How Activist Insiders are Unpacking Hidden Value at EPAX

How Activist Insiders are Unpacking Hidden Value at EPAX – (SeekingAlpha Pro article viewable for free today only)


Risks of a Chinese “hard landing”

Relatively little attention has been paid by most investors to the long-term global consequences of the serious and unsustainable distortions that have been developing for years in China’s increasingly significant economy. Following up on these recent videos revealing the surprising magnitude of the Chinese real estate bubble, here’s a link to an interesting debate on the likelihood of a Chinese “hard landing” from the blog of Tsinghua University economist Patrick Chovanec:

“Developers kept expanding investment by 30% a year, piling up nearly a year’s worth of unsold inventory, confident that the government needed them – and would ultimately support them – to maintain growth. In the meantime, the central bank was reining in credit to counter rising inflation, including spiralling home prices. When developers finally ran out of financing options, they had to start dumping their unsold inventories to raise cash – and the market tanked. Drop one ball and others follow. Land sales – which local governments are relying on to fund basic services, as well as repay their stimulus bank loans – are at a standstill, and some analysts expect private housing starts to fall by 20% this year. I wouldn’t take too much comfort in the reported profits of Chinese firms. Lehman, Bear Stearns, and AIG – not to mention Fannie and Freddie – were all rolling in profits as long as credit was cheap and property prices were rising. That’s the nature of boom/bust cycles: it’s easy to make money when they’re printing it, and nobody’s pressing to be paid back. But as Warren Buffett says, “It’s only when the tide goes out that you learn who’s been swimming naked.” Chinese companies I’ve been talking to, across many different industries, say they’ll count themselves lucky if they can just match last year’s sales in 2012. Sounds to me like the tide’s going out – and I’m betting there are a lot of folks in China who figured they’d never need a swimsuit.”

Chinese Debts Dwarf Official Totals (Bloomberg)

Domestic effects of collapsing housing prices in China will be exacerbated by unpredictable impacts on the notoriously complex and opaque balance sheets of a myriad of Chinese state-affiliated financial entities, which almost put the behavior of developed world investment banks to shame. The consequences of an eventual slackening of China’s recent unusually heavy binge of fixed asset investment spending will not be limited to China itself, but are likely to create significant headwinds for global growth in an already tenuous environment.

China's Debt Crisis - Bloomberg TV (click for video)

Rule Number One

“Rule number one is: don’t lose money.
Rule number two is: never forget rule number one.”
— Warren Buffett

Although I’ve been fortunate to significantly outperform the S&P500 in each of the last eight years, and have also managed to do very well in absolute terms, a central lesson I can draw from an honest analysis of my past performance is the extreme importance of being positioned to avoid losing money during periods of a sharp market decline.

Clearly, I failed to anticipate the crash of 2008, with my portfolio outperforming the S&P by seven percent, but still declining significantly in value. For most people working in the investment management industry this result would be perceived as a monumental achievement, since the industry obsessively tracks its performance over multiple short intervals relative to a benchmark, and their ability to attract outside investors is determined almost entirely by appearing to perform slightly better than their peers over short periods, rather than delivering the maximum performance possible over a very long span of time.

I now believe that people interested in truly maximizing their long-term wealth should adopt a fundamentally very different perspective than this conventional one, and should begin to pay a great deal of attention to positioning themselves to avoid experiencing a large loss during severe market corrections (for example, by investing a small amount in out-of-the-money put options that can generate inflows of investable cash during a market decline.) This is because the risk of a recurrent credit crisis are currently far more severe than most investors anticipate, and because the long-term benefits for value investors of achieving even modestly positive performance during a market downturn can be surprisingly extreme.

To realize this broadly, consider the long-term impact of a large 50% loss, such as that recently sustained by popular hedge fund titan John Paulson in his “Advantage Plus” fund. Because of the compound nature of returns on investment, to merely recoup this loss would require not not merely that you manage to achieve a positive +50% performance the following year, but instead deliver (and hold on to) a full +100% gain. Although this may seem so obvious as to be trivial, the picture becomes even more stark when considering the staggering opportunity costs of having no access to investable cash during a time of market turmoil.

