t’s indeed an honor to receive the Year 2000 Exemplary Leadership in Management Award and especially so to be the first alumnus of The Anderson School to receive this honor. I must tell you that if given the vote in 1971, none of my professors nor classmates would have picked me as a likely recipient. Oh, I had a GPA of 3.7 or so which must have put me in the upper half of my class, but I was a commuter student, spending more time finding a parking place in Westwood than mingling with my fellow students. I made a few friends, and fewer lasting impressions I’m sure. The Anderson School or the UCLA Graduate School of Management as it was known back then, however, made a lasting impression on me – its professors, its dedication to learning, and its willingness to quench my own thirst for anything and everything that was financial market oriented. I was not a classical MBA student – in fact, my degree from the GSM was an MS in finance. I took as few management courses as possible and as many as I could that contained the words “stock” and “market” in close proximity. Even those of course would not lead directly to my eventual home in the bond world, but they were enough to send me on my way.
Still, after reciting my plain vanilla qualities that most must have observed in my years here, the question must remain – why me? Of that I’m not sure. The fact is I’m still only 56 and have plenty of time to change your minds. Business, markets, and financial movements have a habit of turning on us all at the most unexpected of times, so while this award may be in the bank, my own historical legacy – if there can be such a thing in the bond market – is certainly not. I, my clients, and our markets are at risk every day.
But having said that, what is it that fellow students and Anderson professors might not have caught back in 1971 that hinted at least a modicum of success in the years to come? Two things, perhaps. First, an insatiable, unquenchable, near neurotic need to succeed. And second, recognition that in my business, success depends not just on intelligence, but a mastery of two “senses” somewhat divorced from the investment arena itself. To me, success in managing money depends on two primary senses – 1) a sense of timing and 2) a sense of value. These perceptions, like a fine wine, need time for proper fermentation but they also need the proper grapes or fundamental ingredients before they go into the barrel. Value judgment, for instance, does not require the fervid attention to analyst upgrades or downgrades seen on your favorite business channel, but an understanding of history – political, sociological, and financial – blended with an inordinate amount of common sense. The book that rests on my library coffee table is not Peter Lynch’s Beat the Street or even my own, but several books by historian Paul Johnson on the makings of the 19th and 20th Centuries. There is no better teacher than history in determining the future. “Past is Prologue” - “History doesn’t repeat but it rhymes.” Take your pick, but there are answers worth billions of dollars in a $30 history book.
Secondly, the investment manager needs a sense of timing. History might repeat, but the money management business these days demands some sense of “when.” It is one thing to recognize blood in the streets – another to know if more is yet to be spilled. That sense of timing to my way of thinking demands a mastery of human emotion, involving an understanding not simply of the psychology of crowds but of yourself as well. There is a quote from an old 1920’s stock trader by the name of Jesse Livermore that I’ve tried to keep in mind for the past 29 years or so. The words don’t necessarily flow but they contain a massive wallop. “In actual practice,” he said, “an investor has to guard against many things, (but) most of all against himself.” So whereas in medicine it pays to “know thy patient,” in investing I believe it pays “to know thyself.”
It also helps to know what’s on the minds of other investors because markets, as Keynes long ago observed, can be a beauty contest – at least in the short run. I learned this early on in my career from an incident involving my first and only personalized license plate. I had originally purchased a license plate reading “BONDS 1” in an attempt to send a message to the chairman of Pacific Mutual who I felt controlled the fate of my next raise and at least several thereafter. If I could drive that car next to his in the company garage, I might quickly or at least eventually send a subliminal signal that yours truly was a pretty hot ticket in the bond world – an idea, by the way, which had no basis in fact in 1973. Well the “great license plate” comment never came down from the chairman nor did much in the way of raises, but “BONDS 1” did attract the attention of some observers. Several times while filling up my gas tank in Mission Viejo that year, an interested bystander walked up to me and asked if I could bail their nephew and brother out of the Orange County jail. And it was then that I learned that “BONDS 1” meant different things to different people and that understanding human differences and in fact human emotion was a key to the financial markets. So people watching, and reflections of yourself in a mirror or at a gas station, as it turns out, are key to mastering the markets.
