Courtesy of John Nyaradi.
John Nyaradi: Hi everyone, I’m John Nyaradi, publisher of Wall Street Sector Selector, a financial media site specializing in exchange traded funds and global markets. Today, I’m really pleased to welcome our special guest, Mike Dever. Mike, welcome to Wall Street Sector Selector.
Mike Dever: Thank you John.
John Nyaradi: Mike is the author of “Jackass Investing: Don’t Do It, Profit From It.” He’s the founder of Brandywine Asset Management, which is a hedge fund and commodity trading adviser that he started in 1982. His main focus right now is the Brandywine Symphony Fund, which is a globally-diversified portfolio trading in currencies, commodities, equities, interest rates, and metals contracts.
Mike in your book, you expose a number of stock trading myths. Let’s start with myth number one, that stocks provide intrinsic return.
Mike Dever: Most people believe that you simply invest in stocks and they go up and so you’ll make money as if there’s some sort of a magical return to that. But the reality is that every investment has a return driver that powers the returns of that investment.
And with stocks, the primary return drivers are made up of corporate earnings growth and enthusiasm, but the most interesting result of our research was that the primary return driver, the dominant return driver in periods of less than 20 years, is the enthusiasm people have for stocks, the expansion or the contraction of the price earnings ratio.
John Nyaradi: That’s very interesting. So let’s talk about myth number #2, that buy and hold works well for long-term investors.
Mike Dever: You hear this over and over, and it’s supported by the past research, that if people had invested in stocks at the turn of the last century, and held them for the last 110 years, they would have earned a nice return on their money. That’s true, but it’s not any great revelation. It is merely an observation. It doesn’t require a lot of research to see that, but it’s not predictive of future performance, and one of the examples I use is the fact that there were 36 active stock markets existing at the turn of the last century, and only four of them performed as well as the US Stock Market, and fully half of them at one point in time went to zero.
So, you know, essentially, to say that buy and hold works well, it works when you look at it in hindsight and you pick the examples of the markets that it worked for, but you could have picked a number of others and in 50% of the cases lost all your money.
John Nyaradi: And correlated with the opposite of buy and hold is “time in the market.” You say myth number three is you can’t time the market. I guess you think that you can or maybe you can.
Mike Dever: Well, I put it in there because it’s pretty clear that you actually can, and the reason you can is that as long as you do the opposite of what most people do, you can make money, and what most people do is almost randomly haphazard and certainly it’s on a discretionary, impulsive and emotional basis that they buy and sell stocks. If you take a systematic approach where you’re buying when they’re selling and selling where they’re buying, you actually can time the market quite well, and I present a specific strategy that takes advantage of that.
The average investor under performs the average mutual fund investment by 5% per year. That’s a huge number. But when you see a number like that, there’s an opportunity to take advantage of it by doing the opposite.
John Nyaradi: Let’s talk about passive investing versus active investing.
Mike Dever: Certainly. The first thing I make as a point in the book is that passive investing is active investing. It’s just a different form of it. Every investment is active. You don’t simply end up in something and not do anything. Somehow, you made a conscious decision to get into a position, and at some point, you’re going to get out of that position.
John Nyaradi: Myth number 20 is the last one. There is no free lunch.
Mike Dever: Right. That’s the biggest myth of all, and the myth exists because people look at a box that they say, okay, in my box, I’m going to make these investments. I’m going to be long stocks. I’m going to be long bonds. Maybe some cash, maybe some real estate in that portfolio. And if you want to earn a higher return on that investment, you have to take more risks.
But if you just think outside the box, expand your portfolio to include non-correlated return drivers and non-correlated trading strategies, you can earn substantially higher return and with less risk. And I go through it specifically in the chapter in which I present model free lunch portfolios that outperform the conventional portfolios, you know, quite dramatically.
John Nyaradi: Let’s talk about return drivers and how they lead to trading strategies, which then leads to a diversified portfolio.
