Everybody else is doing it

Happy Wednesday to all of you!

Today I wanted to talk about a conversation that frequently occurs amongst corporate executives, as well as professional investors. I am going to call the conversation the, “Everyone Else is Doing It” conversation and it goes something like this…

Executive 1: “We have made all of the loans to safe credit-risk individuals that we can. I believe that we should cut back and avoid the marginal, and unsafe credit-risk folks or we might lose a lot of money.”

Executive 2: “Well, if we don’t make the loans to these people our competitors will and then our business won’t grow the way it has over the last 3 years. Besides, we are just initiating these loans, not actually holding them, so they are not on our books for long. And the investors that are buying them are bundling them together to mitigate the risk of a small number of them defaulting on their mortgages. C’mon, let’s do the right thing for our shareholders. Plus, as you know our bonuses are tied to our growth in profits.”

Executive 1: “OK, I guess you are right.”

*****

This is a paraphrased conversation that I had within the last month with a professional money manager. Except that he was defending the executives in the above scenario because had they not made the same loans that their competitors were making, then they would have not grown profits as rapidly and then their stock prices would have lagged those of the bad-loan-making companies. I said to him:

“Yeah, the stock prices would have lagged for a couple of years, but wouldn’t you love to own shares in that business now?”

To which he replied, “Yeah, but there was no such company.”

And I said, “Exactly!” within the super-critical context of the importance to investing and capitalism of sound ethical behavior.

*****

My point is that as a nation of individuals we are at the bottom of the investment food chain, we are the foundations upon which these choices are allowed to be made. Therefore, we have the power to shift this system if we are willing to, first, pay attention; and second, to act. We pay so much attention to how we earn our money, and usually in how we spend it. We will shop for hours or days for a new car, or a new house, but how much attention is paid to how you invest your money?

Here’s how the structure described above works: You own shares in a mutual fund, likely sold to you by a broker or financial advisor. That mutual fund asks you to make choices with regard to its Board of Directors each year. That Board directs the Portfolio Managers and management of the mutual fund. That mutual fund, and all of the others combined, owns the overwhelming majority of the shares of stock in every publicly-traded U.S. corporation. Therefore, the mutual funds nominate and elect the boards of directors of those corporations. And those corporate boards of directors hire the management teams that make bad business decisions because, “everybody else is doing it.”

The first thing to do is to engage your financial advisor in a discussion about how she or he selects investments for you. Don’t lead them in the questioning by revealing your agenda. Listen to see if they say anything about evaluating the ethics and activism of the mutual funds or stocks that they recommend for you. If they do not mention this, then it is time to have a discussion with them about including this as a part of their criteria. If they are puzzled by such questions then let them know that Morningstar has awarded “stars” for a while now for a mutual fund’s quality in governance – that is, in treating shareholders fairly. This “stars” system is separate from the normal “stars” awarded. I am very familiar with this system because the Fund that I used to manage was one of the initial 11 out of a possible 10,000 that were awarded the highest ranking by Morningstar when they instituted the system. At the Davis Funds our ethical standards were firmly in place, but we had as a guiding principle to: “Do only those things that you would want your mother to read about in the newspaper.”

As a citizenry, we can begin to effect the ethical changes necessary to right our nation by living the principles that we preach. Change begins within then can shift to an external focus when the time is right.

Warmly!

Jason

PS – What’s with the jackass governor of Illinois?