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SOMETIMES OUR BEST investments can be a great guide to what not to do—even better than our worst investments. Consider three of my best:
1. Master limited partnerships. In 1999, I read an article by Paul Sturm in the much-missed SmartMoney magazine. It was a comprehensive review of a security I hadn’t previously heard about, namely master limited partnerships (MLPs).
The two decades since have made the unique commonplace. Still, for those who remain blissfully ignorant, an MLP combines the tax benefits of a private partnership—gains and losses are passed through to investors, with no taxes owed by the company itself—with the liquidity of a publicly traded company. Because of the peculiar tax structure of MLPs, investors are able to defer taxes on the distributions they receive, sometimes almost indefinitely. MLPs are mostly limited to oil and gas pipeline companies, another result of the vagaries of the tax code.
To me, they were the perfect security: tax-deferred, cash flow rich, inflation-protected and high-yielding. We’re talking about companies like Suburban Propane Partners, NuStar Energy, Kinder Morgan and TEPPCO Partners. I remember feeling like Miller Huggins reviewing the lineup card for the 1927 Yankees: all heavy hitters and reliable. Would you say “no” to investing in Earle Combs, Mark Koenig, Babe Ruth and Lou Gehrig, and tax-deferred to boot? I bought my fill and was rewarded quite nicely, though the K-1s were a pain in the ass. But who am I to complain? For some 10 golden years, I felt like a youthful Warren Buffett, consistently outperforming the S&P 500 with less volatility.
But alas poor Yorick, no security or investor is perfect. I’ve come to realize that every publicly traded company will borrow to the limit of its cash flow, and investors’ quest for yield is both insatiable and uncompromising. I won’t bore you with the details of the subsequent deleveraging and retail investor flight. But since the Great Recession, my lineup has reliably underperformed the S&P 500. Company restructurings have stuck me with hefty tax bills, reduced distributions and suffering share prices. As Job said, “The Lord gave, and the Lord hath taken away,” and maybe a little more.
2. Monarch Cement Company. In 2015, I started following a contributor on the mother-of-all investing websites Seeking Alpha, whose column was titled “Sifting the World.” This name had nothing to do with my memories as a child sifting flour for my mother’s lemon cake and everything to do with a quote from Charlie Munger. I found Sifting’s investment philosophy to be refreshing, because it was the antithesis of the usual Seeking Alpha analysis such as “Boeing Tanker Fuels Cash” or “Pfizer: Buy It for a Safe 4% Plus Dividend Yield.” Instead, it tended to be event-driven—with a not-so-distant event serving to unlock the value of the recommended security.
In this specific case, Monarch Cement Company (MCEM) had initiated a 1-for-600 reverse stock split, in which each owner of record that owned fewer than 600 shares would receive $30 a share. As the stock was currently trading at some $28.50 and the event was three months away, I was looking at a potential 20%-plus annualized return. I bought 100 shares and waited patiently for my ship to come in.
Well, it never did, as the thesis for this investment turned on the meaning of “owner of record.” In this case, it meant investors who hold shares directly in their name, as opposed to the “beneficial owner,” who holds shares indirectly, through a bank or broker-dealer, sometimes said to be holding shares in “street name.” As I held my shares in street name, my shares were never redeemed for $30 and continued to be worth around $28 to $29.
I was a little embarrassed. But I was also angry and wanted my $30 payday. I placed a $30 sell limit order, which expired unfilled. I promptly forgot about the stock and moved on to my next investment “score.” And I’m thankful I did, as I am still the beneficial owner of 100 shares of Monarch, which are now worth over $100 a share and therefore I get to pat myself on the back thinking about the even higher annualized return that I’ve since achieved.