“Cash combined with courage in a time of crisis
is priceless.”
— Benjamin Graham

During periods of a crisis of confidence (as have recently occurred with increasing regularity), a rapid evaporation of liquidity can exert powerful downward pressure on almost all asset classes. Correlations between asset prices sharply depart from their historical patterns, often totally invalidating the traditional “beta” and correlation based methods of risk management that are still relied upon by most conventional investors. Although it’s gratifying that value stocks can continue to deliver strong relative outperformance during these periods, being fully invested and unhedged during a liquidity crisis made it virtually impossible to raise cash to invest in new deeply undervalued opportunities that were rapidly developing. As a value investor, I could readily identify companies that were selling for a remarkably small fraction of their intrinsic value, with expected long-term returns so extreme they would put my recent results to shame. Not being able to act on most of these opportunities on a significant scale was incredibly frustrating.

Going into 2008. I had blindly accepted the conventional wisdom (common even among most value investors) that any consideration of “macro-level” economic concerns should not play a role in your choice of investments, and that concerns about the overall level of market valuations generally amount to futile efforts at short-term market-timing. In other words, I remained focused on identifying investments that should outperform the market, not on positioning my portfolio to take the possibility of rare, extreme, and difficult-to-identify macroeconomic risks into account.

Although I was to some extent aware of concerning trends in real estate prices and mortgage securitization, and did avoid exposure to vulnerable and overleveraged financials while remaining invested in fairly boring (but very well capitalized) value stocks that were far less affected by the crisis, I did not foresee or profit from the market meltdown as did a select few investors, including the neurologist Michael Burry. Near the market bottom, of courage, I had my customary modest amount. Of investable cash, I had next to none.

With the benefit of hindsight bias, almost any past adverse event will in retrospect seem easy to predict. Indeed, most people will genuinely feel that they “saw it coming” when in reality they did nothing of the sort. But what we *can* clearly see, both from past events and reasoned extrapolation to the future, is that the assumptions about risk and reward used by the mainstream financial industry can be deeply and even monumentally flawed, setting investors up for another “Black Swan” event within the next several years.

Due in part to increased use of debt, leverage, complex derivatives, and algorithmic high-frequency trading throughout the financial system, the severity and number of sudden and very severe market price declines have now far exceeded the rate that is supposed to be possible in an efficient market, and these market shocks are beginning to happen with increasing frequency over the past several years. While mainstream investors continue to cling to efficient market assumptions, again and again the market has been shaken by periodic declines that are utterly inconsistent with every prediction of these conventional models. While the precise timing of another market correction is likely impossible to predict, investors willing to take a contrarian view of systemic risk will be the only ones to be well positioned when it occurs.

Lessons from past performance

Below are the returns over the past eight years earned in my personal Roth IRA, based on account statements independently reviewed and verified by a Certified Public Accountant.

Although I’m certainly pleased with the final results, I want to prominently confess that throughout this period I’ve certainly made more than my fair share of foolish mistakes and avoidable oversights as an investor. Even while emphasizing the importance of an evidence-based investment strategy, to be honest I’m far from perfectly rational in my decisions and behavior. As unremarkable as it may be to point out, I am a human being with human virtues and flaws, and I can readily identify a generous helping of all the usual human behavioral biases and idiosyncracies at work within myself. Personally, I seem to be very susceptible to overconfidence, the confirmation bias (often in medical diagnosis as well as investing!), and a particularly virulent case of loss aversion.

Fortunately, by paying careful attention to these human behavioral quirks or flaws in myself I’ve been able to eke out a satisfactory return. Like anyone else, I rely on my imperfect human brain, made up of a hopelessly complicated assortment of neurons and glia, rather than the perfectly rational agent enshrined by the tidy assumptions of conventional economic models. Conscious attention to these biases can help to reverse the poor underperformance experienced by most conventional investors, and I believe that a understanding of common sources of behavioral error can provide a significant advantage. Still, it’s likely that I’ll be continuing to make at least some avoidable mistakes in abundance for many years to come.
With this in mind, it can be instructive to review the performance of conventional investors, and what they believe about their own mistakes, or lack thereof. Below is a table of annual performance for US and global equity and bond mutual funds. You may need to click to enlarge, as the font is microscopic. So are the returns.

