19 December 2008

Getting It Wrong

This week I am going to share some ideas that will, hopefully, save you from a large financial loss at some stage in your life. Over the course of your life people will steal from, mislead and generally attempt to swindle you -- if you hit 50 and think that this has never happened to you then you might not have been paying attention!  

Skill-based, achievable, wealth creation stems from two principles:
  • Spend less than you earn; and
  • Protect existing capital.
If you do those two points consistently then your net worth will rise over time.  Sounds easy but it is seldom done effectively.  There are always temptations to cut corners.

Due diligence is time consuming and not much fun -- as such, when I was the new guy at my firm, I got to do quite a bit of leg work checking out potential companies/management teams.  

After a couple quick announcements, I will explain what I learned...

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Tucson and Boulder Training Camps - - we are happy to announce that both of these camp will qualify for USA Triathlon coaching education credit.  Each camp will earn 10 CEUs (the max possible from a single event).  Contact me for more info on Tucson (April) and Boulder (July).  Boulder's dates have been shifted to a Wed-Sun format to better serve working athletes.

Endurance Corner Coaching -- I will be launching an on-line coaching platform in early 2009.  Cost is $25 per week, with discounts if you sign up for a year.  Key differentiator is direct daily access to me, and the EC team.  Specific details in my January 2nd blog.

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Why do research?
Sophisticated investors research companies/management team to reduce losses, not increase gains. 

Promoters do an excellent job of explaining how you are going to make a fortune investing with them. What people rarely do is point out the ways that you can lose money as well as items in their backgrounds that make them high risk business partners.

When you think about the scale of the Madoff scheme ($50 Billion) what comes to mind?  For me, the crime is not the main issue.  What concerns me is the implication for the global economy in 2009.

In 2005, I read Fooled by Randomness and had an epiphany reading Taleb's chapter on Black Swans.  At that time, by way of a personal guarantee, I had over 100% of my assets exposed to a single entity.  The business was run by a trusted friend but my financial health couldn't withstand a Black Swan, so I sold down my exposure.

The lesson we are reminded of with Madoff is that we can all get it wrong.  How does Madoff happen?  Ponzi schemes happen when we allow personal greed and social pressures to cause us to ignore basic investment principles.

Diversification makes the most sense to protect from the unexpected, not to enhance returns.  Right now, I have a 60% exposure to a single bank.  Over the next year, I will be reducing that exposure -- not because I don't trust the bank, rather because the impact of getting it wrong would be too painful.

In terms of the unexpected, fraud is probably #1.  Fraud hits you in multiple ways -- loss of money; loss of time; and risk of reputation.

While it's tempting to focus on financial losses, the money is normally gone by the time you figure out that you've been ripped off.  Pursuing business crime makes sense (and is essential) to help protect future victims, rather than recover assets for existing victims.

I suspect that business crime is going to explode in 2009 -- not because more of it is happening... rather... it will become apparent as the Great Unwinding continues.

Things you can do to limit your exposure to business crime:

Ask questions -- we have an inbuilt inhibition to ask questions in rising markets and public forums (this is one area where I support anonymous posting).  Fraudsters will take advantage of this shared trait -- read Influence, it will save you money.

This Word file link is a mild form of private equity questionnaire but covers the main issues that have cost me money over the years.  If you are using Safari/Mac then click here for an HTML version.

Be willing to walk -- if you get a bad reference then walk from the deal.  Even with this policy, you will make mistakes but you'll make less of them (and that will make you money in the long run).  By paying attention to red flags before investing you will save time, money and protect your reputation.  

From a portfolio point of view, it is a lot more important (and easier) to dump your Enrons, than find your Microsofts.

Get inside -- if you are investing 10%+ of your net worth in a project, or company, then get inside so that you have superior information.  If you can't get inside then don't invest.  VC and Private Equity firms have known this "secret" for years.  

The two main sources of private equity return are leverage and superior information.  Trouble is, as an asset class, the insiders scoop the excess return for themselves.  As well, even the insiders don't know which deals/funds are going to be winners.  They use the same rules -- check up-front & limit losses.  To that the professionals add: maximize financial engineering and access superior information.

Speak to the auditors -- again, sounds simple but it doesn't get done enough.  When you speak with the auditors -- do it independently, without management and speak with the accountant that did the work (not the partner in charge).  

Questions to ask:
  1. Tell me one thing that you found that concerned you.
  2. What was your materiality threshold?
  3. Did you tie all invoices to bank statements for everything above your threshold?
  4. What connected party transactions did you discover?
  5. Did you reconcile large payments to contractual documentation?
  6. Did you reconcile large payments to an approved budget?
  7. What is the approval/payment procedure for large transactions?
  8. Which transactions were paid outside of the normal approval/payment procedures?
Question #1 is a good way to form questions -- people are extremely reluctant to give negative feedback.  So you ask them directly, but for "only one" point.  That opens them up and gets the conversation going.

Write your notes of that meeting up and send them to the partner in charge of the account -- for their file and your own.  The partner will likely come back an tell you that answering all this information was outside of the scope of their work.  Insist on having the work done -- again, it will save you money over the long run.  

If management get upset then assume they have something to hide (it will save you money in the long run...).

The Gipper summed it up best.  Trust but verify.

Maybe Obama will come up with some energizing slogans for what is going to be a very challenging new year.

Back next week,
gordo

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14 November 2008

Reflections on Savings and Investment

This week we return to a more financial-oriented letter. Now that the US election is out of the way, it seems like the bad news has started rolling again. The bad news can seem relentless at times and, following my trip around the world, appears to be happening in the US, Europe as well as Asia.

With the mood (near universally) negative, I've been trying to figure out my long term strategy for savings and investment. As I mentioned a few weeks back, I'm currently projecting a cash flow deficit for 2009. I suspect that I'm not alone in being in that position! Frankly, being able to absorb an unexpected set back is why I've been conservative over the last twenty years. I have been reminding myself that the world isn't ending but human psychology can be tough to counter.

I have also been reminded myself of a few other aspects of investing (at least in my, rather unsophisticated, world).

Ability to forecast -- I have ZERO confidence in my ability to make accurate short-, or medium-, term forecasts and I don't trust my memory about historical forecasting. When it comes to past predictions, I suspect that I tend to forget my errors and remember my successes. Incidentally, this is a large part of the value that an investor/athlete can get from reviewing written logs of past decisions/training.

Timing -- Something about my nature makes me so conservative that I miss a lot of opportunities (not necessarily a bad thing). A friend once made the comment to me that if he'd listened to me then he never would have started his business -- perhaps an exaggeration, but a fair point that I have spent a lot of my life pointing out potential pitfalls to people. Interestingly, the triathlon equivalent of this is that an athlete never really knows when they are going to be in top condition -- so, if you're trying to make a living, then when conditions are right, you need to be willing to go for it. In other words, it's pretty tough to predict opportunity 1, 2 or 4 years out.


So what I have been researching is:
  • What assets do I want to buy, and hold, for the long term.
  • Separate from their current price, what is a reasonable assessment of their long term value.
Once I figure out #1 and #2, I plan on buying every time price gets below value. It sounds simple but is surprisingly difficult -- right now I am struggling to find an asset where I have 25-year confidence on existence, let alone value.

As the above chart shows, I don't think that there is a large rush. You can find the article about the chart HERE. When one is in cash, reading about capitulation is strangely entertaining, another aspect of human nature.

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Global Property Outlook
I had some questions about my views on global property, not just the US. Unfortunately, my research over the last three months doesn't point to any good news. This spring, prices were holding in the prime sector throughout the world. As we near the end of the year, my estimate is that prime properties (UK/HK) have fallen 20-25% in local current terms (in FIVE months). Market participants are not prepared to admit that publicly at this stage but if you actually want to realize cash then market clearing prices are 20-35% off the peak.

The vultures ARE the market. Owner occupiers have, largely, stopped buying.

So my entry pricing advice for non-US buyers would be similar to what I laid out to US readers. Make sure that you have a margin of safety in your entry price and remember that there is very little opportunity cost to renting, versus buying (these days there is an implied option value in waiting).

Take your time and remember that returns from property investment are always overstated because people fail to accurately reflect their holding costs.

That said, a leveraged property investment (where a high quality yield covers a fixed interest expense) can be a good inflation hedge. Still, like most, my recent property investments are impairing my appetite for further exposure. My aversion is why I continue to investigate opportunities.

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The Cost of Time
How does an investor, parent or employer, quantify the true cost of a poor decision?

While a bad investment costs you money. The most costly losses stem from the aspect that never hits your bank account.

What do I mean?

The #1 cost of a poor decision is the time lost sorting out the situation.

Specifically, not having the time to focus on the highest return areas of your portfolio, or life. We make a far greater return from backing our stars, and investing in our strengths, than getting bogged down with losers and weaknesses. High performers have an innate ability to combine passion with inherent ability.

I have recommended this Drucker article before but it is even more important in the current climate -- when we share a tendency to obsess on negative news, sunk costs and weak investment positions.

In challenging times:
  1. consider each dollar (and minute of your time) to be a new investment;
  2. move to limit liabilities and cut-off drains on finite resources (time, energy, capital);
  3. ensure full disclosure to, and honest communication with, all parties; and
  4. make time to identify your highest yielding opportunities.
The four points above are REALLY hard to implement consistently. Why?
  • We tend to overvalue existing positions
  • We tend to overestimate the impact that we can have on a situation
  • We are VERY likely to be part of the problem, rather than the solution
  • Problems rarely turn themselves around in a global recession, with massive liquidity headwinds
So I have started an internal review considering my personal return on how I am using my time and how I have budgeted to use my cash flow over the next year. Looking even further out, I want to figure out my desired life/portfolio 15-25 years out.

Monica loves it when we talk 2033 strategic goals, our lead photo this week shows her coping with more pressing concerns...

To wrap up, I will share the best question I have been asked over the last two weeks...
How much is enough and how will you know?

Back next week,
gordo

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31 October 2008

Family Finances & Bear Market Psychology


Investment strategy is the topic for this week. I am not going to tell you what I think you should do. Rather, I am going to share ideas about how I approach my family's investment strategy and outline some observations from the last few weeks. An interesting article where the author does offer some "to do's".

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Two quick announcements.

Fit Pregnancy -- many thanks to everyone that wrote in. It's been an adjustment -- more for Monica than me. The "fun" part of being Dad is watching my wife morph into an FHM model. The challenging bit is that our daughter seems to be in a pattern of melting down around dinner time. Our photo this week shows me heading out on a walk to chill her out.

Real World Marathoning -- this week finance, next week running. If you have questions about marathon training then insert a comment this week and I will try to address next week.

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Wall Street Compensation
For those of you that wonder what sort of money the folks at the top of Wall Street make -- you'll enjoy the video inside this LINK. If, like me, you pay taxes in America, then you're now paying to keep these guys in business. If you want more detail then this Bloomberg article gives specifics -- wonder how an auto worker feels about this use of taxpayer money?

There's got to be a better way. Watching from the outside, revolutions happen when the elites stray too far from the needs of the people. I sense there's going to be tremendous backlash as the economy absorbs the impact of the Great Unwinding. People will be upset and looking for the federal government to take action -- and -- we are likely to have a Congress in the mood to do just that. It is not going to be pretty.

I suspect that every rich person in America is pulling forward income and capital gains. Tax revenues are going off a cliff in 2009/2010. No matter who wins the election, we're all going to be paying a lot more in taxes. Take it from a Canadian... no free lunch!

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The Great Unwinding
My main concern these days is wondering if the last 20 years were all driven by leverage. Have I lived my entire investment career with a massive tailwind of ever increasing liquidity? Have I fooled myself by seeing knowledge/experience where reality was a global ponzi scheme?

When I look through my best deals -- leverage, and ownership, plays a central role. In fact, even when the gains were "value" driven -- the fact that I was working at a Private Equity fund was a direct result of a huge increase in global liquidity.

If it was 'just leverage' then we are nowhere near the end of the Great Unwinding -- the snap back from two decades of easy money is going to be severe. Our governments are seeking to replace the capital that has been lost in the system. Perhaps the hole is too big? How does the Fed go lower than 1%?

How much further can we lever up consumers, companies, countries? I don't think very much.

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The Psychology of Portfolio Tracking
How often do you track returns?

It makes a big psychological difference in times of stress (such as October 2008). Here is a data set of portfolio returns:
  • 10 yr = 17.5%;
  • 5 yr = 6.2%;
  • 3 yr = 0.0%;
  • 1 yr = -65.0%.
All of these numbers come from the same portfolio, my own. I would have saved myself a ton of energy if I'd been asleep for the last three years! I worked hard for that zero percent return, wonder if I worked smart?

Still, I'm the lucky one - I know people that will be totally wiped out in 2009.

When I compare the family's balance sheet to various equity benchmarks, I can see why folks that have been playing the market have been a bit blue. 1/3/5 year returns are negative (depending on the hour you check!) and 10 year returns are pretty flat. A decade of getting nothing. No wonder Michael Moore calls the stock market "a rich man's game".

Here is where human psychology comes into play. Three years ago, I was concerned over the risk profile of my portfolio, so I sold nearly all of my high risk exposure down. I rolled a fraction of my high risk exposure into a new venture -- which promptly shot up to a paper value of 15x cost, then tanked.

When I talk with people concerned over the current value of their 401Ks... we ask each other... did we really "have" our peak portfolio values? Were you really going to sell a few months ago when it topped out? If not then why does it hurt so bad?!

For me, the 'return' was never there. I wasn't able to take that value off the table, or hedge it, or lock-in any of the gain -- believe me, I tried. Even sold assets at a massive discounts to shift out of risky exposure.

Even when I calmly think it through, I experience a real (and irrational) sense of loss from the movement off the peak. I'm up at midnight trying to write it out of my head so I can get back to sleep...

We are all feeling shell shocked right now. At some stage, we are going to have to pull the trigger and make some investments. Just not sure in what, or when!

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Timing and Asset Classes
Friends, and columnists, are starting to tell me how cheap valuations appear. Speaking from experience, when companies look really cheap, then you had better start checking if the earnings are really there. With the Federal Funds rate at 1%, people wanting to sell you companies priced at 15% yields on current earnings... that should tell you something about the earnings.

When to buy? I see savvy friends (and people like Buffett) buying in the current market (looks awesome on a two week basis). However, I know that being wrong will hurt more than being right. that's the emotional side.

The analytic side runs like this -- where I like to invest (other than core capital) is projects where I am able to increase my return through an employment, or consulting, relationship with the company. Generally, I look for a 20% return achieved through a mixture of current income and long term capital gain.

