Cortez, who famously burned his ships upon arriving in the New World so they had no choice but to conquer and settle the land. His men’s brutality is legendary. We don’t want brutal at Iron Capital, but I basically tell our employees that relying on a sales staff for their own raises is not an option. If they want to grow in their careers here, they will take care of our clients or go work somewhere else. Our investment professionals must grow the portfolios we actually manage, and our service professionals must take care of the clients, because we are not getting new ones.

That is not exactly true. We get more than enough new clients; they all simply come from our existing clients. This only happens because we are laser-focused on keeping and growing our existing client relationships, which is exactly why we don’t take every single client who comes our way. Don’t get me wrong, it isn’t like we turn down all that many, but it does happen.

Our clients understand that we are firm believers in what we call prudent investing. We invest from the bottom-up; we are absolute return-oriented; and we are risk-averse. Our clients understand this, and most of the time this is exactly what their friends want when clients refer them to us. However, we also will get random calls from someone who read about us or saw our name on a list of successful firms. Nine times out of ten these cold prospects start by asking questions that send up red flags, like, “What have your returns been?” And they often start by telling me how much money they have when I ask about them.

These individuals have unfortunately been conditioned by the industry to believe in competitive investing. Most of the time, this would be good for us; we know what we are doing, yet there is no investment strategy that is always successful in the short run, and there is no long-term success without a consistent strategy. I’m not saying that our way is the only way, but one has to pick a way and stick to it. These clients would be our new clients this year and someone else’s new clients next year. Why do we care? Why wouldn’t we just be happy collecting our fee for a year?

Because of you. The time spent on these kinds of clients is time that we can’t spend taking care of our real clients. Then, when they leave, their new adviser will likely sell everything we put in their portfolio, which means they will be selling many of the investments that are in your portfolio. We don’t want that.

So yes, we are selective, but it is not because we are arrogant or believe that only a certain kind of person deserves our help. We are not the investment world’s Soup Nazi; however, if we believe a new relationship will hurt our existing relationships, then it is, “No soup for you!”

Warm regards,

Chuck Osborne, CFA
Managing Director

~No Soup for You!

A few years ago I was sitting in church paying close attention to the minister’s sermon when he mentioned that Henry Ford had invented the automobile. He lost me right then and there, because for the rest of the sermon I kept wanting to shout out, “Henry Ford did not invent the automobile!” I kept looking around and thinking, “Certainly these people know that Henry Ford did not invent the automobile.”

The automobile, like most inventions, evolved. Stating clearly who really invented it is difficult; however, most give credit to Karl Benz, who made the first car with a gasoline-powered internal combustion engine. His car had three wheels. Shortly afterward, Gottlieb Wilhelm Daimler created the first four- wheeled automobile. Both men were German, and, of course, they eventually formed Daimler-Benz, which continues to make the Mercedes Benz to this day.

Why the confusion? I believe it comes from a lack of understanding of capitalism itself and, in particular, capitalistic innovation. To understand what I mean, we need to look at what Henry Ford actually did invent: Henry Ford invented the assembly line, which is a far more capitalistic invention.

What do I mean by that? Henry Ford took an invention which, until that point in history was available only to the very wealthy, and found a way to produce it at a cost that all of his workers could afford to pay. This is precisely what capitalism does: it finds ways to provide the masses access to luxuries that were once available only to a select few.

There was a second part to that: He paid his employees enough to be able to purchase a Model T. This is also part of capitalism. In thirty years of business, I have yet to meet a successful businessperson who did not feel passionately about taking care of his or her employees. This is not to say I have not met such people; I have, and invariably they are the ones whose business is constantly struggling. One of my old bosses used to say, “Our most valuable asset goes down the elevator every night.” Human beings only work well for someone who actually cares about them. The world is full of middle managers that do not understand this basic principle, which is why they will never be more than a middle manager.

The image today of capitalism is one of oppressed workers and an owner class that wants to raise prices in order to maximize profits for themselves. This image is one of pure ignorance. It comes from people who have no understanding, and frankly do not want to have an understanding. They shout down anyone who dares to say, “Look at the facts.”

Having said that, the image of capitalism is not completely negative. People believe that capitalism leads to invention, and this is also not really the case. It is far more accurate to say that capitalism leads to innovation, and there is a huge difference. Innovation involves items that have already been invented; it finds new ways to use them or make them. It does not create something new out of nothing.

The late Clayton Christensen was a Harvard Business School professor and the pioneer of the concept of disruptive innovation. Ford’s Model T and the assembly line that made it possible is a perfect example. The automobile industry had been around for 30 years when Ford launched the Model T in 1908. His innovation was not a better car, but a car that was affordable to those who previously could not afford a car.

Christensen argued that a disruptive innovation was an innovation that created a product that was not as good as existing products, but good enough and a fraction of the cost. The Model T was not a better car; it was an affordable car. Fast forward 70 so years and a young Bill Gates started a company with a mission. His mission was not to become the wealthiest person on the planet, although he did end up holding that title for a while. His mission was to put a personal computer in the home of every American.