The self-attribution bias: blindness to sources of behavioral error

Recently and in the past, I’ve spent some time reading shareholder letters and annual reports from several prominent mutual funds and hedge funds. According to them, these managers appear to have made virtually no mistakes at all. As any MBA student will insistently tell you, it’s safe to make the assumption that these individuals instead act as perfectly rational beings — and it’s abundantly clear that many of them seem to believe exactly that. A recurring theme I have identified in these letters is a remarkable lack of willingness to specifically identify and address prior mistakes.

When performance has been particularly poor, the manager will seek to assign blame to a wide variety of external factors rather than his own decisions. (And it almost always is a he, despite findings that women often perform better than us guys at avoiding certain behavioral biases when investing.) Often, after a terse and obligatory mention of the year’s actual results, the manager will quickly launch into a recitation of a long list of unrelated statistics such as GDP growth estimates, as if these had any bearing whatsoever on the fund’s performance or his skill as an investor.

While likely exasperating to the people who have invested in their funds, the aversion to accepting responsibility for errors is understandable. Biased self-attribution is one of the best studied phenomena in behavioral finance. A conscious and objective examination of personal errors is a psychologically difficult endeavor that very few people can realistically perform.

Compounding this bias is the fact that most fund managers earn the preponderance of their income by attracting customers rather than by performing well; and often have little to no money from themselves and family invested in the funds they manage. Their livelihood is conditioned on generating the appearance, rather than the reality, of competence and success. Unfortunately, a lack of conscious attention to the consequences of past decisions only perpetuates the natural but maladaptive behavior patterns that can lead to ongoing poor performance.

Not all investors appear to suffer from this complacent attitude. I have found that successful investors using a deep value strategy seem to consciously undergo analysis of past errors as a means for enhancing their decision-making process. Warren Buffett in particular is known for his self-deprecating nature, and does not shy away from a demanding analysis of his own performance. In spite of outstanding long-term performance, many of his Berkshire letters include a veritable laundry list of mistakes.

In comparing Buffett’s letters to the self-congratulatory output of many brand-name mutual funds, you might almost never know that he had outperformed the market by an astonishing degree over many decades. To put things in perspective, anyone who had invested $10000 in one of Buffett’s initial private limited partnerships in 1956, then rolled that money into Berkshire Hathaway when he took control in 1964, would now have a nest egg worth nearly $300 million, after deducting all fees.

It is an easy and painless decision to dismiss the success of others as a mere fluke. It is more difficult to thoroughly evaluate the available evidence, consciously focus attention on possible errors in your own decision making, and set high standards for your own performance — but I have found it to be enormously more profitable.

Capital preservation and macroeconomic risk – lessons from 2008

Rather than waste time crowing about past successes and comfortably gloss over the difficult lessons of past mistakes, I want to take the opportunity to identify and explore past errors in my own decision-making, with the goal of improving my performance in the future.

In the coming weeks, I will review my experiences and thought process during the 2008 financial crisis, examine how my investments at the time were successful in significantly outperforming the market (while totally unsuccessful at actually making any money), and investigate what lessons past bubbles and panics may have for us in today’s environment, which in fact has many concerning parallels with that preceding the 2008 collapse.

Europe continues to unravel

Only weeks after the latest “solution” to the debt crisis, resurgent weakness in European bond markets is serving as a potent reminder of how quickly this unstable system can deteriorate. Although central bankers can possibly postpone disaster for quite some time, over the long term I can see very few real ways out of this situation, and at some point in the next several years things are likely to get very bad, very quickly.