If you've ben prudent then you can take (a measure of) solace from the fact that we are all in the same boat and you've likely been hit less than others. I've also rationalised to myself that a major economic downturn is a good time to have kids -- perhaps the ultimate in being countercyclical.

When people tell me that I risk missing the boat, I just don't see it. Even if I timed the market perfectly over the last ten years, I would have been better in cash.

That combines with my sense that the Great Unwinding as a lot further to run and a concern over the deflationary effect due to simultaneous global asset bubble implosion.

Besides being right wouldn't change my life that much and being wrong would blow my daughter's college fund.

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A Good Bet
If I was a young couple, or family, then I continue to believe that there will be good investment opportunities this winter in the housing market. I strongly suspect that we will see a very soft property market in early February. Figure out what makes sense now. As we approach the bottom, you will have a psychological headwind against investing.

In figuring out what type of property might make sense -- review the buy:rent equation. That should be starting to get attractive in many markets. In some places you can pick up houses for less than construction value (and possibly get the foreclosed lender to give you a mortgage).

Here is what I'd look for -- you aren't likely to be able to get everything but it will give you ideas on how to evaluate your potential purchase:
  • 50% reduction from peak pricing in 2006/2007
  • 10% under replacement value
  • mortgage payments no more than 80% of your current rental cost
  • if buying a foreclosed property then negotiate a price reduction that is a multiple of any defects you uncover with your survey
Unexpected unemployment is a possibility for many of us -- consider your income security. It probably makes sense to consider a smaller property than you may have aspired to a few years ago.

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Looking Forward
All-in-all, remember that there is still a lot of good out there. It is so easy to get caught up in the negative noise being pumped out by the media. I have friends that don't own shares that are tracking the Dow hourly.

Turn it off... it's not doing you any good!

While far from a blessing, a difficult economic environment certainly makes life more simple. The core items that make Monica, and me, happy are low cost.

As for my own portfolio, I'm not really sure what to do and I can't afford to be wrong. So I'm going to take the Asian solution... wait.

Back next week,
gordo

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17 October 2008

Ethics, Incentives and Enforcement


I suppose a lot of us are talking about Wall Street, greed, CEOs, bankers, bonuses... much of the discussion that I read, and hear, centers around a lack of ethics on the part of people in positions of leadership. With crisis comes opportunity. We have a unique opportunity to improve our financial system.

I am going to write about business but this could just as easily be a piece on doping.

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A lot of poor decisions are rationalized by a belief that the action was justified by the actor being a good person. Given that we each have to live with ourselves, it is reasonable to believe that nearly every poor decision is followed by a post-fact rationalization.

Once we start living a lie, even a small one, we can find ourselves on a slippery slope that eventually leads to moral ambiguity. Far easier to stay a mile away from "the line" then risk the public humiliation that comes from high profile ethical lapses.

During times like these, one can easily see the costs from ethical lapses but it important to remember that our current situation started with a series of small decisions where the benefits appeared to out-weigh the costs. Step by step, the situation progressed until we have a crisis caused by lack of enforcement, excessive leverage and skewed incentives.

So now society, as a whole, pays the price. People are upset and human nature will seek vengeance. I suppose this article is my attempt to help channel that vengeance towards productive progress.

I like to remind myself that we win (individually, and collectively) by maintaining high ethics. Over a lifetime, there is much financial gain to be had by being reliable and extremely trustworthy. Greater than finances alone, there is much love and friendship to be received. There can appear to be short term trade-offs but there is no long-term cost to avoiding false gods (easy money, sex, alcohol, pride, false performance...).

As humans, we need to be wary of situations that screw up our ability to think clearly:
  • weak peer group (social pressure)
  • intoxication (drugs & alcohol)
  • fear or anger (emotional overload triggering automatic response)
  • all-or-nothing outcomes (perception of nothing to lose)
As citizens (coaches, managers, leaders), we also need to consider the incentives that we are putting in place. Are we creating systems that reward cheating? When we experience a lot of undesirable outcomes then it is more effective to change the incentive structure, rather than punish a never ending line of cheaters.

It's for this reason that you'll never get the drugs out of a big money sport, until the money starts to leave because of the drugs. The money is the incentive and sport rewards performance. Speaking from experience, Investment Banking faces a similar challenge.

It is also why draconian penalties don't work all that well to clean up a corrupt culture. The people on the inside have spent years justifying their actions and likely see the rules as the problem. You don't need a code of silence to enforce a corrupt culture because human nature does the enforcement for you. By increasing the all-or-nothing nature of the outcome, massive penalties can make it more difficult, not less, to break the chain.

To really change a dysfunctional culture, one needs to change the incentives.

So what were the incentives that appear to have created our financial crisis:

Top of my list is leverage -- we had plenty of warning that allowing companies, and investment vehicles, massive amounts of debt was systemically risky. We tolerated laws and investment structures that created a massive shadow banking system. LTCM happened about ten years ago. However, we didn't recognize the need to change back in 1998. You'd have be be a fool not to see it now.

The regulations are going to come. If your livelihood, or business model, depends on plentiful leverage then you had better start thinking about your back-up plan. Industries that rely on easy leverage are going to be decimated. I wouldn't be surprised to see laws making hedgefunds illegal. There is going to be coordinated global re-regulation.

Once you reduce the leverage in a system, you immediately reduce the profits available from gaming the system.

I also suspect that we will see laws banning many unregulated financial instruments as well as statutory limits on personal and corporate leverage.

Next is lack of transparency and disclosure. The act of telling the whole world (or at least your board of directors, bankers, employees and shareholders) what you are doing can help clear the mind. Disclosure needs to be compelled because human nature works to keep most of us pretty quiet in group situations.

Compelling disclosure can protect highly motivated people from themselves. Make it a crime (punishable by fine) for a company to have off balance sheet vehicles. If you are not willing to hold an asset on your main balance sheet... then should you be holding it at all?

In the UK, it is a crime (punishable by fine) not to share conflict of interest information with fellow directors. The law goes even further in that one needs to share the conflicts of other directors, if one has knowledge. I suspect that the US has similar laws on the books. So I don't think that a bunch of new laws are required. Rather, I think that consistent application of a straightforward code of conduct is required.

Next is enforcement. How much money does a white collar crime need to involve before there is a legal obligation to call the cops? I asked that question the other day and a lawyer couldn't tell me. A manager could misallocate hundreds of thousands of dollars and there isn't any obligation to call the police. I was amazed.

There is too much judgement given to directors in how they handle ethical issues. The upper echelon of any industry (or pro sport) is a club, the key players know each other and many outsiders are keen to get a seat at the table. If society has a problem with the culture of that club then we need to provide incentives for insiders to clean it up.

Which brings me to public humiliation, the single best deterrent available. While it might be fun to "win" -- letting down our peers and being disgraced... human nature sees that as HIGHLY unattractive. Elites pay attention when those around them are caught in ethical violations. Imagine how Eliot Spitzer's kids felt -- one really needs to be drunk on hubris not to think through how that situation had to end up.

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Forgiveness and rehabilitation -- I'm not from the ban-them-for-life school of ethical punishment. My preference is to disclose; criminally convict (where appropriate); fine; ban for a reasonable period; and log the information on the public record.

Coming back to where we started this article, good people can make bad decisions and a lot of good can flow from a crisis that resulted from ethical lapses. Some examples:

Campaign finance reform -- McCain's actions on reform appeared to flow from the Savings & Loan crisis. Regardless of one's politics, you have to admit that John McCain has achieved tremendous good for his country. Did you watch the video? They should open each session of Congress by having the legislature watch the Obama campaign's "documentary". The 13 minute clip scared the crap out of me and I'm not even a politician.

Cycling reform -- David Millar (our photo this week) has become an advocate for cycling reform. He was caught, he did his time, his actions are on the public record -- now he appears driven to change the direction of his sport.

There are many more examples of good people getting caught (or not caught), coming clean then becoming a positive force for change (via personal foundations or crusades).

I suspect there are many CEOs and bankers that want to do the right thing for themselves, and their country. What we need to do is reduce the leverage they have available; limit their ability to sell unregulated products; enforce existing regulations; and publicly pursue/ban those that choose the break the rules.

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Finally a few specific items that have been swirling in my head.

Mark to market accounting waivers -- John Mauldin is calling for the government to waive the obligation for companies to mark asset values to market. He is making his case by selecting certain assets that are clearly trading below long term value. We are in this mess because of a culture of non-disclosure, hiding bad assets and moral hazard from companies not having to live with the results of their decisions.

Advocating changing the rules, hiding the problem, giving banks time... that is how we got into the mess in the first place. John is a great writer, I read his letter every week, he has most things right, but I think he's got this one wrong. If you don't want to mark assets to market then don't buy those assets.

Compel full, and open, disclosure to create trust. If banks are allowed to hide their problems then we will never get the interbank market going again. Get everything out in the open and, where necessary, grant short-term waivers for capital adequacy ratios.

Government investments in bank equity -- our governments are shortly going to guaranty all our banking deposits as well as invest massive sums of capital into the balance sheets of our banks. I was amazed when Secretary Paulson said that the government wasn't going to seek board representation, or other rights. Would Goldman Sachs invest $700 billion without board representation, veto rights and disclosure requirements?

I suspect that the government is going to get taken to the cleaners on its investments. I couldn't invest $700,000 effectively if I had to rush -- $700 billion? It is likely to be a mess either way.

The money is the incentive, we must drive change at the same time as investment. As an investor, your power is strongest the moment before you invest. Once you've got a couple billion in a company, human nature creates massive inertia. This is a unique opportunity. There will be zero change if not driven by the governments that are saving these institutions. I take a lot more comfort in the British approach, so far.

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Next week, I'm going to change direction and talk about Fit Pregnancy! Monica says that she really appreciated reading articles that athletic women wrote about their baby experiences. She's not a writer (but she makes really nice handmade cards...) so you'll have to read the story second-hand from Papa G.

Happy Fall,
gordo

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20 September 2008

Financial Security and Capital Allocation

Financial security and capital allocation are the topics for this week's letter. I have been wanting to write about these for some time. What a background in the capital markets -- a very rough week for people.

I am extremely busy on the business front.  As you can imagine, we face a very challenging time in UK Property.  If you are waiting for an email reply then I will get to you, just need some more time. Each day, I have had to parcel my energy, prioritize tasks and schedule recovery.

OK -- a couple of announcements...

***I turned on comments so that so we can interact. Take it easy on me. You'll find that moderation is 'on' so I need to review before they go live.

***
Endurance Corner Radio has podcasts from Joe Friel and Chris McDonald. Send feedback to D.J. J.D., who is leading our effort.  Joe is talking about his background (very interesting) and training. Chris explains how we can break Chris Lieto's course record at IM-Moo by using IM-Loo as part of our taper -- its easy if you just follow his point-by-point instruction for race week...

***Joe is going to be speaking at our Boulder Triathlon Camp next July. The camp is open to all levels/distances and will have a mix of hands-on instruction, training and discussions. Cost is $1,250 -- drop me a line for more details.  We've got some great speakers lined up.

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Who knew the markets would melt down? Personally, I don't blame the short sellers. They are only acting on what insiders and smart researchers have been telling us for months... our financial system needs to be recapitalized. Massive global deleverage is tough. In my own ventures, it is the main cause of the difficult situation faced by friends and clients. 

What lessons can we learn?

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Acquisition of capital is different than borrowing debt. Because debt comes from third party sources, we need to be wary of the tendency to view it as 'free' money. When I work with individuals, or companies, that run into trouble, it is often a crisis created by borrowing to the maximum extent permitted. Permitted under law, permitted under debt agreements, permitted by running X creditcards. An appropriate amount of leverage is well, well below the maximum that can be borrowed.

To me, capital in its most simple form is cash and liquid assets. Before we talk about how to allocate, let's consider how to acquire:

1 -- spend less than you make
2 -- pay yourself first


Physically, I have been overweight before. When I was heavy, I would often wish that I could wave a wand and "be thin". If I could just get a chance to start all over then everything would be alright. I would tell myself that I wouldn't make the same mistakes again.

Finances are a lot like that. When we have no capital, we can spend a lot of time wishing that we had capital.

Physical fitness is just like financial health. Until we take actions, and create habits, that change the direction we are heading... we will keep heading the same direction. We have to make the change.

The two tips that I shared above come from
The Richest Man in Babylon -- a good read on the topic of personal finances. I like that book because it doesn't make things too complicated.

3 -- Protect core capital.

What is core capital?  Put simply, it is capital that you cannot afford to lose.  Having no assets at 65 years old is a far different situation than being wiped out in your 20s.

At 40 years old, my view on core capital is ten years living expenses.  While the income from that capital doesn't come close to covering my living expenses, it does give me years to adjust when faced with an unexpected setback.  Across a full career in business, we can be certain that we will face multiple setbacks.  After the past 14 days, the importance of core capital has become very apparent. 

How do I protect core capital?

4 -- Be wary of leverage.

My core capital is completely unleveraged.  While this reduces my return, it greatly reduces the risk profile on my portfolio.

I go even further in that I don't care about my investment return on core capital, I care about safety.

Within my business projects, I am willing to use leverage but, these days, only with capital that is above my core capital.  Why am I so conservative?

5 -- You only need to achieve financial security once.

By following the basic principles in my book recommendation you can give yourself an excellent chance to achieve financial security over your lifetime.

Sure we are exposed to Black Swans but you can stack the deck in your favor if you educate yourself and stick to the basics.

It is surprisingly difficult to stick to the basics.  We let our guard down, we cut corners, we are less careful.  We need to be constantly vigilant!

++

For capital allocation, my first consideration is
where I will be living in the future.

This is important to make sure that I have assets (and currencies) that will balance my future liabilities.  While I don't trade currencies, I consider purchasing power parity when deciding about large investments which match, or don't match, future plans.

I don't have a lot of sophistication in my review -- I look at things such as daily living costs, relative prices of accommodation, interest rates.

When I think about property purchases, I am very specific -- seeking good value, in a specific neighborhood, of an appealing city.  I define value back to my long term currency.  For me, that means converting back to USD, the US is my likely home.

The cities that I really like are: Edinburgh (GBP); Paris (EUR); San Francisco (USD); Hong Kong (quasi-USD).  I don't have any exposure to those markets presently but I keep an eye on them.

Currencies that I like are USD (matched to long term liabilities); CHF/EUR (long term stability).  Some people like Singapore dollars but you only need to look at a map to see that there is real political risk in the neighborhood.  In terms of Asian exposure, my preference would be a moderate yielding real property investment in Hong Kong.