Those early computers, running the Microsoft DOS operating system, were not anywhere near as powerful as the mainframes that technology professionals had access to, but they did what most people needed at a fraction of the cost. They kept improving and improving until one day a man name Steve Jobs said we can put a PC in the pocket of every American.

Those phones and tablets were not as powerful as the desktops of the time, but they did what was needed at a lower cost, and we could have them with us everywhere we went. Disruptive innovation – that is what capitalism actually does.

Perhaps the best example in recent years is Roku. For those who are not familiar, Roku is a service that is installed on some televisions, or one can buy an add-on device, which allows for easier access to programing that is streamed over the internet instead of the traditional cable TV system. In other words, it allows one to “cut the cord.” We did this in our house about four years ago.

Streaming, whether through Roku, Apple TV, or other such device, was not as good as having cable. It did not offer the hundreds of channels or the guide or the ease of recording shows that our state-of-the-art cable service provided. However, we could get just about every channel we actually ever watched with the flexibility to change plans monthly, and with streaming content, the need to record things on our own devices was pretty much gone. In other words, it wasn’t quite as good, but it was good enough, and it saved us considerable money.

This is the power of capitalism: It is a constant process of making the luxuries of our time more accessible. So why does capitalism get such a bad reputation? Where do the critics go wrong? There is confusion, especially in politics, between capitalism and business. Disruptive innovation, the life blood of capitalism, does not come from big established companies. In fact, disruptive innovation destroys big established companies.

Most successful businesses start out as innovators, or copycats, but either way they are providing consumers with something of value that was either unavailable or really expensive until that point. Then they grow. Then they start to slowly lose the ability to innovate. Then they start to listen less and less to their customers and more and more to Wall Street analysts.

Then the death knell rings: As their business matures and starts to slow down, they hire consultants – young, intelligent, ivy league-educated people who have never actually done anything in their lives, who are now going to tell these seasoned businesspeople how to run their company. This is when a switch is flipped. The company that was all for free markets before suddenly thinks regulation is a good idea.

Don’t believe me? These very words came out of Mark Zuckerberg’s mouth just a few months ago. “From what I’ve learned, I believe we need new regulation….” Of course he does. Zuckerberg is no longer a capitalist; he has become the owner of an established big corporation, and innovation is now a threat. The greatest protection from innovation? That would be regulation.

In economics we call this rent- seeking. Any regulation of social media would have a marginal impact on most of us, but an enormous impact on companies like Facebook. This provides social media companies with a strong incentive to lobby for favorable regulation while the rest of us have little incentive to do anything. Regulation usually enshrines the status quo and makes it very difficult for potential competitors. That hurts capitalism, but helps business.

The most extreme examples today would be in places like Russia. Putin is certainly no free market advocate, but he loves the oil business. He is all for Russian oil interests, and running an oil company is a great gig in Russia, as long as you remember who the real boss is. As I write this Jack Ma, the founder of Chinese technology giant Alibaba, is missing. In late October he made some public comments that were less than flattering towards the Chinese regulators. He has not been seen in public since. China loves big business – the jobs they provide, the income to the state – but they have soured toward capitalism over the last several years. Too much freedom.

Innovation requires freedom, which, in the end, is what capitalism actually means. As Milton Friedman said, “Underlying most arguments against the free market is a lack of belief in freedom itself.” Especially the freedom to earn a profit. Profit is a bad word; it is associated with greed and the cutting of corners. This is only really true if profit becomes the purpose of the business. This, unfortunately in my opinion, is often taught in business schools: “The purpose of a corporation is to increase shareholder profits.”

That is just wrong. Profit is an absolute necessity of survival, and that is true whether we are talking about corporations, individuals, or charities. Every entity must spend less than they bring in if they wish to be sustainable, and spending less than what is brought in is the definition of showing a profit. Being profitable is a necessity of business, but it is not the purpose. Innovators are people of vision, and their desires are far loftier than money.

Henry Ford wanted every American to have a car. He was a businessman, and he knew a profit was necessary for survival, but his purpose was to build cars that everyday Americans could afford. Bill Gates wanted to put a PC in the home of every American. Jeff Bezos has ignored profitability perhaps more audaciously than any business leader of our time while building an empire at Amazon. Great companies all have a higher purpose. There is a move a foot today for so-called “stakeholder capitalism,” which means running a business for more than just the shareholders. My take on this is that it is much to do about nothing, because all truly great businesses have always cared for employees, their communities, and the world around them. One cannot be successful for any period of time without caring about these things.

Only in the classroom does business care only about shareholders, or to be more accurate, only in the classroom does caring for shareholders not include taking care of employees and the community, etc. Businesses that do not do these things do not stay in business, and nothing destroys shareholder value like going out of business.

Henry Ford did not invent the car; what he invented was so much more important than that. He showed the way for Bill Gates, who did not invent the computer, and Steve Jobs, who did not invent the cell phone, and Jeff Bezos, who did not invent the internet. The disruptive innovation of capitalism has improved the lives of the masses in too many ways to count. We need to think about that when people start vilifying and calling for change without even understanding what Henry Ford actually invented.

Warm regards,

Chuck Osborne, CFA
Managing Director

~Henry Ford Did Not Invent The Automobile