European Bond Yields (Der Spiegel International)

With interest rates already at a level that makes debt service unsustainable, and moving in the wrong direction, Italy alone is going to have to roll over 215 billion euros of debt in 2012. European nations will need to finance an astonishing 865 billion euros in debt this year, over 262 billion within the first quarter. It’s not clear where external demand could be coming from — European banks are going to be expected to absorb most of it while becoming increasingly reliant on short term credit from the ECB, which as John Cochrane points out only worsens the systemic consequences of an eventual sovereign default. At the same time, European banks will have to roll over an estimated 200 billion Euros of their own debt in the first three months of 2012.

European Debt Maturities

Eurozone Debt Maturities in 2012

Large and systemically important banks in the ostensibly stable core economies of France and Germany are among the most vulnerable, having in many cases employed irresponsible degrees of leverage and having built massive exposure to low-quality sovereign debts that are now deteriorating sharply in value.

There is a very real possibility that one or more major European banks will fail this year, and as the collapse of Lehman Brothers just 3 years ago has shown, such a failure would have far-reaching systemic consequences. With both bank and public sector balance sheets already under stress, Eurozone governments will have little ability to respond to a Lehman-scale crisis with yet another bailout. Deutsche Bank’s balance sheet alone is nearly half of German GDP, giving an entirely new meaning to the platitude “too big to fail.”

There is still time to reduce the amount of risk you are taking on. Do not go into 2012 exposed to the market without the understanding that the degree of systemic risk is extraordinarily high.

Investment Myths and Realities – New Perceptions for a New Year

As an active individual investor for over a decade, I’ve become accustomed to treating much of the conventional wisdom put forth by the investment industry with a great deal of skepticism. Because many people understandably don’t want to focus much time on their investments, investors can often be led into accepting a number of questionable assumptions that can benefit certain members of the financial industry more than their clients. One of the most profitable New Year’s resolutions could be to spend some time questioning the factual basis behind some of the conventional assumptions investors are often asked to accept.

There is no point in trying to do a better job at investing than the average financial professional – it’s always a wise decision to faithfully entrust all your money to mutual funds or managed accounts marketed by the investment management industry, since the skilled experts managing these funds will certainly perform far better than you ever could.

It is a widely known (but not widely advertised) fact that the efforts of many of the alleged experts working in the investment management industry are effectively inferior to placebo. Most professional money managers fail to show any evidence of any significant investment skill, and often perform at a worse than chance level. The majority of professionally managed mutual funds deliver significantly worse returns than selecting stocks entirely at random. Even before deducting their substantial fees, many can systematically perform even worse than would be expected by chance alone due to overconfidence and other behavioral biases.

The Myth of Mutual Funds
ETF Report – Over 50% of Active Managers Underperform

Although I believe that a select group of dedicated value investors do show evidence of very significant skill at investing, and can gain substantial benefits by carefully exercising the discipline to overcome behavioral biases (for example, see evidence on systematic outperformance by members of the Value Investors Club), these individuals can in practice be exceptionally rare. The assumption that the average member of the financial industry can outperform the market is very clearly a dangerous one to make.

It is safe to assume that a broker, advisor or other representative of an investment firm has a significant degree of highly valuable investment skills and knowledge that you, as an outsider, can never hope to match. You can also assume that person is being employed only to independently and carefully select optimal investments for the sole benefit of their clients.

A significant number of people employed by the investment management industry to interact with customers serve primarily a sales or marketing role, and are incentivized to generate commissions and fees for their firm. Often, the training of many representatives may be focused much more on “customer relationship management” than on performing any independent investment research. It is a real possibility that these individuals may have little to no involvement in independently analyzing investments on their intrinsic merits, and may simply guide customers toward choices that generate fees or ancillary benefits for their firm. As the neurologist and economic historian William Bernstein writes in his 4 Pillars of Investing:

Brokers do undergo rigorous training, sometimes lasting months — in sales techniques. All brokerage houses spend an enormous amount of money on teaching their trainees and registered reps what they need to know: how to approach clients, pitch ideas, and close sales. One journalist, after spending several days at the training facilities of Merrill Lynch and Prudential-Bache, observed that most of the trainees had no financial background at all. (Or, as one used car salesman/broker trainee put it, “Investments were just another vehicle.”)

