Conversation We Cannot Hear

Once or twice before I've mentioned my enjoyment of the very profane and violent HBO series Deadwood. If you are also a fan of the show chances are one of the things you like, you know besides the profanity and the violence, is some of the one liners that the various characters throw out there.

One quote in particular strikes me, it came from the character George Hearst (the picture is of a different character) while talking to Sheriff Bullock. Hearst said "I am having a conversation you cannot hear."

Over the years I have had a few encounters that were investment related that tie in to the quote. When I was working at Schwab there was one fellow there that I came into contact with occasionally (talking late 1990s) named George. George was 71 at the time and this was his post retirement career after having been at General Electric (GE). He was at GE forever and was not bashful about the fact that essentially all of his money was in the stock.

He loved the company, loved the stock and there was no talking to him about the concentration risk he was taking. The stock peaked in September 2000 at almost $60. It closed yesterday at $17.69. I have no idea whether George ever reduced his position or not. Obviously he was not wiped about and while he collected dividends most of the way through (even though the dividend was cut meaningfully) he has a much smaller nest egg than he did ten years ago.

Concentration risk is something he could easily understand but he could not hear it as it pertained to General Electric.

As another example about two and a half years ago one of the guys I fight fires with engaged me in a conversation about real estate. He said you can't lose on real estate with such conviction that knowing him as I do it would have been useless to tell him otherwise.

How many people would not have heard warnings about Fannie Mae and Freddie Mac ten years ago? What about Wachovia, Lehman, WaMu and Bear Stearns? From past periods what about Polaroid? Is Eastman Kodak on its way out? That was a Dow stock for years. Much of the old steel industry in the US is gone.

At various points in history the failure of these companies was simply not possible. I imagine people might have felt the same about Standard Rope & Twine (this was a real company, it was a Dow stock) back in its day.

Any outcome is possible. A given company failing may not be probable but it is possible that any company can fail. Any country can end up not working out despite what we may think. Going back to China from yesterday's post, there is no convincing me that it doesn't work out in the long run but it may not. I sold a position last week targeted at a 2% weight and I could see targeting as much as 5% for the portfolio but that I can go to almost zero hopefully is a sign that I can hear the conversation.

Using moderate weightings mitigates the consequence for conversations you cannot hear. As portfolio management is a series of correct and incorrect decisions, I have said many times putting 3% into a stock that ends up going to zero is not a portfolio deathblow it is merely a bad day. I believe the worst performer I've ever put into client accounts was Macquarie Infrastructure (MIC). For most clients who owned it it was targeted at a 2% weight. I under estimated the impact of it being so transaction oriented and thus reliant on capital markets to function. Despite it being (probably) the worst holding ever I have no recollection of a client even asking about it.

Whether you manage your own portfolio or manage money for others there is no avoiding bad holdings--from time to time you will be wrong. Being wrong is not the thing, the thing is the consequence for being wrong. A 2-3% holding blowing up is not a big deal but at some point a holding becomes large enough that it is a big deal.

If you have a chance, I will be participating in a panel at Seeking Alpha at 2pm EDT about retirement investing. Hope you can check it out.