++

When I was starting out, I thought that it would be nice to "be rich" -- whatever that means.  Along my journey, I have realized that wealth is neither the goal, not the benefit of financial security.

The two main benefits are ethical reinforcement and personal freedom.  If the pursuit of wealth forces you to compromise your values, or ties you to unpleasant situations... then one really needs to consider if that is a benefit at all.

Following the events of this past week, a very relevant consideration.

gordo

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05 September 2008

2008 Review, Part Two



This week’s letter is about taking the time to consider the long term implications of our current choices as well as offering some insight into how I approach my personal planning.

The photo above has me thinking about some additional adjustments to my TT position - I will be tinkering this winter!

+++

If you haven’t been to the Alternative Perspectives page in a while then you might enjoy two articles from Coach Kevin Purcell. The most recent was a thought provoker for me and very enjoyable.

2009 Boulder Camp – I am very happy to confirm Joe Friel and Bobby McGee as guest coaches at our Summer Triathlon Camp. Joe and Bobby have been instrumental in my athletic career and share more than fifty years of collective coaching experience.

As a reminder, the camp will run from July 20 to 25, 2009. By letting you handle your accommodation and morning meals, we have been able to set the cost at a very affordable $1,250. This camp is open to all abilities, all-distances and will have a balanced focus between skills development, triathlon training and athlete education. To confirm a slot, please drop me an email.

Two book recommendations for you: FIASCO is a great read about structured products and investment banking – it fits with my observations from a career inside the financial services industry.

Website Optimization is a good read for anyone that runs a web driven business, or brand. The book made me realize how little I know -- lots of easy ways to improve the reach of my writing. I read the book with pen, paper and a high speed internet connection. I approached the read like a "workbook" taking notes and making changes to my website outline.

+++

I was walking around Edinburgh this week and noticed that it is impossible to see a credit crunch. The buildings don’t know who owns them, or the prices that we place on them. That realization settled me down at the start of a very busy week. The UK faces challenging economic times.

My trip to Scotland confirmed suspicions on the state of my personal NAV. Long time readers may remember that I sold my UK property exposure in 2005/2006 and used a portion of the proceeds to help establish a Scottish residential property developer. While the development business is stable, the market outlook for sector is weak.

I’ve seen a big reduction in the upside component of my personal portfolio and a stack of paper profits went up in smoke. My marked-to-market net worth went down significatly in 2008. No wonder investment banks are looking for a way to avoid reporting the true market value of their illiquid securities. It was a (very) good thing that I am not personally leveraged -- I would be toast if I was a hedge fund.

Interestingly, prime residential rents are way up in Scotland. We have seen a 50% increase in our portfolio yields over the last three years and, I suspect, there are more rental increases to come. The upward yield shift gives comfort to our bankers (in a time when they aren’t hearing a whole lot of good news).

We haven’t seen any evidence of forced selling by developers. This could change if the main lenders take a hard line but, to date, all the key participants seem content to sit-it-out until market conditions improve.

Times like this are potentially volatile because if everyone is doing nothing then there is substantial downside risk if assets (at the margin) are forced through the market. Prices always move at the margin and, in a thin market, the actions of a few can impact the balance sheets of the many.

+++

The Tri Biz
While there isn’t much that I can (or want to) do with my personal balance sheet, I have taken a hard look at my personal profit and loss account.

Over the last three years, my largest single expense category has been “triathlon”. In 2005, I downsized my sources of triathlon revenue to create space for a big increase in my financial consulting business. The net cost of doing that was probably on the order of $100,000. I suspect that is a much smaller cost than many athletes bear when they downsize work commitments to focus on qualifying for World Champs. A single year off as a doctor, investment banker or CEO can cost a multiple of my figure.

I’m fond of saying that the easiest way to increase net income is to reduce personal expenditure. I remind myself of this because the consumption treadmill is a seductive trap, constantly marketed to us through the media.

In my annual review, I look at my expenses (current, projected, core and surplus) as well as my revenues (current, projected, downside, potential). I would encourage you to do the same.

Why? Because we always underestimate the large effect that small changes have over the time lines of our lives.

$33K per annum, for seventeen years, at 4% is $782,000.

By taking action to eliminate my net triathlon cost (today), I can finance my unborn daughter’s college education (tomorrow). Of course, all this is contingent on not spending the money elsewhere, or being miserable with the change. We can take cost control too far.

For me, starting a business helps spending discipline. My accountant tells me that the IRS will "help" further by disallowing losses if we lose money for three consecutive years. As well, I have considered bringing in a financial partner to create social, and profit, pressure. There are a lot of benefits to 100% ownership (see Raising the Bar) but I also benefit from having obligations to people I respect.

My game plan for personal expenditure control:

***Focus on the training camps that I am hosting Tucson (April); Epic France (June); and Boulder (July). Last year, I attended nine training camps and only one made a positive contribution to Gordo Incorporated.

***Consolidate the best of my writings into a single location for you (the reader) to access easily. The best marketing lesson from my triathlon experience is “give away good information for free”. Helping people is fun and creates massive goodwill. I have a stack of content spread between five websites. My content is underutilized and tough to access.

***Place my library within a website where I will be able to combine: (a) my coaching skills; (b) my writing skills; and (c) my enjoyment of helping people learn from athletics.

My financial consulting business has (effectively) total concentration with a single client. I am a big believer in the value of concentration (and the illusion of diversification). However, small things matter over long timeframes… one, or two, additional relationships will make a difference.

The benefit of my business model is it fits with my desire to main freedom of location and schedule. Commitments given to clients limit my freedom of occupation (somewhat), but I love working and there is a fair exchange.

An up-coming letter will discuss (in detail) my current personal portfolio strategy. While my outlook hasn’t changed, my portfolio structure changed (due to those paper profits evaporating).

+++

The Truly Precious
Because time is far more precious than money, I also do a time inventory. I have become provicient at considering my happiness return per hour. Still, it takes constant pruning to maintain a high quality life.

There are clear requirements to a long term focus on elite athletics. These requirements have associated costs that can increase over time.

Financial – outlined above.

Structural – to run well in triathlon, I need to maintain a high level of annual run volume. Having spent most of 2007 walking around my house in fluffy slippers (to comfort bruised feet), I know that the required level of volume is wearing my feet out.

Emotional – I don’t know about you… but I am not a whole lot of fun from three to eleven weeks out from a key competition. I used to get around this by living alone in the spare room of a fellow endurance athlete, or hibernating upstairs at my house in Christchurch. The IronMonk-gig worked for athletic performance but lacked in terms of emotional well-being. I have increasingly found that I can’t be the husband I want be while spending 20 weeks a year on the knife edge of human endurance.

Monica is so completely loyal that she’d back me for another five years of relentless focus. She respects me too much to offer the soft option of backing off to please-the-wife. I didn’t truly understand the brilliance of doing that for your husband until this year. If you are married to somebody like me, it is the best way to ensure peace of mind in your man. I’ve got a couple buddies that have managed the freedom but haven’t (yet) found their peace. Don’t think that I’ve necessarily found any!

Addicts come up with all sorts of ways to justify their actions. Generally, I am only able to fool myself for five to fifteen years at a given vocation. Increasingly, I find better and better things to focus on. Fatherhood represents another opportunity for self-knowledge.

I have been truly fortunate to have the opportunity to spend much of the last decade living as an elite athlete. It has been a tremendous experience and worth all the overtraining, financial costs and other occupational hazards. I rarely regret the past, even my mistakes and “hard times”.

One of the main hazards of objective decision making is caused by a combination of consistency bias, overvaluing what we own and overweighing sunk costs. “I have given up too much to change course” is a common thought pattern that can skew clear judgment. There are also tremendous social pressures that we place on each other to remain consistent in approach. We have an in-built bias against “flip-floppers”. This is a bit odd in a world where most of our key decisions are made against a background of incomplete, and changing, information.

I have always enjoyed “doing what it takes” and, I suspect, that most obsessed folks are excellent at getting the job done. Seeing this trait, could be why Monica likes me to have a project. Too much idle time leaves me short on endorphins.

It’s an interesting time for me. With my sport, increasing costs are reducing my enjoyment from doing what it takes. Frankly, I’d rather be a world class person than a world class athlete. I am fortunate to have been exposed to role models that manage to do both.

Since 2004, I hoped that winning Ironman Canada would give me a fairy tale ending. Just like Monica, Life doesn’t appear to have offered me an easy way out.

Back next week,
gordo

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01 August 2008

Buy Signals & The G-Zone

As you can see from the picture above, wild animals have moved in with us. The kittens have a few strange habits but, all in all, are a good addition to the team.

This week I'm going to share some ideas about what I am seeing in the financial world as well as discuss how July went for me (in an athletic sense).

First an announcement on 2009 Training Camps. Right now, I have committed to three training camps. Each camp has a slightly different focus that I'll touch on. If you are interested in more information on any of them then drop me a line.

Side note -- cyclists are welcome to any of the Endurance Corner camps, the swim/run aspects are optional.

Endurance Corner Tucson Camp -- March 29 to April 5, 2009 (Sun-Sun), training will run Monday to Saturday. An early season camp with a "training" focus. Appropriate for 13 hour and faster IM athletes -- as well as -- 6 hour and faster Half IM athletes. Highlights will include Mt Lemmon, Cactus Forest Trail, Kitt Peak and Madera Canyon. We will be based at The Hotel Arizona -- camp price is all inclusive for the week ($2,350).

Epic Camp France -- June 13 to 22, 2009, training will run Sunday to Sunday. It must be the Kiwi Winters but John and Scott have upgraded our initial thoughts on route. This one will be doozy! Highlights will include the Galibier, the EmbrunMan Bike Course and Stage 17 from this year's Tour (Embrun to Alpe d'Huez, massive). We will finish off the camp with an EpicMan competition that includes a TT up Alpe d'Huez -- camp price is all inclusive and expected to be ~e3,300. Epic Camp is only appropriate for athletes in sub-11 hour shape -- be prepared for up to 27 hours of training in the first three days of the camp.


Endurance Corner Boulder Camp -- open to all abilities, all distances -- July 20 to 25, 2009. Camp starts the Monday following Boulder Peak Triathlon. Camp will mix education with training.

During the day we will take advantage of the outstanding terrain that is offered in, and around, Boulder. Evenings will include expert speakers on a range of subjects (nutrition, mental skills, building your training week, getting the most out of our bodies). The price point on this camp will be lower as athletes will sort their own breakfasts/lunches/accommodation/transfers -- we will handle support, sag, sports nutrition, and dinners. More info to come -- drop me a line if you want to reserve a slot.

If you've been looking for an opportunity to train with me (and my network) but were concerned about your "speed" then the Boulder Camp is a great opportunity for you. It will be an active week that blends physical fitness with education on performance and personal wellness.

Speaking of personal wellness... Alternative Perspectives has a great piece from Kevin Purcell about a number of different factors that relate to endurance sport and exercise. Click THIS LINK to check it out.

===

Buy Signals
There hasn't been a whole lot of good news on the financial, or economic, fronts recently and this has started to impact my outlook. Here are some of the things that I have been reminding myself over the last little while:

Pricing -- prices move at the margin. Stepping back from commodity markets (which I don't understand), the "margin" appears to be characterized by increasing supply, reduced ability to pay and increasing risk premiums.

Transaction Volume -- the people that I know with the capacity to pay are staying on the sidelines. A few are dabbling in commodities but no one is, yet, investing real money (for them). Regardless of what they say publicly, I don't see the international banks doing much external lending. As I wrote a few months ago, what seems to be happening is internal discussions on how best to sort their existing client relationships. Done properly, an active restructuring of loan portfolios could prove to be profitable for the banks (and painful for the shareholders of non-performing loans).

I started my career in the early 90s when asset values were falling, PE ratios were (relatively) low and leverage was only available on conservative terms. In that market, my firm made solid profits from backing solid management teams and cash flow businesses. However, what really helped was multiple, liquidity and leverage expansion (a tailwind of mushrooming global liquidity).

I've been thinking about how one might profit when things turnaround. Haven't come up with anything -- although I have put any US property investments on hold while the financial sector's liquidity position continues to weaken.

Another thing that I remind myself of... the world isn't ending. Times are tough for the people at the "margin", no doubt about that -- if you are working in a factory building SUVs then there will be very real stress. However, broadly speaking, the economy is rolling along, slower but still moving.

Given the scale of the write-offs in the financial sector, the economy is doing well. Perhaps there is a longer lag effect that has yet to be seen. I expected the impact from last summer's credit crunch to be larger and more severe. My contacts in the banking sector lead me to believe that there could be a wave of "action" coming towards the end of this year. In the past, I've found that most large organizations prefer inaction, over action, in a crisis situation.

If the banks start taking clear, consistent action on their loan books, that would lead me to believe that we are through the worst of the crisis. Right now, most organizations continue to consider their options.

+++

The G-Zone
I am typing this blog from the base of Mt Evans, Colorado. My training buddy, Ed, is likely heading down from the summit. I missed the summit due to fatigue -- my high altitude run training seems to require extended recovery. Even with the extra fatigue, I love it in the high Rockies.

Ed made the observation that many triathlon writers have a background current of anger in their blogs and forum posts. The anger is something that I have noticed and stopped reading certain sites/writers because of it.

Perhaps anger is too strong a word -- a better way to put it might be "grumpy". I was swapping emails with Tom and Scott the other day. Tom made the comment that his training approach was designed to avoid getting too grumpy. Scott was forgiving me for an email that was sent
during a very grumpy afternoon!

So maybe that is another early warning signal that an athlete may have done enough training... when we move from being fatigued into the Grumpy-Zone.

I called Monica this morning from Vail and made sure to point out that I was merely tired, not grumpy. She chuckled and said that the drive back to Boulder offered plenty of time to enter the G-Zone.

Anyhow, when guys as experienced as Evans/Molina warn about the G-Zone... it might make sense to keep on eye on it. When the world starts to drive us crazy, perhaps we are simply a little over-reached.

Cheers via bootleg wireless in the high Rockies,
gordo

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08 June 2008

Poor Charlie's Almanack


I am going to change gears from the tri-writing of the last few weeks and write about some personal and financial ideas.

Before we get into that a few announcements.

Boulder Summer Training Weekends -- we have a couple of slots left in each of our July and August camps. Full details here -- The weekends are a mixture of training as well as a chance to sit down talk with the EC coaching crew.

Epic Camp Italy -- starts this coming weekend. You can follow the action on the Epic Camp website. Scott and Johno have come up with a very challenging route. Should be entertaining and I am glad that I've taken my preparations seriously. Unfortunately, Mike Montgomery won't be able to join us so it looks like Molina is the man-to-beat for the campers with Pink Jersey aspirations. I have made a promise to myself that I won't tack on a single bike kilometer so that probably rules me out of the overall competition.