What do brokers think about almost every minute of the day? Selling. Selling. And Selling. Because if they don’t sell, they’re on the next train home to Peoria. The focus on sales breeds a curious kind of ethical anesthesia. Like all human beings placed in morally dubious positions, brokers are capable of rationalizing the damage to their client’s portfolios in a multitude of ways. They provide valuable advice and discipline. They are able to beat the market. They provide moral comfort and personal advice during difficult times in the market. Anything but face the awful truth: that their clients would be far better off without them.

Although I wouldn’t agree with Dr. Bernstein that markets are always perfectly efficient, his central point about the value of a healthy skepticism when approaching the investment management industry cannot be made forcefully enough.

In interacting with any advisor or stockbroker, it is safe to assume they necessarily must be a highly ethical and dispassionate professional who will always put your interests ahead of their own. Or, even if they’re self-interested, all other interests will surely be secondary to their clients’ investment performance.

Unfortunately, as borne out by repeated scandals from Bernard Madoff to Jon Corzine, it is not always safe to assume that all people in the investment industry uphold the same ethical standards shared by physicians. While the majority may try to act ethically and are not involved in any blatant scam, the compensation of many managers or advisors generally has no relation at all to the results experienced by clients, and much of their role may be to generate commissions and management fees or sell securities that directly or indirectly benefit their employers. As independent research has borne out, the lack of any performance incentive for brokers and money managers can often cause them to actively make decisions that are bad for their customers.

Even if the actively managed mutual funds sold by the investment industry perform poorly, I can always do well by assuming that passively managed index funds are always the best possible choice. I can simply place all my money in passive index funds and ETFs without needing to worry about the likely risk and return resulting from that decision.

Although they can and will perform somewhat better than most professional money managers just by staying away from their counterproductive activities, most passive index investors may not currently have a realistic perception of the real risks involved. Average market returns of the past 30-year period may have been artificially boosted by excessive accumulation of debt and leverage during that time, a trend which is now at risk of reversing, with potentially severe consequences for asset prices. Based on several measures of historical valuation such as the Shiller P/E ratio, and a current ratio of corporate profits to GDP that may prove unsustainable in the long term, the likely range of returns from investing in the market index at current levels may be much lower than many investors have been trained to assume. Multiple macroeconomic risk factors including the continuing European sovereign debt crisis, excessive leverage by global financial institutions and governments, and a large and unstable real estate bubble in China, are now creating a very significant degree of real risk that is still not fully anticipated by most market participants.

Happy New Year – A Guarded Prognosis for 2012

I know this is a gloomy outlook to start the New Year, but I’m not calling for immediate financial Armageddon or a total collapse of society, just an appreciation that the real risks involved are much greater than most investment professionals are likely telling their customers. Personally, I have continued to invest in several specific stocks that I believe to be deeply undervalued, while attempting to hedge against risk with put options that will pay off significantly during a market decline; however, I know this type of strategy still has some risks of its own, and will be not be suitable for most individual investors without significant prior experience.

For most people, a more prudent course may be simply to reduce market exposure and hold cash reserves, enabling them to sleep better at night and benefit from a potential decline. The January Effect may provide a near-term boost for the market in the coming weeks, providing an opportunity for investors to reduce market exposure and raise cash. In the event of a sharp market decline, investors who have built cash reserves in appreciation of the risks may find themselves wealthier in real terms, with a rare opportunity to invest in attractive assets at significantly depressed levels.

Happy Holidays

Peace, joy, and prosperity to you and yours.

Mind Over Money – An Introduction to Behavioral Finance

As a behavioral neurologist, I’ve been extremely interested by continuing progress in the growing field of behavioral economics. Moving beyond the abstract assumptions of perfect rationality which much of traditional neoclassical economics has relied upon, behavioral economists are interested in exploring the actual ways in which human beings make decisions in the real world, and how observable biases in human behavior can create very significant market distortions that people who do not directly study human behavior will entirely fail to appreciate or predict.

Many of these findings happen to fit extremely well with the common-sense value investing philosophy espoused by many highly successful investors including Warren Buffett, but receive remarkably short shrift from mainstream market participants.

