Seth Klarman on productive worrying

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From an email Whitney tilson sent to investors

I think this excerpt from Seth Klarman’s 2004 annual letter is very timely:


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Oddly, risk moves to the forefront of investor consciousness only when things are already going badly. Losing money is perhaps the only thing that makes most investors worry about losing money. With so much pressure for competitive short-term performance, worrying about what can go wrong may seem like a luxury. Ironically, when almost no one is focused on the downside, even a minor increase in investor perception of risk can trigger dramatic market declines.


While we believe it is crucial to worry about what can go wrong, unproductive worrying will not and cannot make a difference. Worrying that your favorite team will lose is obviously unproductive. Worrying that you might have an ulcer could even prove counterproductive. Productive worrying, on the other hand, enables you to identify action that reduces or eliminates the source of concern, often at little or no cost. Concerned that it might rain? Pack a raincoat and umbrella. Worried you will be late? Leave earlier than originally planned.


Successful investing goes hand in hand with productive worrying. Worried that a stock you hold might fall sharply? Reduce your holdings or buy some puts. Concerned that interest rates may rise or the dollar fall? Establish an appropriate hedge. Worried that the stock you bought on a tip might be a bad idea? Sell it and move on. Worry enough during the day and you can, in fact, sleep justifiably well at night.


All of us are subject to biases that can impair our objectivity in investment decision-making. Striving to overcome these biases is crucial for long-term investment success. Have we been too optimistic in our assumptions? Have we blindly ignored new information because we are clinging too tightly to our original thesis? Have we held onto an investment because it keeps going up, irrationally ignoring that it has become overvalued? Without a healthy dose of reflective worry, we are unlikely even to identify our lapses in judgment, let alone correct them. In other words, only by actively, productively, relentlessly worrying about what can go wrong can we maximize the odds that things will go right, by doing everything within our control to perfect our decision-making. You rarely, if ever, make money from worrying; it does not typically enhance return. But by avoiding loss, you are able to hang on to what you have accumulated, which is a cornerstone of successful investing.


2) I’m definitely seeing this:

Investors are giving up on stock picking.

Pension funds, endowments, 401(k) retirement plans and retail investors are flooding into passive investment funds, which run on autopilot by tracking an index. Stock pickers, archetypes of 20th century Wall Street, are being pushed to the margins.

Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds, according to Morningstar Inc.

Advocates of passive funds have long cited their superior performance over time, lower fees and simplicity. Today, that credo has been effectively institutionalized, with government regulators, plaintiffs' lawyers and performance data pushing investors away from active stock picking.

In developed markets, “the pressure has gotten so great that passive has become the default,” said Philip Bullen, a former chief investment officer at active-management powerhouse Fidelity Investments. He and others say active management can succeed with less widely traded assets.

The upheaval is shaking Wall Street.

Hedge-fund managers, the quintessential active investors, are facing mounting withdrawals as they struggle to justify their fees. Hedge funds, which bet on and against stocks and markets world-wide and generally have higher fees than mutual funds, haven’t outperformed the U.S. stock market as a group since 2008.

Some giants of passive investing, such as Vanguard Group and BlackRock Inc., are attracting lots of money and gaining clout in shareholder votes at public companies.

Although 66% of mutual-fund and exchange-traded-fund assets are still actively invested, Morningstar says, those numbers are down from 84% 10 years ago and are shrinking fast.

It feeds on itself in two ways: a) when money is redeemed from active managers, they have to sell stocks they own, depressing their prices and hurting their own performance as well as that of other active managers who own the same stocks; and b) as more money shifts to indexing, it pushes up the biggest stocks in the indices (which active managers tend to own less of), further widening the performance gap.


Possible lessons: 1) maybe own a few big-caps like GE (which I owned until recently), if they’re cheap; 2) stay away from hedge fund hotels; 3) beware of shorting stocks that index funds are likely to be buying.


3) Another article about the shift to passive investing:

Steve Edmundson has no co-workers, rarely takes meetings and often eats leftovers at his desk. With that dynamic workday, the investment chief for the Nevada Public Employees’ Retirement System is out-earning pension funds that have hundreds on staff.

His daily trading strategy: Do as little as possible, usually nothing.

The Nevada system’s stocks and bonds are all in low-cost funds that mimic indexes. Mr. Edmundson may make one change to the portfolio a year.

News doesn’t matter much.

Will the 2016 elections affect his portfolio? “No.”

Oil prices? “No.”

He follows Fed Chairwoman Janet Yellen , but “there’s a difference between watching and acting.”

Mr. Edmundson, 44 years old, has until recently been a pension-world outlier. Other state retirement systems turned to complicated investments and costly money managers to try to outperform markets with algorithms and smarts.