PodCast -- I did an interview with Mark Byerley, a fellow Canadian based in Waterloo. You'll find MP3 and WMA versions HERE.

+++

Alan wrote a fun piece about his thoughts on athletic performance. I enjoyed it and can relate to a lot of what is in there. Thoughts that flowed...

In life, participation trumps performance -- however, successful performance helps maintain participation.

If it really is all about participation then playing the "performance game" can be a good way to keep going. If tweaking, experimenting and fine tuning keeps you heading out the door then its all good!

I need to maintain an open mind about the sources of other people's motivation. Motivational tools that work are important.

I have a lot of respect for 'scientists' (and coaches) that front up and get out there. There is so much about sports performance that we don't understand. If we get all the MSc's/PhD's out there then we're bound to learn some more!

AC wrote about heading towards the end of the first half of his life. That caught my eye as I have started preparing my 40-year plan that will take me to 80 years old!

I have been reading Poor Charlie's Almanack a great read and a reminder about several keys to successful living, and investing.

The best tip (so far) is to approach your lifetime investing as if you have a twenty punch card. Each time you make an investment, it costs you one punch. Consider a 40-year investment career with twenty key decisions. That really appeals.

The implication of this approach (for me) is that we want to think very carefully about each investment and be highly selective. When we bet, make a substantial investment, with a margin-for-safety built into the price and ensure capital preservation.

This is great advice -- thinking back, my investment track record is dominated by the performance of my five largest investments. Get rid of those five deals and my personal track record would be below average. I have never been diversified and have had poor returns from my limited stock picking. I would be ahead if I removed all my small investments // every one that I ever made. As a portfolio, they had a poor return and sitting on cash would have been superior. I appear to lack discipline when I am not committing a substantial portion of my net worth.

Munger is a fan of Ben Franklin (see section on Virtue in the link) and points out that Franklin reduced his commitment to business when he was 42 so that he could focus on his writing, science and other interests. Thinking about Franklin triggered the decision to consider the second half of my own life. The key questions that I have been pondering:

What are my values?
Where do my greatest skills lie?
What can be achieved when these combine?

I recommend the Almanack to you. I have the Second Edition and it looks like they just revised with a Third Edition.

Not sure about internet connectivity in Italy -- if I can get on-line (and have the energy) then I'll update from Epic Italy. Otherwise, I'll be back the week of June 16th.

Cheers,
gordo

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03 May 2008

US Property, May 2008


This week I will share some thoughts on US Property.

I'm enjoying my last afternoon in Southern Arizona. Tomorrow, Ben (from the February Snow Farm camp in NZ -- in photo above) and I will head north to Phoenix. Then on to Flagstaff and a repeat of the Canyon run. Monica warned me not to be a hero and JD's advice was to PB by "one second" so... I think my pals are telling me not to fry myself when we head to Phantom Ranch on Tuesday.

Next week, we follow the same route back to Boulder with one modification -- inserting a ride from Cuba, NM to Los Alamos, NM (the long way via Jemez). We drove that road to end our April trip and the climbing is too good to miss. Back-to-back centuries from Farmington to Los Alamos will put the final touch on my preparations for Epic Italy.

Dr. J was trying to figure out why the camps are so much fun and decided that the best aspect is the fact that we offer every camper an opportunity to challenge themselves on each day. You don't have to take the offer but it is there. Sharing those sorts of experiences with people is a lot of fun for us. We'll be running the Tucson camp again next spring as well as adding a mid-summer camp in Boulder. The camps tire us out but it is a "good tired" and provide me with a role to play as I age.

Come along next year and you can benchmark yourself against my Mount Lemmon time -- I do well on anything uphill over 20-miles...

+++

US Property
I told Monica that I was thinking about giving myself the week off from the blog and she suggested that I write about property. Perhaps, she was hoping that if I write my thoughts down then I might not have to act on them.

Here's a summary of the key articles that made it through my media filter this past week. Given that I was training an average of five-hours-per-day with the campers... you probably heard even more than me...

***Declines in median prices of over 20% in Sunbelt and Southern Californian locales.
***Pundits talking about further declines over the next six years.
***Unsold inventories double normal levels (Nationally).
***Continued write-offs and rights issues in the financial services sector.

Looks to me that both Mood and Money are heading down. Financial historians note that the property market is like a giant aircraft carrier... slow to turn but, when it does, tending to overshoot fair value.

I suspect that everyone in America knows someone that has had their house repossessed in the last year -- that is going to color all of our judgment as we hear more of these stories.

Towards the end of last year, I recommended that aspiring homeowners get their Net Asset Statements and Revenue/Expense budgets in order. Have you done this? In order to position yourself to take advantage of potential buying opportunities you need to have your financing, and finances, in order.

We are thinking about buying an investment property (not second home). Here are my criteria:

***Climate opposite to Boulder, CO
***Would enjoy using during vacant periods
***Less than 1% annual holding costs
***Forecast net yield (after all expenses) 10% over treasuries
***50% capital upside over a ten-year view
***Entry price less than $200 per sq foot
***Superior location in a prime destination
***No leverage purchase -- don't reach financially

Sound like a good deal? It does to me -- perhaps a bit "too good" for this stage of the cycle. To hit those numbers I would need a vendor to accept 15-40% less than their current asking prices. However, having done my homework, my bid price is 10% less than the most recent deal that actually completed and therein lies a tip...

Figure out what an asset is worth to you, prior to anchoring with the price expectations of the vendor


This is important all the time but even more essential in a declining market with constant negative information. By figuring out a price at which you are "unlikely to be wrong" -- you have a much better shot at being right over the medium- to long-term.

What are the signs that a target market might be poised for a large correction?

In this environment, I would look at the mortgage service cost relative to the cost to rent. Even with the recent corrections, many markets have rental costs that are fractions of the cost to own. Given large inventories of unsold homes, rental increases are unlikely. Given weak mortgage markets, mortgage costs are unlikely to fall. That leaves the most likely adjustment mechanism to be capital depreciation.

Potential buyers are building in expected price declines -- no one in the nation is expecting prices to rise. Most owners are holding depreciating assets -- we all HATE holding depreciating assets. At some stage, vendors will sell to remove the pain of a thousand paper cuts.

If you rent with a view to buying then negotiate strongly on early termination provisions -- the more Blue Chip your profile, the more aggressive you should be on all terms.

The ability to complete quickly will be seen as highly attractive by sellers. Vendors are going to get increasingly keen.

On the corporate lending side, I have not yet seen credit contraction in line with the capital that has been written off by the financial sector. I suspect that the front line banks are current preparing strategies for how they will deploy, preserve and recover capital over the next 12-18 months. When we start to hear about rising corporate bankruptcies then we will know that we've moved into that phase of the credit crisis.

Here are three things that I keep hammering into myself when I'm thinking about making an investment:

#1 -- I don't "need" to do deals (doing nothing is OK)
#2 -- I desire to make good investments
#3 -- Above all else preserve capital (for me, the time for "betting big" was 10-20 years ago)

Be prepared, attractive buying opportunities will present themselves to educated investors.

Until next week,
gordo

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14 March 2008

Happy As Stu


A little over ten years ago, my good friend Stuart was run over after a big night on the town. This past week, a friend of mine (Kristy Gough) was killed while enjoying a Sunday morning bike ride.

When I heard that Kristy had died, my thoughts turned to three people: my buddy Clas, my dead pal Stuart and my wife Monica. At some level, I realized that I ought to be thinking about Kristy but that didn’t happen. Instead, my first thought was for the survivors, most specifically, my friend Clas. Kristy was the first young person close to Clas that died unexpectedly. Stuart was the first young person close to me that died.

I was able to speak with Clas this week and he reminded me that it is wise to live _every_ day. Clas noted that it is often tempting to live for a future day (world championships, a key race, or even retirement). The death of someone close to us can be a trigger for considering a wider view of personal success.

I think about death a lot – some days when I am riding, I wonder about each truck that rolls up behind me. Out on my run last Tuesday, I reflected on Stuart’s death and asked if I had been wise with my extra time – 127 months and counting… I wondered if I had any obligation to Stuart, or Kristy, and what they would have wanted for me, for us. If anything good comes from a death then it is likely the fact that the survivors take a moment to consider the daily choices we make. Stuart’s death didn’t trigger any changes in my attitude (my divorce had a more powerful effect) but reflecting on his death (weekly/monthly) helps me focus on my limited time.

Ten years on, I am certain about two things: we got Stuart’s funeral right and my extra time was well spent.

As I ran in the rain last Tuesday, I said a prayer that Kristy’s spirit, and the people around her, find peace in the weeks to come. I tapped my prayer into the road and felt the vibration in my heart.

Thanks for the memories.

+++

Gates Investing

Over the last few months, I have started asking myself the opposite of the answer I am seeking. Sample questions:

What do I know won’t work right now?

What options are clearly the wrong decisions?

What would I do if money was no object?

In my SnowFarm notes (published below a few weeks ago) – you will see that Renzie talks about a disaster cascade – to locate our self-defeating patterns write a list of every action required to turn a situation into a total disaster. Then search for the actions/patterns that you undertake within that list.

In these uncertain financial times, I ask myself the question, “What if capital wasn’t a constraint?” By removing financial return criteria, I find it easier to understand the underlying need that I am seeking to fulfill. Vacation homes, automobiles, property investments, share purchases, clothes… I spend time considering the “why” behind my motivations.

I often catch myself justifying purchases on the grounds that they are “investments”. If you look carefully inside most marketing pitches you will see the underlying message that you are “investing” in something. The rationalization of investment (in fitness, in health, in property, in stocks, in IRAs, in peace-of-mind…) can be alluring.

It is often a trap… the salesman nearly always enjoys more benefit than the purchaser.

++++

Stepping Up

Various ideas on commitment from people that have helped others achieve success:

Joe Friel talks about athletic success arising from the smallest dose of the most specific training required to achieve the goal.

Dick Jochums reflects that people will do the minimum to achieve their goals.

My dad shared his personal investment strategy of the smallest investment required to maximize his personal return from a situation.

We share a common bias to underestimate our workload and overestimate our work capacity.

In private, many of my “successful” friends note that most people don’t seem to work very hard. While some may be lazy, I think that work-drive has a mix of generic and environmental influences. Probably the greatest thing that we can do is surround ourselves with people that are good at what we want to achieve – if we lack ability, or drive, then it will quickly become clear as our peers leave us behind. At this stage, many people will move into denial -- seeking a change in protocol, or coach.

With my aspiring clients, we spend significant time identifying patterns/habits that limit work capacity – it is not until the circle of success is established that we concern ourselves with the workload. In my view, this approach maximizes the achievement each client will achieve relative to themselves.

The other approach is to lay out the training required to be a champion and invite people to “step up”. Our sport is littered with coaches that ruined themselves, and others, with this philosophy.

I wonder if one champion is worth dozens of carcasses.

++++

Shorting Europe

I’m bearish on Europe relative to the US. Having spent two weeks on the far side of the Atlantic, I can not see justification for the relative value differentials between the regions. London, in particular, strikes me as a place that will take a lot of pain as global liquidity unwinds.

I think that we are in the early stages of the liquidity effects that we are going to see over the next three years. The sectors that most benefited from leverage are still in denial.

++++

How Companies Die

Within our property development business, we have not seen any distressed deal flow since the liquidity crisis began last summer. My business partner takes this as a sign of the strength of the prime sector. He could be right. However, I had the opportunity to bend the ear of a senior banker last week with this scenario…

Summer 2007 – Credit crisis hits and the weak companies run into trouble. However, hardly anybody realizes that they are in trouble – things have been too good for too long.

Winter 2007/Spring 2008 – Management can normally hide a poor portfolio for at least a year. They have a strong incentive (their jobs and equity investment) to keep the situation private for as long as possible. Lenders are concerned but the full extent of the trouble within their loan portfolios isn’t apparent to them. All their clients continue to report “business as usual”.

Spring/Summer 2008 – Smart lenders and savvy equity investors notice that they could be in trouble – stakeholders start internal investigations while praying for market conditions to improve.

Summer/Fall 2008 – Crunch time. Weak companies have security called, shareholders in negative equity positions are washed out.

Fall/Winter 2008 – Reality sinks in, prices shift downward to market clearing levels, transaction volume rises.

I am unlikely to have the timing right but that was the pattern that I witnessed in the early 90s.

Only hedge funds and investment banks die fast – in the real economy, companies die slowly.

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Right now, I am looking out my window to fresh snow in Boulder, Colorado! Next week I will be writing you from (hopefully) sunny Tucson.

Our triathlon training camp runs March 22-30, we have one slot left and it could be you enjoying the sun alongside us! If you are interested then please drop me a line or send an email to mat @ endurancecorner dot com.

Battening down the financial hatches,
gordo

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08 March 2008

US PPP, UK Property and Sports Knowledge


Check out that photo... Makes me want to ride! In three months time Epic Camp is heading to Italy. Johno and Ian are perfecting the logistics for how we will get up the Stelvio Pass (pictured). If you would like to join us (June 8th to 15th) then drop me a line with your triathlon CV.

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Visiting Europe & UK Property
I am currently mid-way through a European business trip and tapping on my computer in Edinburgh, Scotland. The UK is certainly expensive for the dollar-based visitor -- Yesterday I went through $100 and that only included a visit to a health club and some breakfast. Out of all the countries that I visit in the world, the US appears to be offering the best value right now. I have been considering how to take advantage of that point but haven't come up with much (other than telling my European business contacts to diversify away from Euro-based assets).

A few years ago no one in my peer group wanted to hold Euro assets. Now, many talk as if the dollar is heading for a permanent slide. My simple purchasing-power-parity (PPP) analysis from my global journeys is telling me something different.

Here in Scotland, I am the director of a firm that specializes in prime residential development. I work in the Scottish part of the company's portfolio -- they also have projects in London, Boston, New York and Dubai. Generally, the company follows a buy-build-hold strategy but we do sell a portion of the portfolio each year. The sales enable us to 'prove' our valuations to bankers/shareholders and manage the overall composition of the portfolio.

For those of you interested in residential property prices here is what we are seeing -- the prime Scottish sector grew 5% last year and has been flat in the early part of 2008. This is against a backdrop of 10-20% falls in the UK's new build and 'investment' sector.

Up-and-coming market segments and secondary locations are under extreme pressure -- investors, and firms, that bought heavily into the new build sector are going to have a very tough time.