In recent years the importance of studying economic activity in a behavioral context has been reinforced by a growing tide of evidence that is becoming increasingly difficult to ignore, including numerous experimental findings culminating in Daniel Kahneman’s 2002 Nobel prize in economics, the undeniably accurate predictions of the 2008 mortgage crisis by Yale behavioral economist Robert Shiller, and the glaring examples of the dotcom boom/bust, the housing bubble, Wall Street pyramid scams, out-of-control executive paychecks, the current escalating sovereign debt crisis, and widespread other evidence of behavior in the financial industry that is, to put it kindly, less than perfectly rational. In order to understand what is going on, you first have to understand that the decisions made by many financial professionals have been phenomenally bad, and learn how to try to avoid falling prey to similar errors yourself.

Due to the sheer volume of material, a comprehensive review of behavioral economics is certainly beyond my expertise or the scope of this blog. For those interested to learn more, the 2010 PBS documentary Mind Over Money (now available for free online) is an enjoyable introduction to the topic, giving a balanced exposure to both behavioral and neoclassical viewpoints.

Among recent books aimed at a public audience, Jason Zweig’s Your Money And Your Brain is an interesting and readable account of many important experimental findings relating to human economic behavior. From a practical standpoint, Why Smart People Make Big Money Mistakes
gives valuable advice about how you can apply evidence from behavioral economics to easily avoid some of the costly behavioral errors many people make in their personal finances.

Having understood that many investors can make serious errors that are in part predictable, it can be possible to use this knowledge to enhance your own investment performance, perhaps very significantly. For many years I have carefully applied methods from behavioral finance and value investing to identify mispriced securities while investing for myself and family; although this does take serious thought and effort I have been fortunate to have some very considerable investment success, and also happen to enjoy the process a great deal. One valuable resource is James Montier’s excellent Behavioural Investing, a collection of essays containing dozens of research findings about exploitable market anomalies resulting from human behavioral biases. At over 700 pages this is definitely not for the casual investor; a more concise but still useful treatment can be found in The Little Book of Behavioral Investing by the same author.

Chinese Ghost Cities

The Chinese economy is often portrayed as an inexhaustible engine of growth, and some find it difficult to conceive of China sharing any of the problems plaguing the developed world.

Take a look at the following videos for a surprising view of how much of the apparent growth in China has come from massive and unsustainable real estate investments on a far greater scale than the prior excesses in the US. which are now showing signs of a massive real estate bubble in the early stages of collapse.

The stories of these men and women would be very familiar to Americans flipping real estate in 2005 Miami and Los Angeles.

“The locals all loaned them money, and all their money has been invested in property. Now no one can sell apartments, and the money is gone.”

If the collapse of the housing bubble was so painful here, just imagine what consequences this might have.


Thanks very much for all the comments on the message board thread and the subscriptions to my blog. In reading some of these comments and talking to the many friends/colleagues who have been taught to rely on the conventional wisdom of the financial industry, I can anticipate it might be difficult to effectively communicate my investment strategies and what I see as the significant risks facing investors over the next several years. I realize that most readers of this blog (likely being much better doctors than I) will have understandably spent much more time acquiring expert clinical knowledge and skills than on thinking about investing, most people will be coming from the default assumption that the stock market is always perfectly efficient, and much of what I want to say will likely sound alarmist, overconfident, or unnecessarily complex. Hopefully in following these posts, investors will get exposure to some alternate perspectives that I think are very important to become aware of, even if they do not initially agree with them.

Specifically, in future posts I want to call attention to a number of important pieces of evidence that should alert investors to the possibility that the real state of affairs on Wall Street may not be as miraculously efficient as they have been told.  These pieces of evidence include the remarkably consistent market outperformance of a very specific subset of fundamental “Graham-and-Dodd” style value investors including Warren Buffett, Seth Klarman, and Michael Burry, and the remarkable failure of Wall Street’s traditional concepts of risk based on the efficient markets theory to actually hold water during any of the unusually severe market collapses of recent history. These events are very inconsistent with the core assumptions of the efficient markets theory, and should motivate people with the unique advantage of an evidence-based mindset to begin to search for more evidence and question what they have been told. Researchers from the growing field of behavioral economics, including Yale’s Robert Shiller and Nobel laureate Daniel Kahneman, are delivering increasingly powerful criticisms of efficient market assumptions that can in fact prove very useful to investors willing to take the time to learn.