3. Genzyme. In 2010, my wife hired a personal trainer. She had religiously worked out for years but wanted to take it to the next level. As part of the new training regimen, her trainer had her run up and down stairs at the gym. This struck me as a little odd. I wondered why the trainer had my wife, who wasn’t a spring chicken, running up and down stairs at a gym filled with millions of dollars’ worth of fitness equipment. Then again, I thought, “What did I know about physical training, he’s the professional.” Well, my concerns were valid, as a few days later my wife came home with a very sore right knee, which in time became quite painful and eventually required surgery for a torn meniscus.
The surgery went well, but the knee continued to be painful. She tried physical therapy. When that didn’t get the job done, she turned to having a shot of Synvisc injected into her knee. Synvisc is a drug containing hyaluronan, which is a natural joint lubricant and cushion. It is synthesized from the cockscomb of a rooster—the feathers on his crown. I was a little skeptical. Chicken feathers?
The thing is, though, it worked. Almost as important, it was covered by insurance. In fact, it worked so well that my wife wanted to invest in the company that made it, Genzyme. Now, back then, I was a proponent of fundamental analysis, but my wife was quite excited, and I didn’t want to ruin the moment by mentioning terms like price-earnings multiple, quick ratio or drug pipeline, so I said “yes” and a few days later she purchased some shares for $54.
A few months later, I’m reading The Wall Street Journal and almost fall off my chair when I notice a certain article mentioning that Sanofi (SNY) was buying Genzyme for $74 a share and we were looking at a 37% annualized return. Apparently, my wife was onto something with her orthopedic analysis and, more important, we would be rolling in it. When I returned home from work, I excitedly told my wife the “word” and then started planning how to spend our newfound riches—vacation, new car and such—only to be informed that we owned just 32 shares.
Reviewing my best investments has confirmed what I already knew: Trying to beat the market is a fool’s errand, with outperformance more likely due to luck than skill. The humble investor needs to invest in low-cost mutual funds and have patience. That said, I’ve started putting a little money aside, as my wife is complaining about a sore shoulder.
Michael Flack blogs at AfterActionReport.info. He’s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.
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I agree that trying to beat the market is a fool’s errand, but I think though a minority probably more than most assume end up doing it without trying. After all Voya fund picked 30 stocks in the 1930’s and never sold and beat the market. Look up the article “The Strange and Happy Tale of Voya Corporate Leaders Trust” by Morningstar’s John Rekenthaler. Even beating the market often comes down to merely making fewer mistakes than the rest, and/or not learning or not believing the wrong things. There is always luck involved, but Buffett has it right that American investors won the lottery simply by being born in the right place. But they don’t realize it and end up outsmarting themselves.
macropundit, the article you cite is a very interesting read. Just read the fund’s fact sheets and noticed it has underperformed the S&P500 over the last 10 years (10.82 vs 12.56%) and that the fund was called the “Corporate Leaders® Trust Fund” for 53 until its subsequent management companies decided to change the name three or four times. I assume the new names resulted in better investment returns.
Really enjoyable article, Michael. We had a lot of these kinds of experiences in the investment club I belonged to in the 90s. We would argue when to take profit on some obscure internet start up that had no earnings, or prospect of earnings.
Rick Connor, Thanks for the kind words. I used to find investing in some of these more unique investments quite interesting. And I enjoyed doing the research. Now that I’m retired and have the time, I don’t find it nearly as interesting.
One of my buddies bought as much as he could of each internet IPO all through the late 90s. Since he was wealthy and had a large account, he got allocations. He sold each one after three or four weeks – he knew they were all crap, but would go up for a while.
A lot of the MLP problems were due to regulatory changes. If you own a particular class of investments, you should follow the regulatory environment closely.
Some MLPs reacted by rollups, which limited partners had no say in, and which in effect transferred a lot of their capital to the parent company.
Ormode, Good point on the MLP the regulatory issues and limited partner say. I’ve slowly been extricating myself, but they’ve taken such a drubbing, I’ve decided to wait for at least a modest rebound.
Great piece—it’s nice that once we become “humble”, we can work less and enjoy better returns!
Funny. Thanks for sharing your experiences. I’ve never been that adventurous. I think I prefer reading about them than living them! 😉