Given our financing strength, we had been hoping to make distressed purchases. We aren't seeing many of these and good deals remain competitively priced. One favorable change is that development margins have expanded back to 2004 levels. Of course, that might be the result of our sales assumptions being more rosy that our competition. UK home buyer sentiment is as bad as I've seen it in the last 15 years but prime prices are stable (paradox #1). It will be interesting to watch how the market moves over the next 12 months.

The credit markets are tight but we have been approached by lenders that are keen to build their loan books in prime residential (paradox #2). While the credit markets are poor (in general), we are being offered loans at attractive prices. Similar to the property markets, there is a lot of variation within the credit markets.

Within our key financial relationships, liquidity is more of an issue than credit -- banks want to do more deals than they can fund with their balance sheet. They are limited by the short-term funding capacity of their balance sheets, not the quality of their deal flow. (Paradox #3) We remain the other way around -- high quality prime property deals are in shorter supply than capital.

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Who Controls Knowledge?
Scientific research costs money, takes time and is very difficult to control. Have you ever wondered wondered who funds the research that we take for granted? Have you ever considered if the population studied is an accurate representation of your current position?

I ask these questions because (in ultraendurance) the best athletes appear to do impossible feats -- coping with excessive hydration, dealing with material dehydration, superior fat oxidization, superior carbohydrate metabolism... it can seem that everywhere I look in ultradistance triathlon, there are outliers that don't fit the data.

By definition, the highest athletic performers are outliers but I wonder if industry-funded research on collegiate men (or sedentary adults) is the most accurate representation of my peer group. I'm also aware that, in a market with limited funding, the established players have a vested interest in maintaining the status quo, and their position.

Specifically, I've been thinking about how I perform...

***my capacity to process food (huge)
***my performance when dehydrated (just fine, mostly)
***my ability to remove fluids from my gut (massive)
***my capacity to oxidize fat for fuel and/or my ultraeconomy (unable to explain via the literature)
***my power/pace profile when fit (far below average reduction from VO2 down to AeT)

How much of the above is genetic, how much was trained, how much is due to the 'norms' being inaccurate? We may never know for sure and worrying about our profile is likely a waste of time. Focus on enjoying the training and see what happens.

There is a lot of silent evidence that is lost when people that aren't suited to ultradistance athletics retire from the sport. Each year, a BIG segment of long distance triathletes disappear. In most fields, people that underperform relative to effort (low inherent ability) fade into the background. Evidence from people that outperform relative to effort (high inherent ability) is what we cling to. The mind wants to believe that there might be an easy way... if only we had the magic protocol... [motivation, inherent ability, opportunity, time, luck].

One benefit that we have within our Boulder team is a wide range of physiological baselines. Alan is the most science-savvy team member and he faces the greatest physiological hurdles for going long. If you read his blog then you'll see that (physically) he performs best at 10-30 minute efforts -- one of the toughest zones for me to perform in. Triathlon is the only sport where a sprint takes 60-90 minutes!

Alan and I were talking about motivation for athletics -- performance vs enjoyment. Understanding our motivation is important because it relates to the satisfaction that we receive from our sport.

For example, I am an enjoyment-oriented athlete (that happens to have high inherent ability for ultra-distance triathlon). The least satisfying periods of my athletic 'career' have been when I focused on performance benchmarks. Working within a team, or with a coach, that is highly performance driven totally drains me. Interestingly it took me NINE years to figure this out!

That said, performance-oriented coaches have helped me breakthrough with my racing. Sometimes this was enjoyable, sometimes not!

Knowing what drives you, and your clients, is an important consideration in ALL advisory fields (finance, business, academics, athletics). To be effective teachers, we need to understand the values of our clients, and ourselves.

Coaches can't create motivation but we can certainly kill it.

Back next week,
gordo

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25 February 2008

My Southern Retreat


I have been off-the-grid for the last two weeks and staying up at Snow Farm in New Zealand. I am happy to report that the world didn't end and I wasn't fired by my clients. In fact, everything seems exactly the same as when I left the world of connectivity. Makes me wonder how long I could pull the plug before something material happened. I bet one month.

Aside from the President, I can't think of many occupations where we have to be in constant contact. In fact, there are a few (banker, accountant, CFO, CEO) where best practice forces you to leave for two weeks in a row. A two week holiday reduces our ability to perpetrate a fraud on our employers.

This piece is a recollection of thoughts that I had across the retreat, when the stimuli of constant outside influences was removed.

The first thing that I noticed was my mind calmed very quickly. Within 24-hours I was grateful that I had made the fortnight's commitment to stay off-line. Monica offered to clean my email server but I was worried that she might see something and mention it to me. So we waited. The grand total of spam, and real, messages was 8,500 when I 'mailwashed' the server last Thursday. If you are waiting for a reply then I'll need a bit more time... I'm making good progress, should be back to you by the 1st of March.

The next thing that I noticed was my sleep improved in all areas. The speed that I fell asleep was faster, the number of times that I woke up during the night was reduced and my ability to wake up (refreshed) before my alarm increased. All this while living at altitude and undertaking challenging training with elite short course athletes.

Pretty much everything improved. So I wonder... does technology and the media serve us? Or do we serve it?

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When I stop writing, I miss the release, and learning. Even on retreat, I kept my writing going. You will find my complete Snow Farm Daily Diary below, all 14 pages of it. Worth a read if you are interested in athletic performance -- we had excellent speakers.

So I miss writing but I don't miss TV, movies, newspapers, email... one of my goals for the next 12 months will be to do a better job at restricting my input (even more) and see if I can outsource a few more of the items that clutter my mind.

What about clients? Over the last three years, I have been shifting to a model that is based on high value interaction with my clients. I noticed that I am most effective when I work shoulder-to-shoulder with clients -- our Tucson Camps are an experiment with "doing more" of that work.

I am effective remotely but that sort of work doesn't appear to build me up. Instead, it clutters my inbox with low-value chatter than doesn't address the key issues facing the client. Email can be useful but, overall, it is low value communication.

To get to the core of performance requires trust -- and trust requires spending time with people. Another paradox is that a large impact, need not require a large amount of time. Spending a few days with John Hellemans reminded me of that. More than anyone I've met, his life is an example of the impact one man's high standards can have on the world around him. PodCast Here -- sound is mixed in terms of quality.

We were talking about Tibet and John noted that it was difficult for one man to make a difference. I shared an observation that one man can make a huge difference and that his work in NZ has made a massive difference in the lives of thousands of people. He started triathlon at the same age as I did (30). John's life shows what combining passion, talent and work ethic over 25 years can achieve -- a lot!

Up there at Snow Farm, I asked myself a few questions:
  • What am I good at?
  • What do I enjoy doing?
  • Where do I spend my time?
I do a decent job at spending my time at things that I am both good at, and enjoy doing. However, I have identified a few items where I am spending time, not enjoying it and not being particularly effective. I also sense that I've placed a few of my team members in situations where they aren't particularly good and aren't enjoying it. There could be a way to make those around me more effective. I'll need to ask them when we are together.

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So that's the Big Picture items that came into my head. Here are a few detailed items from the specific of the camp, and my time with Hellemans.

Choices -- most of us will reach a point in our lives when performance deteriorates, or ceases to improve. At that stage, we have a choice to make: Quit, Change or Hang On. Most people Quit or grind themselves into the ground by Hanging On. Only the select few learn to manage themselves through continuous change.

Tightness -- tight muscles are weak muscles. Rehabilitate your personal weak spots by trigger point release, muscle activation and strengthening. If the muscles are small then they need small exercises, done gently.

Authenticity -- I read a book by the title of this bullet point. Perhaps that is the attraction of the South Island. It's weather, wind, people and topography are deeply authentic. Not always comfortable, but real and full of power.

Kiwi Real Estate -- With gross yields at 3% and mortgage finance at 10%, I'm bearish on the Kiwi property market. I don't see the room for yields to come up and I see speculative buying in many markets. However, given interest rates, the liquidity position of the local economy looks like it will stay buoyant (unlike most other markets). My personal rent-or-buy decision would be rent.

Wanaka vs. Queenstown -- Comparing these two towns, I can see why the internationals like QT but Wanaka has better weather, more sunlight and cheaper housing. Long term, I expect Wanaka to outperform.

PPP -- In US dollar terms, New Zealand real estate is 400% more expensive than seven years ago (22% p.a.). Petrol has shown a similar increase and food is up 17% p.a. in USD terms. New Zealand isn't expensive but it is not cheap any more. For what the visitor gets, it offers fair value. The days of US$110,000, five bedroom houses are long gone!

My final realization was that New Zealand is one of the few things in the world that I miss when it is not in my life. Monica was the first person that I ever placed on that list. Now I have two things.

By "New Zealand", I mean Molina, Hellemans, the wind, the mountains, the weather and the people.
  • Molina because he is a bit nuts, accepts himself and gets on with his life.
  • Hellemans because he is successful by putting others ahead of himself (keep hope alive).
  • The wind because it is so ridiculous that you just have to laugh.
  • The mountains because of their beauty.
  • The weather because you can get snow, hail, heat, cold, rain and wind... all in 24 hours.
  • The people because they work their butts off and have realistic expectations -- they are also loyal and friendly.
You Kiwis have a good thing going down there.

Hope to be back soon,
gordo

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In case you are wondering, Marty and Ben are in a Kiwi Ice Bath in the photo. Chillin' at 5300 feet...

Word File of My SnowFarm Daily Diary

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24 January 2008

Sweet Home New Zealand


This week, I am going to share some observations about what makes New Zealand a special place. But first a few items.

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There will be at least a ten day gap before my next letter due to Epic Camp New Zealand -- you should find an pre-epic blog over on the Planet-X site next Monday. I have started Epic podcasts on Endurance Corner Radio and hope to continue across the camp.

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A reader sent in a question regarding my curtailing the booze. Here's what I wrote back:

Clarity of thought // I saw this pretty quickly. Once I stopped drinking my mind became a lot more clear. I spotted that in about two weeks.

Emotional hangovers // at some level, I always knew that booze, sugar, toast, cereal, etc... didn't 'work' for me. Not sure if this makes sense but all the changes that you read in my interview -- those are driven by the fact that once I "see" a bad habit, the joy of doing it tends to drain out.

Productivity // I was losing a good chunk of my personal productivity -- I prefer to apply my time productively and enjoy working.

There is a health benefit but that doesn't seem to carry as much weight in my mind. Perhaps because it is too obvious and I do a lot of other healthy things. I am likely rationalizing that I am "healthy enough".

A friend taught me that the true enemy of "great" is "good". When we see ourselves as good people, we can give ourselves excuses that prevent us from being great. If we see ourselves as "bad" people then our self-destructive tendencies can be tougher to modify -- I would seek help if that was the case.

Heavy drinking (binge eating, fast food, nutrition, etc...) -- all are lifestyle choices -- not much different than being an athlete. Once any of these items become inconsistent with the life that I want to lead, they have to go // OR // I had to accept that I wasn't going to be the man that I was capable of being. The worst sort of "settling".

If you eliminate the booze then you will have a huge amount of time and energy. Time and energy are two of the most valuable things a person can have. Combining them gives us tremendous personal freedom. Freedom and personal responsibility are scary . It is normal to prefer self-imprisonment, or self-medication.

There is a transition required from one life, to another. I'm fortunate to have a supportive wife and great friends -- if you don't have the personal infrastructure then there are plenty of sources of support/assistance/help. It takes unique courage to ask for help in a culture where men struggle to ask for directions!

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Reader feedback on start-up investing...

Things that run counter to our investment instincts:
  • Not doing transactions (buying or selling);
  • Sitting on cash;
  • Declining to accept capital when the climate isn't right for investment; and
  • Returning capital to investors.
Things to remember about start-ups:
  • Starting a small business limits personal freedom;
  • Consider what happens if your staff quit, steal from, or compete with you. All are likely to happen at some stage; and
  • Consider if you have a sustainable competitive advantage -- specifically, what drives your economics and how that might change over time.
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The picture below is Lake Tekapo -- 245KM from our start point on Day Two of Epic. A worthy destination!


Mark Allen taught me the importance of establishing a connection with where we live. As an athlete, Mark felt a connection with both Hawaii and Boulder -- two places where he expended tremendous physical energy. After Scott Molina won the Ironman in 1988, Mark came down to the South Island for a training camp. Mark had a pretty solid 1989.

It has been two years since I spent any material time in New Zealand and, returning, I realized how much I missed the place.

The picture at the top of this letter is Akaroa Harbour, our turnaround point for Day One of Epic Camp. From the hill top you are looking into a volcanic cater that opens to the sea. Along the top of the crater, you will find trails, tracks and roads that enable some seriously challenging training. If you make it to Akaroa then return via Long Bay Road, pack your climbing gears.

In 2005, I sold my house and left New Zealand to take on a substantial consulting assignment. Returning in 2008, it feels like I have new eyes.

Last weekend, Scott and I were riding towards Gebbies Pass (far end of the shot below). We were getting completely drilled by the wind but, for some reason, I am always relaxed on Gebbies Pass Road (had more than a few Zen moments there). Grinding away in my 55-21, I remembered Mark's lesson about the benefits of having a connection with a place. I feel very connected to this part of the World.

Why are there so many great athletes down here? For triathlon, I think it is a combination of factors.

Attitude -- Kiwis expect to work hard, for limited financial reward, for their entire lives. This stands apart from my experience in Canada and the US.

In Canada, there is an expectation that the government's role is to take care of its citizens. Down here, you take care of yourself (for the most part).

An aspect of the American Way is an expectation that there will be wealth differences but these are tolerable because upward mobility is available to all. In many ways the Kiwi's are the exact opposite. For successful people to remain popular, one needs to be sincerely humble. Not a lot of "show me the money" happening down here.

Terrain -- The hills are short & steep, the road surface is slow and the wind can be relentless. From the bottom of the island, your next landfall is Antarctica and you can feel that when the wind comes from the South! It is so challenging that I probably couldn't hack it for a Southern Winter.

Expectations -- The swim squad that I train with here is a good example of Kiwi realism. The triathletes that want to improve expect to swim 4-5 times per week 4,000 to 5,500 meters per session. Those are agegroupers, not pros. They do swim squad in the morning, work all day and train again in the evening. They do this every single week, for years.

You will never hear about them because they rarely travel and don't post on the internet. While we debate the finer points of human physiology, they plug away at 1,000 hour training years.

It's good to be back.


The photo above is Karekare Beach in the North Island. I'll be speaking with the Epic Vets to see if there is interest in riding the length of the North Island in January 2009.