His strategy is to keep costs low and not try beating markets, he says. “We’re bare bones.”

4) The more reporters and investigators dig, the more horrific things they discover at Well Fargo. I hope they do so at other banks, because I’m certain that Wells wasn’t alone in taking advantage of its customers (hopefully what’s happened to Wells will cause other banks to proactively take steps to clean up their acts):

Mexican immigrants who speak little English. Older adults with memory problems. College students opening their first bank accounts. Small-business owners with several lines of credit.

These were some of the customers whom bankers at Wells Fargo, trying to meet steep sales goals and avoid being fired, targeted for unauthorized or unnecessary accounts, according to legal filings and statements from former bank employees.

“The analogy I use was that it was like lions hunting zebras,” said Kevin Pham, a former Wells Fargo employee in San Jose, Calif., who saw it happening at the branch where he worked. “They would look for the weakest, the ones that would put up the least resistance.”

Wells Fargo would like to close the chapter on the sham account scandal, saying it has changed its policies, replaced its chief executive and refunded $2.6 million to customers. But lawmakers and regulators say they will not let it go that quickly, and emerging evidence that some victims were among the bank’s most vulnerable customers has given them fresh ammunition.

5) These interviews with former Wells employees are really shocking. Here’s the first of five in the article below:

Actions that I was forced to do as a banker included:

1). Opening travel checking accounts for customers by convincing them that it was unsafe to travel without a separate checking account and debit card;

2). Coercing customers to open credit card accounts to use as overdraft protection for their checking accounts when they were already struggling to keep their checking accounts balanced;

3). Witnessing other bankers and being pressured by management to add credit defense onto new credit applications without the customer’s knowledge, which led to unnecessary monthly fees;

4). Closing and opening new accounts for customers by convincing them that there had been fraud on their existing accounts.

I started to have extreme physical stress-related symptoms as well as random panic attacks. At some point during that summer, the stress was so intense that I could no longer handle the pressure. On the banker’s desk, in the bathroom, behind the teller line and in the vault, the store kept bottles of hand sanitizer.

One morning, before meeting with a customer, in which I knew I was going to have to sell unneeded services, I had a severe panic attack. I went to the bathroom and took a drink of some hand sanitizer.

This immediately reduced my anxiety. From that point, I began drinking the hand sanitizer all over the bank.

In late November 2012, I was completely addicted to hand sanitizer and drinking at least a bottle a day during my workday. In December, I was confronted by management about my behavior. I decided to seek treatment and went on leave.

The recent news stories have reactivated my memories and P.T.S.D. I am now having nightmares and flashbacks of that time period. It is horrible.

6) What a total failure by regulators:

Dan Graves, a mental health aide in San Jose, Calif., had mixed feelings when he heard that ITT Educational Services had filed for bankruptcy in mid-September.

As a former employee who had blown the whistle on ITT, an operator of some 140 for-profit schools, Mr. Graves was happy that the government had finally taken action to protect students from the company’s aggressive sales tactics, which lured them into debilitating debt and provided little in the way of an education.

Still, he wondered what had taken the government so long. After all, it has been 17 years since Mr. Graves and another former ITT employee brought a suit alleging that the company had systematically violated the law governing compensation of sales representatives.

The two former employees shared extensive documentation with a half-dozen federal prosecutors and regulators. These officials expressed keen interest, Mr. Graves said, and estimated that the government could recover $400 million in damages from the case. But by 2004, the lawsuit was dead and Mr. Graves’s effort to provide the government with damning evidence had come to naught.

“We thought we had a pretty good case,” Mr. Graves, 65, said in a recent interview. “They were abusing that system for years and ripping off the government for billions of dollars and we brought that to light.”

7) A friend asked me to send this around:


West Coast fundamental, bottom-up investment manager firm looking to hire an equity investment analyst. If interested, send your resume along with answers to the following three questions to [email protected]


  1. Investors should presumably get better at their craft over time as they gain more experience. If this is true, why aren’t all the best investors in their 50s+?


  1. How do you think about valuation?


  1. If you were in our shoes, what question would you ask in this slot? And how would you answer it?


PS—This is my first email in a while in which I didn’t include any articles about Con Man Don. No need anymore. I will simply say that: 1) I’m breathing a huge sigh of relief that this despicable madman/con man isn’t going to become the most powerful man on earth (in fact, I suspect he’s on well-deserved road to ruin); 2) I took many slings and arrows by being early and loud about the dangers he posed, so it feels good now that everything I said about him has been proven correct; and 3) I’ve never been a huge Hillary fan, but she’s growing on me. I think it’s likely that she’ll be a good President – maybe even a great one.


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