And now for a little forecasting as opposed to reminiscing. What does history and human emotion tell us about the financial markets today? Well, I think history teaches us that we are in the middle of a new secular wave or a New Age Economy that is similar to ages past yet contains elements that are distinctly different. The observation of human emotion tells us that we have projected these changes into the indefinite and near infinite future, resulting in a series of bubbles which can be observed in the NASDAQ stock market, the U.S. trade deficit, our strong U.S. dollar, and the extremely low level of Japanese interest rates. These bubbles are now in the process of deflating and will cause damage to the global economy as they do. Their initial inflation or “exuberance” as Alan Greenspan would say, was the result of a classic extension of human emotion based upon the dynamically changing global economy.
Not only companies, but countries as well have joined the globalization frenzy in a desperate effort to attract capital and compete. Since investors have signaled that they hold strong currencies, high growth, and low inflation most dear, governments have moved from large fiscal deficits to in some cases, startlingly large fiscal surpluses, and central banks have adopted what is known as “inflation targeting” to insure that foreign and even domestic capital has a place to prosper in a low inflationary environment. Net result: global prosperity and low interest rates with admittedly some pretty rough bumps along the way.
It’s those bumps that I’d like to address now, because for all the benefits of the American capitalistic ethos, there are negatives as well. The French would claim that American capitalism is no cocoon to be emulated, in fact is no cocoon at all. But aside from the unsolvable philosophical differences of stressing equalité and fraternité before economic liberté, they have a point about the process itself. American capitalism is in relative terms, reminiscent of our wild wild west as opposed to the refined culture of Paris. It allows for risk and risk taking – backstopped of course in many ways by government and central bank policies but flexible enough to promote the modern entrepreneur in his quest for a profit. That promotion, however, provides for, even encourages, risk and innovation and in most cases allows for not just success, but outright failure and bankruptcy.
It is this lesson, I believe, that an investor must recognize and learn above all as we wind our way up the long-term mountain of portfolio management in this New Age Economy. The adoption of a system that can offer all the advantages of disinflation and technology-based prosperity carries within it perhaps not the seeds of its eventual destruction as Marx proclaimed, but certainly the seeds of “creative” destruction as Schumpeter more accurately recognized. And when capitalism – especially American capitalism – is at its most vital, then creation and destruction should move to relative extremes as well. That, in a word is my simple economic message to you today. Expect “destruction.” Note that this admonition goes beyond the simplistic and almost always accurate forecast of predicating that markets will be volatile. Of course they will be and especially so when capitalism is on the move. I suggest instead that you should expect destruction, which in bond manager terms means default, bankruptcy, and loss of principal and in stock manager terms means lower prices.
With the passage of time, I’ve also learned another valuable lesson, and that is that all money managers and certainly bonds managers have a responsibility that goes beyond the accumulation of assets, the earning of fees, and outperformance of the competition. We lend money to companies, countries and continents, and what we do affects the fortunes and the lives of hundreds of millions if not billions of people. If you think I exaggerate a bit you need only look to the capital starved continent of Africa to know that things might be different if more equity and loans moved in that direction. That is not to say that it should, because lending depends upon the expectation of receiving your money back in addition to a fair return for risk, and these expectations depend upon political, economic, and sociological judgments that do not always flash green. But even if the traffic light is a vivid green, when irrationality or greed get the upper hand, as they did in our own S&L crisis in the late 1980s or perhaps most recently with our Internet bubble, then markets, economies and people, can be damaged for years and years.
So it is my responsibility and the responsibility of all money managers, to be aware of the broader picture. CAVEAT EMPTOR for certain, but in addition, caveat emptor globus, which means that the institutional buyer should beware on a larger and more global scale. There’s a classic Shakespeare line in Henry VI that says, “Come the revolution, they take the lawyers first.” If that should be the case, I would then surmise that surely they’d take the money managers second. I intend to be retired come the revolution, but many of my future colleagues, some of whom I may have met this afternoon at The Anderson School, may not be. I hope they heed these closing words most of all and I wish them well. Thank you once again for this distinguished honor. I hope to live up to it for years to come.
William H. Gross
This speech was presented on November 14, 2000 at The Anderson School (UCLA).