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11 January 2008

Financial Start-Ups


Our photo this week is from our first Epic Camp in January 2003. Many speedy people in that shot -- some of them didn't even know it at the time!

Endurance Corner is accepting applications for 2 to 4 month internships. For more details contact mat at endurancecorner dot com. Prior experience is useful but not necessary.

Endurance Corner is looking for an MD, PA or Nurse Practitioner for its medical consultancy practice. The position would, initially, be part-time and ideal for a parent looking to re-enter the workforce. Please contact gordon at endurancecorner dot com if interested.

Endurance Corner is based in Boulder, CO.



We start this week with some feedback from Europe.
D.D. Observes:
A couple of things that come to mind regarding your recent piece on "motivation":

Interesting how "achievers" are usually - not always - driven by primarily selfish goals. No judging here, just observing.

CAREFUL! I know a lot of people who place themselves amongst (relative) "losers" just to look good. Those guys ARE NOT the top achievers. "You are as good as the expectations of your peer group." At least in the long run. IMHO
Selfish Goals -- I am not so sure that high achievers in 'self-less' vocations are more purely motivated than high achievers that work for themselves. As well, there may be a lot of selfish people that don't achieve -- it may not be a defining characteristic.

Peer Group -- this is a very good observation and why I advised 'periods' of out-performance. My podcast with Chris McDonald was interesting in this regard. Chris moves between towns where he is 'normal' and a 'star'. He stays in Boulder until he can't handle it anymore then heads back to Aussie and pounds his mates. Like I tell Mat, Fast in Indiana isn't always fast.

One last point, most people are not working towards maximizing their personal achievement. Their daily choices and actions are inconsistent with achievement -- the true goal is something else.

We can have very fulfilling lives while being clueless. I have enjoyed my periods of unconscious incompetence! High achievers are some of the most tortured people I know.

Alan wrote an outstanding article on what limits achievement. Understanding the process he outlines is a requirement for breakthrough performance.



And now... this week's letter.

I received an interesting email. If this letter triggers any ideas then please send them in. This topic is one of my favorites and I have been considering a few start-up opportunities myself.
A.R. writes:
I come from an entrepreneurial background and started with my current mentor and boss in real estate development XX years ago. With the current market and industry conditions my mentor has decided that 2008 will be a very safe year where we will not be looking to acquire or develop any more properties but just finish out the few condo conversions that we are doing and manage the apartment buildings currently in the portfolio...

I will be in the position to either find a new job in RE development or take the plunge (sooner than expected) of going on my own.

As I do some job searches I find positions that are interesting but that would be developing, raising capital, or acquiring properties for another organization and my thought is why do that for another company when I could be doing that on my own. The thought of going on my own excites me and what I want to do, however I only have about a 2 months capital reserve currently in the bank without liquidating anything and so I would be looking at going into some sort of debt.

If I go to another company I feel like it will be demoralizing and that I will not have the passion and work ethic that I would if I was on my own; however it would give me more time to gain experience and save more equity for a better time to go solo. I do have a couple projects that would provide a strong foundation if I go solo- raising capital for a distressed homebuilders fund, multiple client kitchen/bath renovations, development of 10-20 single family lots that a partner of mine owns which we are planning to develop, and 1 or 2 other opportunities but will not bring in cash flow for at least a few months. I also feel that I would miss out on these opportunities if I join another company as in that case I will not be able to commit the necessary time for these independent projects.

When I receive these emails, I get a little bit nervous because I fear that you might actually take my advice! So the first thing to remember is that there are no 'right' or 'wrong' answers. Odds are, you are going to be just fine going down any path.

That said, "trust your heart" can prove to be expensive when leverage is involved.

I would spend time on your Personal Plan before shifting to your Start-Up Business Plan (which you should write out in full and share with a respected adviser). Our society has romantic ideas about entrepreneurship that are far removed from the reality of owning your own business.

The first thing to do is read The E-Myth. That book helped me understand the roles required for entrepreneurial success as well as what often kills a business. Step back from the 'franchise' discussion and consider the broad strategic issues of simply achieving your business goals. Remember that a business exists to serve the aims of its owner. Do you know your aims?

That will help you frame the second thing... Do you know what you are good at? (Drucker summary and full article as well as more resources) Then consider if you enjoy doing what you are good at.

My Answer: I work as a consultant because I am good at project management, financial analysis, deal execution and strategic planning. My best skill is taking all of those components and expressing them in a clear written plan that is attractive to key decision makers. I spent the 90's doing that 50-80 hours per week.

Working solely on work was slowly killing me. I completely lost touch with my physical self (weak nutrition, no fitness, plenty of booze) and was disconnected to my spiritual side (never close to nature).

The solution was a position where I can alternate very intense periods of effort with recharging phases. However, this means that (absent change) I cannot be the CEO of a new company.

If you are talking about setting up a business then you are looking at a sustained, full-time total commitment. It is no different than what I write about elite athletics. The best CEOs that I know have tiny off-seasons and build their lives completely around the success of their businesses. World champion obsession.

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In Private Equity, we break the business into three pieces: Deals; People; and Money.

Deals -- do you have access to attractive investment opportunities? Many markets are characterized by a magic circle of established players that have access to proprietary deal flow. The property market is characterized by incomplete information and many conflicts of interest. Good deals often succeed by using superior information. How good is your information?

People -- do you have the skills to capitalize on the investment opportunities? I was fortunate to have been taught by one of the best Private Equity teams in the world. Even today, I haven't met a group of people that comes close to the team that trained me. I was the lowest paid person (in the building!) when I joined but it was one of the happiest and fulfilling periods of my life. Being part of a winning team can be more fun than struggling in your own business.

Money -- do you have access to capital? On what terms? How do those terms compare to your competition? Established players have a big advantage here -- it is tough to be the new guy.

With the investment business that I co-founded, it took us five years before we were successful raising institutional equity -- we relied on individual equity. Over that five year period, I was cash flow negative every single year. All the while, we were ahead of our business plan.

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Further thoughts to consider...

For more than a decade, investors would have had to do something stupid not to make a great return on any property investment. A sustained bull run leaves all players convinced of their deal selection 'skill'. We can't help but be influenced by this bias. As markets revert to the mean, most of us will find out that asset inflation, rather than investment smarts, drove our returns.

Do you know how to manage the capital that you have? Look at your personal track record with your own capital -- a two month personal reserve seems small at your age (but is not uncommon). People with the skills to be long term managers of funds demonstrate those skills (first) with their own capital. A great story from Asia...

Investment Banker Pitching Rich Local Man:
'So Mr. Lee, I think that this fund is an excellent opportunity for you.'

Mr. Lee to IB:
'Tell me, how much are you worth?'

IB: 'I'm worth over a million dollars.'

Mr. Lee: 'I'm worth over a hundred million. Why don't you give me your money and I'll see if I can do better for you.'
The best investors take care of their own money -- and -- treat their investors' money as if it was their own.

Market Timing -- most the reports that I am reading these days are talking about property inventory being clogged through to early 2009. These are huge generalizations and you need to consider your local situation. It is very tough for a small scale developer to make money in a flat market. Our early development deals only made money from asset appreciation -- frankly, we probably lost money on the development while we learned the ropes. Even today, we aren't experts. What we do is team up with experts and align our financial interests. There are a lot of ways to be ripped off in construction.

Against the current market background, building personal capital; broadening your skills base and studying under a smart investor -- could be time well-spent.

Family Capital -- if you can't raise start-up capital from sophisticated third parties then my advice would be don't do the deal. People will cite exceptions to this rule -- they exist but are exceedingly rare. If the market won't back you then there is information in their refusal. We have always been able to get our best ventures funded.

Missing Out -- Don't worry about that. This market will get cheaper, inventory will build and deal flow will increase. Your worst case scenario is that pricing will stay the same. Always be willing to lose a deal.

Cash Flow -- Make sure your can hold for at least a three years. One of my strategic goals for this year is to arrange funding through 2012 for my main client. Being able to hold through the bottom of the cycle is fundamental for long term returns.

Liquidating -- Twice in my career I have "sold everything" to invest in a new venture. It was good discipline to consider the new 'position' relative to my existing holding.

If you decide to go for a position with an existing team then consider people that are strongest in your weakest area -- when we go into business, we often partner with people that we've worked with before.

Hope this helps,
gordo

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14 December 2007

Risks and Returns


That's Monica on Sunshine Beach, Sunshine Coast, Queensland, Australia. That's the real name of the place! While I'm not much of a beach guy, the scenery has been worthwhile.

This week I'm talking about finance and company valuation. If you would prefer a solid endurance article then Coach KP writes about Ironman Pacing on Alternative Perspectives.

This week's announcements run a bit long. I'll update on our Tucson camp next week -- we still have a couple of spaces.

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Brad Kearns has a project called Running School (aka Running's Cool). The idea is to educate elementary and middle school kids/teachers/parents about nutrition and exercise. The program touches on a lot of things that we believe in. Brad started at his kids' school and is planning on branching out to other schools. You can clickthrough to find out how to help him with the worthwhile cause. We are sponsoring a school in 2008.

A reader sent in this speech by the former Chairman of Bankers Trust (good stuff, thanks for thinking of me). The fourth paradox (about moderation and extremism) rang most true. It is worth a read.

There are other speeches by Sanford on that site -- his defense of Financial Services puts forward a good case. Reality lies between Business School speeches and books like The Game, Liars Poker, Barbarians at the Gate and The Smartest Guys in the Room.

I'm surprised this didn't get more comment... getting paid tens of millions to run a business which writes $10 billion off then walking with $162 million for failing to see it coming. This is not an isolated incident -- only the scale makes it noteworthy.

In hedge funds, trading and investment banking, there is a massive incentive to game the system. Given the amount of leverage available to these companies, there should be clear disclosure and firm regulation. When it really hits the fan, taxpayers are the ones that ultimately foot the bill.

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This past weekend, I read a book on the Enron collapse, The Smartest Guys In The Room. When I arrived at the end of the book I was left with two impressions. First, it is terrifying how fast a highly leveraged vehicle can unwind. Second, I have read that story before.

The problems, and financial techniques, that are part of the Enron story aren’t unique. They have been used, and abused, prior to Enron (computer leasing, software maintenance) and after Enron (sub-prime crisis).

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Concentration

In addition to giving me the advice to “save 10% of what you earn”, my Dad also told me to “never have more than 10% of your net worth in a company you don’t directly control”. The people most hurt by the Enron collapse violated this key tenet of investment strategy.

Even if you are an insider, be wary of monster bets. There have been stages in my investment career where I had more than 100% of my net worth riding on a single company (but it was "my" company). While this ensures “focus”, I feel that I am more effective with a significant, rather than total financial commitment.

++++

The Deal You Don't Do

If you are in a leadership position then you must foster a culture where it is OK to make a little less money. This helps maintain business, and personal, ethics. Senior management must empower, and support, team leaders that walk, rather than compromise company values. This is _extremely_ hard to do when large amounts of money are on the table. I have seen private equity partners eat hundreds of thousands of dollars in dead deal costs.

++++

Return on Capital Employed (ROCE)

Towards the end of the Enron book, the topic of the company’s return on investment comes up. A figure of 7% per annum is quoted. The basis of measurement isn’t clear from the text. Here’s how I define it…

Cash Flow Before Interest and Taxes

LESS

Capital Investment Required to Sustain That Cash Flow

Take that and divide by “Net Debt Plus Shareholders Funds”

Tracking this figure back ten years for a business, and its peer group, can tell you quite a bit. Can’t go back ten years? Then place a discount on the quality of those earnings.

A lot of people use “Depreciation & Amortization” instead of “Capital Investment Required…”. If you choose that method then know that your number can be skewed by the recent capital investment history of the firm (and industry) you are evaluating. Age, and capacity, of capital employed should be considered.

Other folks like to use “Earnings” rather than “Cash Flow”. I prefer cash flow because generating cash is the financial purpose of business.

Attractive businesses have a high ROCE and good management teams know their ROCE.

If you meet a company without a clear focus on ROCE then a red flag should go up. It isn’t the only metric but (for businesses with more than just human capital) it is an important figure to track.

++++

Profit Recognition and Asset Valuation

Inside the book, there is a clear explanation of Mark-to-Market vs. Historical Cost accounting. They are two different methods used to achieve the same goal – a true and fair picture of a company’s financial position. Enron went wrong in its application of its valuation methods as well as its employee rewards structure.

The questions to ask:

Does the business have any contracts/transactions/projects that extend greater than one year? What is the recognition basis for revenue, income and capital uplift on these projects? Describe the nature of historical revenue/cost/value revisions on these contracts. What are the key assumptions that underpin profit recognition and project valuation?

How does employee compensation relate to the assumptions used on the above transactions? Specifically, who benefits and how do they benefit?

Rapidly growing businesses with a material part of their income statement (or balance sheet) linked to management judgment are risky with lower quality earnings. They can still make good investment targets.

If management fails to give clear, immediate answers on the above questions – red flag should go up.

++++

Off-Balance Sheet Financing

This one often gets companies (and people) into trouble. The main reason to use off-balance sheet financing is to raise debt over-and-above a prudent level. There can be times when these techniques make economic sense.

These structures bite when a company (or person) hits hard times. In particular, financial and performance guarantees can create large, and sudden, liabilities. A business with weak internal controls can have large hidden contingent liabilities.

Some questions to consider:

Have you used any of the company’s shares, assets, or guarantees to support (formally, or informally) projects outside of the company’s balance sheet? Has any outside entity guaranteed (formally, or informally) any aspect of the company’s operations?

Have any members of the management team issued personal guarantees (for any reason) to any financial institution connected to, or separate from, the company? If yes then please supply the specifics.

In the mid-90s, we would go as far as having key management warranty their NAV statements. You can learn a lot about a senior management team by the way they manage their personal finances. In the recent era of covenant-lite financing and non-doc loans, I expect this practice may have fallen away.

If there is a lot going on, or if you can’t figure out why things are going on, then don’t touch the business, or the manager. It’s not worth it.

++++

Bottom Line

The senior person leading the transaction should ask the CEO these questions. As well, ask employees in accounts, sales/origination and operations/fulfillment. Remember that large frauds start as small frauds – always be willing to walk away.

People want to do the right thing but often feel trapped by their situations. For this reason, you need to ask the questions, a lot of questions. You will save capital (and time) by talking to management before investing.

As personal investors, we rarely have the ability to check these questions with large companies. That is why I don’t invest in the stock market. If you feel that you must have stock market exposure then I recommend a low-cost, broad index fund.

Good luck,

gordo

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22 November 2007

Credit

It has been a fascinating week over here in Scotland. As I've been writing about athletics for the last few weeks, I will turn to a few finance oriented topics that may interest.

