1st Qtr Newsletter- April 2020
Keep Calm and Carry On
The coronavirus epidemic has changed our world in a hurry. A few weeks ago the stock market was touching record highs, and now stocks are plunging, schools and restaurants closing, events canceled, and people are afraid to hug their friends. Government has sprung into action by (1) spending $2.2 trillion that they/we don’t have, with no idea where the money is coming from, and (2) reaching for extraordinary powers that in calmer times we never intended for them to have. They say it’s necessary, and we can only hope it works.
Whatever happens in the markets, remember that your stocks are fractional ownership shares of real companies, and they are valuable. Don’t get spooked into selling them at panic prices. When in doubt, hold on and do nothing. If anything, it might be a good time to add to our holdings at attractive prices. The companies may have a bad year, but most likely they will be still standing, and ready to do business, after the virus is brought under control – which will happen sooner or later.
Too Much of a Good Thing? The Investor’s Dilemma
One of the first things they teach at investor school is that we always need to diversify our portfolios. “Don’t put all your eggs in one basket” is good advice, guarding against disaster if something bad should happen to one of our securities. For investment advisors like Monarch, it is actually more than advice, it is our fiduciary responsibility. The objective is to protect you, the customer, by reducing the danger of large losses. One good stock would be all we needed, if we could perfectly see the future; but that is a power not given to us. So we diversify our holdings.
A few years ago we encountered a tragic illustration of this risk, too late to do anything to help. A couple in their fifties had worked most of their careers for the same large Fort Wayne company, but were laid off. At the time we met them, the firm, once a profitable international enterprise, was in severe decline and spiraling into bankruptcy. The pair had saved money since the beginning of their employment, but they had invested everything in that company’s stock, not realizing the risk they were taking. As the business foundered, the stock became worthless – a calamity for them. Both their jobs and their savings were gone, after a lifetime of work. It should never have happened. Too much of their future depended on that one doomed company.
It’s obvious they should have diversified. And yet..……Like some other things in life that seem obvious, it is not always such an easy decision, and a lot of people don’t get around to doing it.
The typical equity investment portfolio starts out with roughly similar sized holdings of several stocks, which will grow over time if we chose well. But they don’t all grow at the same rate. After some years you may find that one or two of the stocks have been hugely successful – a happy development, and just what we were hoping for – but now monopolize the portfolio. You have too many eggs in that one basket. What to do?
A standard tactic is to sell off a portion of your biggest winner, and add shares of something else. That may seem completely backwards, like pulling up the flowers and watering the weeds, but we professionals call it “rebalancing the portfolio” which has a better sound to it. Rebalancing does lower the exposure to your largest holding; there is risk in the other stocks too, but it’s not the same risk. Our own human nature causes us to fight selling even a part of our most outstanding performer. A further deterrent is the capital gains tax, if the stock is in a taxable account. Adding to our anguish is the fact that you can get all kinds of advice, pointing either way. Take your pick.
Another nagging consideration is that we all know of wealthy people who hold concentrated investments, seemingly with no ill effects. Jeff Bezos did not become the world’s richest man by investing in a diversified portfolio, but by owning a boatload of shares in a single terrific company, Amazon. Warren Buffett, a famously risk-averse investor, has most of his enormous net worth in Berkshire Hathaway and doesn’t seem to lose any sleep over it. Likewise the Walton family has a lot of Wal-Mart, Bill Gates has too much Microsoft, etc. In fact, most entrepreneurs gained their wealth by creating a single wonderful investment and riding it up as it prospered. And once rich, they tend to keep it.
It would seem that a concentrated portfolio is a fine way to get rich, but maybe not always a good way to stay rich. Bad things can happen without any warning, especially if you aren’t running the company. As fiduciaries – managers responsible for other people’s money – we at Monarch are obliged to lean towards caution. So yes, on occasion we will recommend shaving off some shares of the biggest winner in your portfolio – even if it makes us cry to do it.
The Jewel in Indiana’s Crown: The Lilly Endowment
The State of Indiana and the city of Indianapolis are blessed to be home to, and a prime beneficiary of, the Lilly Endowment, at $15.1 billion one of the five largest private foundations in the United States. Lilly grants in 2019 totaled $547 million, of which 69% went to grantees in Indiana. The Endowment’s three main areas are Community Development, Education and Youth, and Religion. One of their notable achievements in recent years was the creation of charitable Community Foundations in every county in Indiana. If you look online at lillyendowment.org and check their Annual Report, the list of grants takes your breath away. It is inspiring to see the breadth of interests that are supported. Many worthy organizations simply could not exist without it. This largesse benefits all of society. Without it we would be so much poorer – and not just in terms of money. We can be glad, too, that this enlightened philanthropic fund is managed by community-minded private individuals, who can resist the political pressures that would likely creep in if government controlled it. A private organization, unlike government, can stop giving money to a program if it isn’t working.
The Lilly Endowment was created in 1937 with three large bequests of Lilly stock donated by members of the family, J.K. Lilly, Sr. and his sons J.K., Jr. and Eli. (Those who like to rage against the “greedy rich” might reflect upon this fact.) Of course the fund was a lot less than $15 billion in the early years, but it has grown. Since its founding, nearly $10.4 billion in grants have been awarded.
You might think this wonderful foundation would be showered with gratitude and admiration from all quarters, but in fact they get quite a lot of criticism. About 90% of their investment portfolio consists of shares in Eli Lilly & Co. – not surprising considering where the original money came from. For several years we have read indignant articles and editorials pointing out that the Lilly Endowment is not adequately diversified. Nothing irritates an expert more than seeing his well-intentioned advice ignored; and the Endowment, which for over 80 years has been doing their benevolent work in their own way, has not seemed in any hurry to divest their extremely large holdings of Lilly stock. If anything should happen to that one security, warn the critics, many worthy recipients might get no grant money. It would cause a major budget crisis for the Indianapolis area and for the entire State of Indiana, and beyond.
This concern is justifiable. Like many businesses in the pharmaceuticals industry, Lilly has had good years, but also some not-so-good years. The odds that a highly profitable company like Eli Lilly & Co. would ever seriously drive their wagon into the ditch seems somewhere between negligible and zero. But we might once have said the same about General Electric, and if it could happen to GE, it can happen to other companies.
Yet it is mildly amusing to see the Lilly Endowment being scolded about improper investing practices by academics and journalists who, taken all together, never accumulated anything close to $15 billion. It seems a little arrogant, like telling Babe Ruth he is holding the bat wrong. Talking is easier than doing. We can agree with the critics that more diversification would be a good idea, but at the same time we must respectfully tip our hat in admiration to the Board of Directors of the Lilly Endowment. Their achievement is remarkable. There are plenty of wrongs in our world to complain about, but here we have something that is working very, very right. Let us not be too quick to condemn.
Written by George Donner