Mike Dever: Absolutely, and the reason I bring that up in the very first chapter talking about the return drivers for the stock market is to point out that nothing is magical, and with every investment, there is a return driver that makes that go up or go down. You know, the point now with the stock market, it’s really enthusiasm for stocks by individual investors and institutional investors that drives stock prices up or down, the enthusiasm or lack thereof.
So the idea is to first come up with a rational concept that you feel may drive a market price up or down. That would be a return driver. And now, you’ve got the concept. You can test it, turn it into an actual trading strategy, and then employ that trading strategy to actually trade those markets so that you’re not buying them when that return driver is not valid. That’s a return driver, a systematic approach to turn into a trading strategy. You can follow it on a very disciplined basis and then apply that just consistently and systematically over time.
John Nyaradi: You mentioned just briefly the action section of the book. So what’s in there?
Mike Dever: Right. So the book is about 280 pages. That covers the 20 myths, and in there, I described a lot of concepts and expose the different myths, but in the action section which is an additional 80 pages, the JackassInvesting.com website, I present specific ways to exploit, take advantage of each of the myths in the book.
So there are different trading strategies, some specific mutual funds and ETFs that were developed to exploit the myths that are in the book, and it culminates in the action section for myth 20 where I present model portfolios. There are two different types: the simplified free lunch portfolio that only puts positions on and tests the mutual funds, and then the regular free lunch portfolio where I outline five trading strategies that investors can employ. Certainly, they can go in and create a diversified portfolio that provides them with the possibility of earning higher returns with less risk than what’s conventionally preached.
John Nyaradi: Let’s talk a little bit about your firm, Brandywine Asset Management. Commodities and hedge funds can seem like some sort of mystery so let’s talk about what you’re doing there at Brandywine, and what you’re doing with people, and how it works.
Mike Dever: Sure. I started my trading in 1979 and I launched Brandywine in 1982, and today our focus today is solely on managed futures, and we do that because they can provide us with great global diversification within one instrument type where we trade over a hundred markets globally, anything from commodities to interest rate, stock index, currencies, other financial instruments, and our focus is on developing a multi-strategy model that earns returns from a variety of return drivers across these 100 plus global markets. So it’s all about strategy and market diversification. We’ve been practicing exactly this approach since 1991.
John Nyaradi: I always like to end these conversations by asking if there’s anything else you’d like to add, the one thing that’s really on your mind right now that maybe keeps you awake that people like us should watch out for going forward here in the 2012.
Mike Dever: The same concepts and concerns I had in 1999 apply today. You know, people are being told to continue to sort of gut it out, ride out their losses, and what bothers me is not so much the financial system. It will continue to have its ups and downs, and there will be, you know, country collapses and stock market collapses. It’s that people continue to maintain non-diversified portfolios. They’re overly exposed to one or two return drivers primarily counting on stocks to go up when the tools are out there, the ability’s out there for them to earn returns across a variety of market conditions.
And so, we’re comfortable in the way we’re positioned. I don’t really get kept up at night thinking about what I’m doing, but the reason I wrote the book, and what does bother me is seeing other people being mislead and continuing to create portfolios that are non-diversified and subject to one or two return drivers.
John Nyaradi: Folks, we’ve been talking with Mike Dever, author of “Jackass Investing: Don’t Do It, Profit From It,” and the founder of Brandywine Asset Management. The book has received some great reviews from people like Michael Covel, the author and the founder of The Complete Turtle Trader; Leslie Masonson, author of “Buy – Don’t Hold” and Charles Rotblut, charter financial analyst and vice-president of the American Association of Individual Investors. It’s a great book. It has lots of great things for us to think about and learn about in terms of active versus passive investing.
To learn more about Mike and his work, just follow the link at the end of this interview, and that will take you to the book’s website where you can learn more about Mike and his work.
Mike, it has been great chatting with you today. Thanks for joining us, and I know we’re really all looking forward to talking with you again soon.
Mike Dever: Great. Thank you, John. I appreciate it.
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