For most of us "credit conditions" lie invisible until we need a personal loan or a mortgage. However, in my various lines of work (private equity, finance, property development and asset management) we are nearly always in the credit markets. I had a very interesting conversation with a senior banker this week.

By way of background, we founded our Scottish property development business in 2005 and have been assembling property deals since the mid-90s. We are a material, but not massive, relationship for our bankers.

With property development transactions, our company makes money from the value of finished projects being more than the development cost. By way of example, if it costs $80,000 to build an apartment which is worth $88,000 on completion then the "capital uplift" is said to be 10%.

Financially, our business "works" for our shareholders because we are able to refinance their equity investment by borrowing against the "capital uplift" at completion. This lets the company move its share capital along to the next investment -- this drives our return on equity.

I spend most of our board meetings listening, thinking and taking minutes. It is good practice for my 2008 goal of listening more. None of what follows was explicitly said in the meeting, I simply noted it and will share some conclusions later in this letter.

Capital uplift (our company's profit margin) -- after two years of declining margins on new deals -- we were suddenly presented with a large opportunity (>$50 million) that had a projected capital uplift of 25%. The deal popped up because (we believe) the buyer was having financing trouble.

As part of our year-end review, our bankers asked us to provide them with additional comfort on our portfolio valuations (easy for us to do as we operate in a specific geography with transparent market pricing).

Our bankers mentioned that the syndication markets were closed. Debt syndication markets are how banks share and diversify risk for their largest loans. They noted that when the markets came back on-line only the best deals would be taken up. Valuation verification is an important step towards ensuring we will be at the front of the queue when the debt markets re-open.

As for new debt, we have heard from our bankers, as well as others in our sector, that new money will be tight for the next six months. That's a polite way of saying that many banks are presently closed for new business. It's not a case of asking for their money back, rather it is a case of not being in a position to fund new deals -- regardless of how attractive they look. I feel sorry for any business that is operating below par in this market.

Bankers are talking about balance sheet decisions, rather than investment decisions. There is a very clear focus on the balance sheet, rather than the quality of new business. Personally, I take this as an excellent development. In a challenging credit environment, we want to be with an institution that has a keen eye on its own balance sheet. The sooner a bank gets comfort on its own credit position, that faster it will be able to start lending again.

However, the fact that senior bankers are more focused on balance sheet strength than new business is a powerful statement in itself. The credit contraction that is happening in the major financial centers is not visible to Main Street at present. If your business (or your personal life) relies on new finance over the next twelve months then I would start the refinancing process early and make sure that you tick-the-box in every conceivable way. Once the credit markets re-open, lenders are going to choose the highest quality credits first.

The days of covenant-lite and non-doc loans are gone. For the better, too.

I attended a presentation from an executive that works at the Bank of Scotland's treasury department. He had many excellent slides and I've scanned three that are relevant to this letter (and my life).

Here's the first one. I noted the date that we bought our first flat in the UK. To say we had good timing is an understatement.
This next one shows the dislocation between base rate (set by the government) and LIBOR (what people like us actually pay for our loans). What killed some mortgage institutions is that they pay LIBOR but lend to their clients at base. This mismatch is highly costly when the markets move out-of-whack.
Those dotted lines show that the forward markets think that things will return to "normal". However, people are pretty jumpy and when I hear bankers noting that "liquidity and confidence are illusions" I fasten my seatbelt.

The last chart is a neat one that we certainly didn't realize at the time.
What I did on this one was draw in the point where we negotiated the initial portfolio of deals that formed our property development business. Once again, we were fortunate in our timing.

I don't have confidence in my ability to make predictions, however, I think that it is fair to say that the following are happening:

***a large credit contraction is underway in the UK and US (perhaps elsewhere, I can't really comment)

***a high degree of uncertainty (bordering on distrust) exists within the international banking community (reflected in interbank rates)

***due to the lag between liquidity and pricing; there is a dislocation between asset pricing and credit availability -- many sellers don't realize the lack of funding available their potential buyers

What does this mean?

From a business point of view, we are going to focus on keeping our credit providers informed and confident in our company. In this environment you want to make sure your capital providers know exactly what's happening in your business.

If your business, or your main customer, relies on credit, then you've likely seen the impact of the credit contraction already. However, if you are a few steps removed from the credit markets then you might not fully grasp what is heading our way. There are hundreds of billions of debt capacity being removed due to the equity write-offs within our financial system.

Over the next few months, keep a keen eye on accounts receivable as well as your key customers/distributors. If you have any clients who's demise would bury your firm then see if you can get credit insurance (it can be a cost effective way to reduce your exposure). In the early 90s, I watched a number of firms go down as credit tightened and the economy slowed. If you are conservative and cautious then you'll be able to navigate your way through. I have seen "services" recessions in Asia but never really witnessed them in Europe or the US.

From a personal point of view, I'm bearish on asset pricing, especially in the property markets. Liquidity is going to be highly valuable in 2008.

Sitting over here in Europe, the US offers outstanding value right now on a Purchasing Power Parity basis. It's crazy expensive over here in Europe. Seems like dollar-for-pound in the UK. My British friends talk about shopping trips to New York (a town that seems expensive to me). People are flying to New York for a weekend of Christmas shopping. If you are in the US then run the numbers on that same weekend to London or Paris!

Off to Paris next week -- we won't be doing much shopping and I hear that there is an excellent multi-day museum ticket.

Happy Thanksgiving to my American readers,
gordo

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02 November 2007

Ownership


“Mate, you should get the families on board when you are doing athlete planning. I have seen far too many relationships screwed up by this sport.”

-- Greg Bennett, World Champion Husband

====

I had a T-Rex in my kitchen this past Halloween... Mat went to CostCo and bought 300 pieces of candy and 30 "full bars" (for special costumes). We live in a cul-de-sac and hardly any kids came! Dave had sixty kids over to his place and he was giving away breath mints... next year, I am going to ramp up my marketing.

As a personal reminder... we did quarterly evaluations this week at Endurance Corner. It was recommended that I work on three things:

(a) remember that my mood has a direct impact on the team's productivity (the leader needs to lead);

(b) reduce interruptions when the lads are working on tasks that require sustained thought; and

(c) when I start to focus on being "right" rather than my objective... stop talking and take a break.

====

My dad describes a blog as… “a collection of ideas, given away for free, that you would normally spend more time developing and seek publication”. I suppose that is a polite way of saying that these letters read a little choppy sometimes.

I am going to share some ideas that came out of the Endurance Corner advisory meeting last weekend as well as recent discussions that I’ve had with some very smart people. We’ll see how this turns out – lots of snippets, hopefully, they make sense.

Before we kick off, Robbie Ventura is going to drop into the last four days of our April Tucson camp. As you may have heard on IronmanTalk, he is preparing to race Ironman Canada and I’m sharing a few tips with him. We have a bit in common, in 1998, I signed up for IMC when my only triathlon experience was a sprint tri. He’s in a similar boat, especially with his swimming.

In Tucson, we will get the chance to share Robbie’s first super-long triathlon training day (the day before we will SBR Mt. Lemmon). If you’d care to join us at the camp then drop me an email for details. We have a few spaces left for the March/April camps.

The March camp will be set-up to fit with athletes preparing for IM Arizona as well as those looking to jump start early season fitness.

====

A few months ago, I asked a friend if he thought that he was operating at his maximum potential. I have been thinking about that question as it relates to my own life. In reading Dead Certain, I was struck by the thought that President Bush has certainly achieved close to his personal potential. Quite separate from his popularity, the man has achieved close to his maximum potential. It is an interesting case study that has me looking inwards.

In my mulling over of this topic, I see a distinction from achieving greatness and achieving honor. A great person need not be honorable – and an honorable person need not be great.

When I speak with my grandmother, I note that she takes comfort in doing her best to have chosen an honorable path. I haven’t had honest conversations with any people that achieved greatness without honor – I imagine that their later years are filled with regret. Something for all of us to consider when we are tempted by the easy way. For this reason alone, be wary of situations (and people) that tempt you to cut corners.

I am kicking all this around because I know that my potential as a “person” is far greater than my potential as an athlete. I sense that when I seek one, I let go of the other. I was talking about this point with Graham Fraser – a guy that has witnessed his share of holding on, and letting go. He didn’t offer any specifics, merely the catalyst of placing the thought on my radar screen.

Why this is so interesting to me is that it is easy for me to see that there is a risk that we neglect our larger potential when we seek our athletic potential. Monica thinks that I do a pretty good job of balancing things – however – that’s because she is on-my-list when I’m hitting triathlon hard.

Still thinking that over while I consider a business opportunity that offers me the chance to do something “great”. When business deals look very attractive, history tells me that I am probably tired.

====

Ownership

I have been talking with a few business owners about ownership. The same topics keep repeating:

***Equity ownership should only be shared with people that provide capital essential for business growth – human capital counts, probably more than any other type.

***My preference is to share equity capital with individuals that are essential to the development of the goals of the business founder and increase both the size, and likelihood, of success.

***Within the management team, my preference is to share equity capital with individuals that are fit for leadership. Does someone improve the CEO’s ability to lead and improve the quality of that leadership?

***I’m not keen on 50:50 partnerships as someone needs to be in charge and contributions are never equal. In that situation, I prefer 67:33. This is a neat number as: (a) the two founders can sell 24% of new equity to a third partner; (b) the founders can still control 76% of the company, post issue; (c) the smaller founder retains a veto over special resolutions that require 75% approval; and (d) the larger founder controls >50% of the equity, post issue.

***If you create a business that is a wild success then you should not feel obligated to deal out a stack of money to everyone around you – you’ll screw them up and you have done plenty for your team by creating the business. Even more likely is that you are best person around to allocate and manage capital. During your lifetime, consider if you dilute the power of your money to do “good” by spreading it into the public at large. After your lifetime is a topic for another time – I have an article in my head about inheritance and motivation.

***Remember that equity and bonuses are most appreciated at the time of allocation. Frequent cash incentives are much more appreciated than single long-term allotments.

***If you are the founder of a small business then consider who is truly necessary for the business to operate. When you stand back and take an honest look – you often see that you are the only person holding things together. In that case, it doesn’t make sense to deal people in as shareholders.

***People that increase your personal freedom; require limited management; and work towards your goals – are highly valuable. Do what it takes to retain them – frequent cash incentives based on their performance and skills in managing other people – that is what I prefer.

***Ideally, the individual that is most fit for leadership should control the equity capital of the firm. If you are the founder, and best decision maker, then be wary of diluting your ability to steer the direction of the firm – far easier to place key employees on generous profit sharing. If you are in a human capital intensive business then this doesn’t always work. Still, try to keep control vested in a small group of individuals – the best partnerships are run by a core group of senior partners.

***As a counterweight to the above point, if you have the ability to greatly improve the value of a firm and/or increase the likelihood of success… then be sure to negotiate a deal that rewards you for the value you create. There is often a balance between paying your dues and achieving market value for your services. The best and brightest can be underpaid until they test their market value – be very polite to your senior partners if you plan on playing this game. If you over-estimate your market value then you are exposed to having your bluff called.

***Always remember that bigger isn’t better and that you’ll cut your best deals when you are willing to lose them. Keep a steady focus on what you want from your business. It is very easy to get caught up in growth, for growth’s sake.

***Always consider if a new opportunity will give you more satisfaction – or merely more work. Know your personal goals and seek to align them with your work goals.

Two final thoughts:

1 – always be willing to make a little less money to maintain high personal standards

2 – remember that your most important brand is yourself – invest in that brand

gordo

====

Files referenced on Endurance Corner Radio

Bike Efficiency PDF File

Recreational Athlete Treadmill Protocol

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14 September 2007

The Two Ms



Yesterday, Monica and I did a "dry run" for our late summer camping trip. In the photo, you can see the result of my campfire skills. Physically, I get tired these days so exercise is limited to easy trail walking.


Over on Alternative Perspectives, Clas shares his experiences from Epic Camp over the years. Coming up he will explain "How to run a 2:42 marathon off the bike" -- we'll get that live in a few weeks. It is an entertaining read.


I've been reading Ayn Rand -- (GV, I'll mail the book back soon). Ms. Rand is a fine writer and gets me excited about living up to my maximum potential. Her encouragement to reduce theory to basic truths interested me in relation to endurance sports -- I'll continue to think about that because I sense that with some effort it would be possible to create a straightforward model for endurance training. I've tried to do that with my Four Pillars article but there could be a clearer theory waiting out there.


In the meantime, as the summer winds down and the cyber surfing season heats up... two things kept coming back to be as I flipped the pages.


Equality -- the need to place personal responsibility for individual action as a high priority. This is even more important for those that seek to lead, or influence, others in the field of individual rights.


Intellectual Domination -- I watch media pundits (and cyber celebrities) claim to be guardians of the truth while engaging in satire and bullying. Their actions cloaked in humor and/or intellectual superiority while seeking to subdue any discussion that runs counter to their ideas. Spending one's talent bullying the students (we once were) strikes me as the path of a wasted life. There is a higher way available to us.


++++


So, I'm back in Colorado following a few meetings in New York. In the Big Apple, I was fortunate to be able to stay with my Everest climbing, hedgefund’ing, Ironman’ing buddy, Greg "the kid" Vadasdi.


It is always fun to spend time with “The Kid”. Similar to my buddy, Ed McDevitt (I’m on to you, amigo), Greg is one of those intelligent guys that enhances his success by having the world underestimate him. I’m going to start working on that in 2008. Life can be easier when our competition under-rate us.


I received some follow-up on my piece on international financial markets. A few people asked what I thought was going to happen in various markets.


I have no clue!


Be suspicious of people that claim to have a clue!


When it comes to forecasting my experience is that it is totally impossible to predict short-term movements. We have no idea and the more certain the experts become, the greater the opportunity for an unexpected event to really shake things up.


My formal financial education is getting a touch dated (Class of ’90). At McGill, I was reasonably well schooled in the traditional drivers of markets as well as the technical theories that have been purported to drive financial markets. My academic and technical background is useful for reading the FT, or Wall Street Journal, but it doesn’t serve me well when I try to comprehend what I actually see in the world around me. In fact, it is probably a liability.


If you’ve been reading my stuff for the last couple of years then you will have seen my interest in learning from authors that immerse themselves in how things actually work (be they markets or people). The GordoWorld team is in the process of updating my website and one of the additions will be a section on my recommended reading list. Mat and I will trawl through my library and type-up what I liked, and why.


