New investment idea: invest in good businesses

Here's a recent article from the New York Times entitled "New Investment Strategy: Preparing for End Times."

It describes a host of "investment" vehicles designed to protect against "tail risk" or "black swan" events -- terms derived from the academic fields of probability modeling, which took over the financial world during the course of the past four decades, where the marriage of mathematics and financial engineering became known as "modern portfolio theory."

For our part, we never subscribed to modern portfolio theory in the first place, and we have written that MPT is about as "modern" as a 1974 Ford. In fact, it should be perfectly clear by now that the tendency to trust that a bunch of financial engineers who create complicated structured products designed to whisk away various forms of risk led directly to the Wall Street implosion of 2008-2009. Nevertheless, as we noticed all the way back in April 2009, instead of learning this fairly obvious lesson, advisors and investors were already clamoring for still more products based on the false premises of Modern Portfolio Theory.

The hallmark of Modern Portfolio Theory -- and all the latest manifestations of MPT described in the recent story from the New York Times -- is the belief that analysis of individual businesses or individual securities is a waste of time. Individual securities don't fit into the standard distribution curves with "tails" at which the high priests of modern finance worship. Because they don't fit their models, the devotees of MPT believe individual securities are less predictable and more dangerous than huge numbers of securities, or statistics, or indexes such as the "fear gauge" cited in the article.

As we mentioned in the previous post entitled "The ideology of modern finance," this is exactly the sort of belief that led to the idea that structured investments composed of thousands of securitized mortgages were more predictable than careful analysis of individual mortgages or borrowers. Those who are currently investing tens of billions of dollars into "tools engineered to bulletproof investors" (in the words of the NY Times article) might want to consider that fact of history.

Instead of rushing into "Armageddon funds" which are tied to everything but the fundamental analysis of individual securities, we would recommend that investors consider a novel investment idea: going back to the analysis of individual companies that prevailed before the Modern Portfolio Theory craze began to take hold in 1974.

A good place to learn about that time-tested approach would be the pages of this blog, where we have written many times about the fundamentals of the investment strategy that we have followed for twenty-five years, and which we in turn inherited from Richard C. Taylor, who inherited it from Thomas Rowe Price. We would also recommend some of the collected wisdom of the investment professionals who achieved decades of success before the advent of the ideology that took over modern finance, some of which is described in this previous post.

We believe that the concept of analyzing individual businesses for the investment of one's capital is the only method with a long-term record of success, and that the kinds of novelty vehicles described in the Times story have a long track record of being invented by Wall Street one month, only to be discarded a few months later when something new comes along.

This is something that anyone who lives through times such as these should understand.