NYU economist Nouriel Roubini, once openly mocked by efficient markets proponents for his now all-too-accurate prediction of the US mortgage crisis, is again delivering an articulate warning about the real consequences of the European credit crisis and other potentially devastating sources of structural instability in today’s global economy. Investors who are repeatedly being told that constant passive exposure to a market index fund is the only possible answer to any possible situation, are simply not being given a complete picture.

To try to quickly get across the basic gist of what I am concerned about and what I am currently doing in response, I will attach one current issue from my investment newsletter, and summarize part of it in a following post. Unfortunately, I realize that what I am doing will be complicated, difficult, and risky for most individual investors to implement; specifically, I would not recommend this be done by anyone without several years of experience in actively managing their own portfolio and a detailed understanding of how options work. There are real risks associated with buying options; my purchases of deep out-of-the-money put options amount to less than 10% of my portfolio, and it is very possible (and in some cases very likely) that many of them will expire completely worthless. Unlike most professional investors, I try to consciously focus on the fact that in any situation there is a very real possibility I can be wrong, and plan my portfolio accordingly to anticipate multiple possible outcomes. If my concerns about the global economy are overblown, I will gladly take a 100% loss on my options positions and expect to have done well from my long-term investments in stocks I believe to be undervalued. I will in fact feel relieved if this happens, since a recurrent credit crisis could cause much more pain than I think most people currently recognize. If however the efficient markets theory is yet again proven wrong by another Black Swan global credit crisis (which I now see as a very real possibility), I believe that a variety of small positions in carefully chosen options against overvalued and overleveraged securities will deliver disproportionately large payouts compared to the small amounts invested. Having invested for many years, I know that I am making a calculated and somewhat complex bet with real risks that will not be suitable for most people. I’m personally willing to take these calculated risks, but would not recommend them to anyone who does not already have extensive experience with their use.

I think there are going to be no easy answers about where to invest. For the majority of people who are currently mutual fund or passive index fund investors, it may be more prudent to simply reduce their exposure to the stock market in recognition that the degree of potential risk may be more than they had been made aware of.

Especially for people who have been taught to accept that putting all possible worries aside and continually investing in index funds is the only rational strategy (very understandably, given the undeniably poor performance of most professional investment managers), what I am saying will just seem apocalyptic and overwrought; many people reading this today will not be convinced, except perhaps if several years from now much of what I am now prospectively warning of has in fact happened. To people who are already value investors, or have already been reading extensively on the global economy, much of what I am saying will probably not be news to them.

The people I am trying to reach with this blog are those who have been told that the only rational approach is to entrust their money to various “investment professionals” trusting blindly that they will outperform, or told that the stock market is perfectly efficient and that maintaining perpetual 100% exposure to a market index such as the S&P500 represents the only rational choice in almost any circumstance.

I know that one of these two contradictory viewpoints are accepted by the vast majority of the public. Over many years as an investor, I have come to believe that they are both wrong. In the coming weeks to months on this blog, I will call an end to long-winded and obscure rants about deep OTM LEAP put options and try to put together several shorter and more straightforward posts about some of the surprising evidence investors need to know about the actively-managed mutual fund industry, the likely real risk and return of index funds, Graham-and-Dodd value investing, behavioral finance, exchange-traded funds, the European debt crisis, 3 million vacant apartments in China, and various other topics of use to investors (topics that I, at least, think can be much more interesting than they sound ;).

If you have enjoyed this blog or found it thought-provoking, I hope you will mention it to friends and colleagues and encourage them to also follow along for free. I think that physicians and other investors are not being accurately informed about many important financial realities, and I think that they deserve better.