What We Learned On Our Way To Our Publisher

WHAT WE LEARNED ON THE WAY TO OUR PUBLISHER By Wayne H. Wagner and Ralph A. Rieves During a sunny 2007 spring week in New York, we attended two different investment conferences. Inside the halls of each conference the outlooks were equally sunny. Surprising to us because earlier that spring both Wanen

What follows are some of what we leamed or were reminded about as we worked on the book.

1.

We Need to Be Cool

Buffet and the late Peter L. Bemstein had commented about the astonishing perceptions of low risk embedded in

asset prices. We were surprised that the opinions of these two sages weren't addressed from he podiums at either conference. Moreover, hardly anyone mentioned these alanning articles in any of the informal sessions.

We found these cursory responses to the well reasoned concems of Buffet and Bemstein perplexing: "What are most of these people thinking about if they're ignoring the concems of two of the brightest minds in fte business?" The answer was given to us later in the week by two other experienced and successful observens of the business. Summarized, the answer was: 'Nof a hell of a lot ... and ffie consequen@s are goingto be ugly.' Later in the month, we leamed that this concem was shared by offier people whose opinions we had leamed to appreciate. They had eamed our appreciation by their habit of thinking about their thinking. They viewed asset management as an everchanging series of challenges encountered among all the elements and playens in the

global capital madtets. They identified the challenges, reflected on them, assessed the attendant risks and then made decisions they and their clients could live by. During the summel we found ourselves engaged in

discussing this 'state of the business" with trustees, academics, and regulatorc. Some of them encouraged us to undertake a book. Soon after, we had recruited some of those whose work we appreciated to contribute to the

book.

We build our mindsets, models and our reputations on our experience. But our experience can never cover all the possible situations that may occur. As Bemstein wisely wamed, 'Being wrong on occasion is a disagreeable reality.' The situation is particularly disagreeable when it challenges our rationality and exposes the deep emotions that arise while sailing in uncharted watem. Thus, there is no such being as a totally rational client, and therc will never be a portfolio manager who can continually ouperform the market. These systemic or macro economic disruptions force us to reexamine our core assumptions. For example, we leam that statistical distributions are not always 'normal" and our faith in slatistical certainties may be misplaed. We leamed that the covariances we measure may become unstable just when we rely on them the most. We may need to slow down the tempo to guard against kneejerk reactions such as finger pointing, panic selling, or (spare us all) another rush to more regulation.

2.

We Need to Retain a Sense of History

Markets get out of balance, and we quickly forget that the record shows they seem to go crazy every few years. Publicly traded companies emerge and disappear. Smart people occasionally will be wrong, very wrcng. The story of the wodd is full of unexpected instances, both fortuitous and calamitous. A heightened sense of perspective might be the best attribute we can have.

By that Fall things had definitely tumed "ugly."

The past we grew wise in may or may not replay,

While compiling the book we enhanced

our appreciation of how much the future all of us are striving

for depends on our thinking about the relationships among all playens in the capital markets; as well as reappraising the consequences of astonishing digital velocity. Markets are comprised of people and people will act like people. Regardless of how quickly information is retrieved, it still has consequences which can result frcm the conclusions drawn and the actions taken.

particularly in the short term. We may need to adjust to a "safe mode" in the face of ovenuhelming uncertainty. We dare not lose the capacity to spring into action. Perhaps in ways that are entirely new to us, but that are demanded by the changing environment. Adaptabili$ is the key to survival in economic as well as biological environmental change. We don't know how much we don't know. But what we don't know is always out there, waiting for us.

3.

The Study of Finance ls Interdisciplinary

Much has been written about the behavioralists' influence. Now no one thinks that investment management remains just an amalgam of accounting, statistics, and economics. Moreover the contribution of the behavioral school has extended beyond how invest-

tors make {or don't make) decisions, but into brain science as well. (How much dopamine is activated by a sizable retum on an investment?) The political scientist's had-nosed acknowledgment of inefficiency juxtaposes the economist's predilection for the observable, and the methodology of biology is now being applied to the study of markets as evolving organisms. We see potential for exciting breakthmughs.

4.

Conspiracy theorists may not agree, but we believe that the consequences of being caught Tront running" are severe enough to dissuade attempts to do so, even within the cunent nanosecond time frame. Hence, the continued improvement of tnading systems favons the portfolio managers and their clients over market insidens.

This power shift just may be the most significant change in the history of the capital markets.

The competition among venues has long replaced competition among brokerdealers. Economic rents for market making have come down, activating an ability to resultant transaction costs into better performance. Only thus can portfolio managers justify the

tum the

fees they charge to clients.

lt's All About the Clients

6. lt's lmportant to Manage the Business Too

h

Well, duhl You would surprised (as we were) by how often the focus is not on the only essential element: the multi-dimensional needs of the client. Note that Bemstein and Buffet have never thought of themselves as Masters of the Univene. They are respected because they maintained their humility and their focus on the

clients. Perhaps clients were overcharged by sky-high management fees in too many instances, but this is fte kind of problem that encompasses its own solution, What

concemed us most was the discovery of how little trustees and beneficiaries know about the rudimentary elements of investing. C,aveat Emptor is not an

Managing the enterprise is just as important as managing the p,ortfolios. Hiring, training, and retaining managers, tmden, and support staff who walk the firm's walk and talk its talk is an inestimable competitive advantage. Having everyone on the same page promotes efficiency and client empathy. Rigorous and easily

monitorcd cost controls and compliance systems will assure that less time is spent putting out fires, and more time is spent meeting client needs and growing the business. A key tenet of budgeting should be to assure the maintenance, enhan@ment, and refinement of the

cases. ln loco parentius is appropriate where levels of sophistication are vasily different. The burden is on the trustee leadership and consumer activist groups. We need from them an unending commitment to design and promote an

information systems has first call on the operating funds.

environment which assures that pertinent decisions are made consistent with the Prudent Investment Rule. There .do is ample opportunity for consultants to the right thing".

that which enhanced rctum this moming might not work after lunch. Amorg the many enduring values held by Peter Bemstein was a commitment to lifelong leaming. We agreed with him that what distinguishes proficient investment managerc is that "they think about their

appropriate axiom in many

5. Technology Has Empowered the Buy Side

7. Keep Thinking In a time when capital flows instantly through borders,

thinking.'

Wayne H. Wagner is the lead principal of OMo NI. Ralph A Rieves is the managing director of Farragut, Jones, & Lawrence. They are the editors of Investment Management: Meeting lhe Noble Challenges of Funding Pensions, Deftcits, and Growth I

(WILEY, August 20fi)).