Fundamental analysis works well for estimating the likely long term path of an asset or investment opportunity. However, it falls short when asked to explain what actually happens in the short term. In other words, my academic (and real-world) training are useful for valuation but something else seems to drive pricing.


What is it?


For me, the two main drivers are:

(a) Mood; and

(b) Money.


Let’s take money first. How many people have the ability to purchase the asset, or make the investment? Most people will spend to the maximum limit of their ability to pay. As an aside, always find out your client’s budget before bidding on a project.


If we enhance ability to pay with low cost finance and easily obtained credit lines then you’ll bump up the demand for assets and, in most people, reduce price sensitivity. Many corporations (and CEOs) follow a similar path -- it very difficult for spending and investment decisions to be made free of the influence of capital available.


There is limited transparency on the true position of global liquidity – however, the careful observer can make educated guesses on the impact of global shocks on capital markets. Our recent experience with the credit contraction that followed the sub-prime shock is an example.


With mood I consider:

How do “I” feel about the opportunity?

How do people around me feel about the opportunity?

How does the broader public feel about the opportunity?


While I think that I’m an optimist when it comes to life, my conservative nature means that I’m a nervous seller. Where I’ve made mistakes on pricing is when I failed to take into account differences between my perception and the broader public. I’ve consistently sold early in my deals.


Interestingly, this tendency hasn’t cost me many investment opportunities. I’ve always had more deals available than personal appetite to fund them. In fact, our property development company started because we had a mismatch between good deals and available capital.


Why is it important to track these factors? It’s important because a change in either one can be a leading indicator of an approaching valuation swing. When these two factors change direction in tandem then we are going to see a shift in asset pricing.


So when people ask me what’s going to happen… I have to say that I have no idea. As an investor, what I look for is situations where my best guess is that my entry pricing is less than fundamental valuation. That creates the opportunity – reality is then dictated by the hard work of an ethical management team.


Investing is about: (a) solid fundamental analysis; (b) limiting the cost of your mistakes; (c) paying less than fundamental value at the front-end; (d) avoiding fraud; and (e) backing the efforts of outstanding people. Of these factors, the two deadly sins of Private Equity are overpaying and backing crooks -- very tough to recover from either of these. If your deal doesn't fit these parameters then you are speculating, rather than investing.


In terms of market timing, don’t expect to get that perfectly right other than by fluke. Watch for shifts in the two Ms. When a trend is established, consider the likelihood that this direction will be sustained. Invest only when you see a gap between price and valuation.


It sounds so easy. Reality is tougher but the basics will serve us well for as long as we temper our greedy instincts.


Stick with your winners; sell them only when concentration fears start to keep you up at night. Historically, that’s been my early warning system on both people and deals – if I’m thinking about you at midnight then we’ll probably be speaking shortly!


Always hold a portion of your portfolio in high quality cash equivalents – this will enable you to capitalize on unexpected opportunities and assist with the (near impossible) task of staying calm when everyone else is losing their cool. By definition, your best deals will be offered to you when everyone else is out of cash. As much as possible, be countercyclical in your fundraising and capital reserves.


Waiting and watching…

gordo


PS -- I'm off to Santa Cruz next week to see Brant and Mark. After that Monica and I will be camping for two weeks. I've set things up so that I should be able to keep publishing.

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06 September 2007

Financial Thoughts


My IM Canada race report is drafted and I'm giving myself a few more days to mull it over. As promised, it will be live by September 10th.

I have a few hours this morning before my taxi comes to take me to the airport so I thought that I'd address a question that I received this week.

I enjoyed your continued comments on finances and economy. At about the same time you posted being "overweight cash" I was doing about the same... ...I would love to hear your thoughts on the blog about the subprime situation and the US housing market if you're looking for suggestions from the viewing public ;)
For background and continued info on the sub-prime situation, check out this website. John is a great analyst when it comes to explaining the background as well as the specifics. My gut feel is that the sub-prime situation was merely a trigger that resulted in a (beneficial) repricing of global risk. Things were totally out of control in terms of liquidity and lending. My personal view is that the "powers that be" should let a lot of people lose a lot of money -- investors should not be bailed out when they make crappy investment decisions. People need to lose money.

That said... I'm reading the Lex Column this morning (on the back of my FT) and notice their chart on three-month interbank rates. It is a look at what's happened to Sterling, Dollar and Euro interbank lending rates over the last six months. If you can punch that up on your Bloomberg then it's worth checking out. This is the rate that banks lend to each other.

I combine that chart with a discussion that I had with a senior banker this week. He was telling me that there are rumours about some medium sized institutions that are expected to need to merge with a stronger partner. That's a quaint British way of saying that they expect a few medium-sized banks to go bust if they don't get taken over.

I flip elsewhere in my paper and note that the last month saw record levels of capital raised by the strongest financial institutions (to strengthen their balance sheets). Elsewhere, my old boss is talking about the regulatory authorities being ill-equipped to handle the nature of the crisis.

So there is a real financial crisis happening right now. To date, the stock market, real economy and general public haven't focused on this issue. Given the magnitude of what I see happening, I can't see how it won't hit the real economy. Massive amounts of liquidity are being removed from the global financial system and the cost of capital is increasing.

That's my view on the macro picture.

On the micro picture -- life remains good for everyone that I come across. Unless you are a realtor, housebuilder, mortgage broker or specialist investment banker -- you will have been insulated from the crisis.

In Scotland, we've seen 5% capital growth in our property portfolio (YTD) and have been able to achieve returns much greater than that by creating value through project design; enhanced planning and "financial engineering". The team here are experts at getting the most out of difficult refurbishment projects in prime locations.

Consistently moving around the world, what most strikes me is the value that the United States offers relative to Europe (generally) and the UK (specifically). Europe is an expensive place to live and do business.

I'm writing this piece inside a two-bedroom flat at the edge of the New Town of Edinburgh. It is a converted warehouse, rather than the traditional buildings that make up most of our portfolio. This flat is valued at US$565,000 and I'd expect to see it get close to US$600,000 in an open market sale. At market value, you'd be looking at a gross yield of 4% and I wouldn't bet on you receiving much capital growth over the next three years. Smart financial buyers have been priced out of this market (they weren't really participants up here anyhow).

What's all this mean? Not much of change from what I was concerned about in 2004. I saw that we had to shift our business strategy to one that is based around value-creation, rather than asset-inflation. Personally, I reduced exposure "too early" and my partner made a quick paper profit on my holdings. However, together we created our new business and I "made" far more by helping him create something new -- than kicking back and letting him (and our team) do all the work on an established business.

At some stage, I'll talk about exits, sales and the strategic nature of working with entrepreneurs. I'm very happy about how things turned out. Selling to a CEO (& very close friend) was highly educational -- I'm glad that we're consistently on the same side of the table now. Personally, I prefer to sell early and for a bit less than full price.

So that's what I'm seeing out there right now. No real change in my outlook from last time.

++++

In portfolio terms...

Asset Allocation is 75% USD and 25% GBP
Forecast Capital Growth is 5% USD and 95% GBP
Forecast Income is 20% USD and 80% GBP
Forecast Expenses are 50% USD and 50% GBP

Breaking my portfolio down I'm 50% cash equivalents and 50% property related. The property investments are split 50:50 between the US and the UK. Our US property investments have a negative yield (we live in our house). My UK property investments have a high (but indirect) yield as they are tied to my advisory income.

All my portfolio leverage (up and down) sits in the UK property component of my portfolio. I hold cash as a hedge against this volatility. If we saw a major crash in global property markets then my UK holding would be hit. It is important to me to avoid dilution through the trough of the next property downturn.

It all sounds pretty complicated! More simply... a house in Boulder; a financial advisory business; a UK property developer; and cash. One major client in Scotland and personal expenses dominated by US taxes and a UK-domiciled consulting team.

++++

In reading through I didn't address your question on the US housing market. I think that the market will continue to fall over the next 12-18 months. If I wanted to enter the market then I'd start looking in January next year. I think that you'll have a lot of scared vendors early next year -- there is a wall of ARM debt that is going to adjust in the spring.

The only reason that I'd buy would be to have a primary family residence -- I expect that the terms on "buying for investment" will greatly improve over the next 12 months. I also expect that vacation locations will see better values when over-leveraged buyers are forced to unload properties.

Given the "yield gap" on most properties, I see little capital upside and the potential to get smoked by an adverse yield-shift (for the last ten years we've been benefiting from a favorable yield-shift). If that happens then there will be some great buying opportunities but we'll all be scared (witless) about putting money into a falling market.

Cheers,
g

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08 August 2007

Mind Training & Investing


Our photo this week is Clas and me in 2004. We're on the boardwalk in Hilton Head Island, SC. Lots of good memories from that trip and I think about Clas quite a bit.

I wrote a short piece on my August training over at the Planet-X site. One error that I discovered this evening -- I ran an 11-23 cassette rather than a 12-27 // sometimes it's best not to know that you are overgeared for a TT. Amazing what we can do when we don' t realize it. I thought that I had a gearing advantage over the boys and that made the TT feel easier -- the edge was all in my head!

In a future article, or podcast, I'll be discussing "Going Pro" -- if you've got any questions that you'd like me to address then send them along via email -- I listed all our email addresses last time.

Sam's written another interesting piece for us on Alternative Perspectives -- it compares powermeters with flying an airplane.

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Investing
If you are thinking about buying assets in the next few months -- I'd pause and consider three probabilities...

a -- that your purchase will cost more in February next year
b -- that it will cost the same to make the investment in February next year
c -- that it will cost less to make the investment in February next year

For what it's worth, in housing, I expect that the worst that you'll do is pay the same price next year -- with yields low (in most markets) that, effectively, means that you will have saved money.

In our Scottish business, we've done very well locking in deals across the winter when conditions are uncertain. We did that with the tailwind of a strong liquidity environment -- with tighter debt markets, there will be attractive deals to be had for fully funded buyers. Within our property development joint venture, margins have started to expand again (after contracting for the last two years).

The press appear to have latched onto the fact that we are in a credit crunch. I don't see that. [Ed Note: Whoops! ECB injects e100 billion into the debt markets.] What I see is that we've moved to more 'normal' debt conditions with borrowers having to demonstrate ability to pay and offer security -- the numbers don't look like a crunch to me. There is a clear overhang of poor credits and marginal developments in many markets -- still, fairly priced, quality product in prime locations continues to attract good pricing.

I think that there is a decent chance that we'll move through our current, benign, conditions through to a real credit crunch. The global liquidity picture should be a bit more clear by early spring.

Greed continues to dominate fear in the markets that I follow. I'm overweight on cash and biding my time.

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Mind Training
I'm going to keep this as simple as possible because, I think, that we waaaay over-complicate mental skills training. Here's the way I see it...

First -- identify our habits and patterns
Second -- remove the "mind" from the playing field

Most of the literature that I real about sports psychology focuses on exercises and techniques to deal with Part One of the challenge. Create consciousness about what's going on upstairs. That is a powerful first step.

For me, what comes after that is shifting from being (unconsciously) controlled by our thoughts to (consciously) observing them. Personally, I don't hold much hope of being able to control my mind -- I merely want to observe it.

I think we all experience thoughts, patterns, habits that we'd like to change -- only a minority of folks seem to be able to pause (a fraction of a second) to gain control of the automatic response that our fears and habits generate within us.

That fraction of a second is the most valuable second in my life -- it is where I am able to achieve a handhold of control over my actions. That small element of control helps me with the many little decisions that, ultimately, form my reality.

It sounds 'new age' to state with certainty that I control my life, my reality. Is it really? Consider the opposite -- how many times have you experienced the complete lack of control over your destiny? Being controlled by automatic responses to people, situations, emotions -- having your mind click into autopilot leaving you unconsciously following along. I spent YEARS like that.

Coming back to athletics -- I found a great article in the archives to illustrate my point. Here is my 2001 Race Plan. I must have been pretty nervous because I considered just about everything! The Plan worked great but there's no way that I could have remembered all that stuff on race day.

Six years later, here's my race plan for August 26th...
Swim -- long strokes, peaceful mind
Bike -- smooth power, patience
Run -- hands up, ribs down, WIN

No prizes for guessing which race strategy is easier to remember. Six out of seven components are under my direct control for the duration of the event. The seventh is a reminder (to me) that racing is a test of will (at many levels).

More than being able to remember/execute. What I notice between 2001/2007 is that, over time, I have incorporated many of the "Phase One" lessons (of racing) into my life. I don't need to be reminded of them, they are part of my life. So when you are working through mental skills training; consider that the ultimate goal may be to get past the exercises.

In my life, the "not thinking" is often more valuable than the "thinking".

Cheers,
gordo

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03 June 2007

Personal Investment Strategy



A.C. Writes:

I live in XXXX and bought my first property 14 months ago. I have done well in the 14 months that I have owned it. It has appreciated in value somewhere between 20 and 35% if the comparables are to be believed. It may have even increased by more. I am looking to move and I wonder whether I should remove equity from the property and purchase a second home and rent out the first all be it at a loss, or sell the first and purchase a substantially more expensive property and only own one. The XXXX market is difficult to read and I suppose if enough people / journalists / commentators tell us the market is over valued and will crash it will eventually become a self fullfilling prophecy but what would you do? Stay put for 12 months and see what the market does, remove equity and purchase a second home or sell and purchase?

What I'll do here is share the questions that I ask myself as well as the information that I prepare for myself when evaluating a property investment decision.

This should not be taken as investment advice or any recommendation on what to do with your own money. My goal here is to highlight some concepts that, I believe, are essential for making smart investment decisions.

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First up, what is the expected yield on the investment -- there are a lot of different ways to look at yield.

Gross -- when people are selling to you, they will quote Gross Yield and they will define that as Total Annual Rent divided by Purchase Price. As an example, if you are paying $550,000 for a property with a $2,500 per month rent then your estate agent might quote a prospective yield of (12 x 2,500 / 550,000) = 5.5% per annum.

Now that might sound pretty good, 5.5% per annum plus the potential for capital growth. However, Gross Yield on Purchase Price isn't what you really get as a landlord. What I like to consider is my net yield.

Net -- when I buy, I want to calulate my Net Yield and I define that as Net Annual Income divided by Gross Acquisition Cost.

To calculate Net Income you need to factor in... insurance; advertising; letting agents fees; maintenance; accounting; void periods; and all other costs. You also need to consider the time commitment that you will make, which can be material if you try to self-manage.

To calculate Gross Acquisition Cost you need to factor in... purchase price; acquisition costs (legal, valuation, bank fees, finders commissions, stamp duty); renovation costs (we redo most of our flats before letting); and furniture.

If you are running things as a business then you also need to consider an allocation of your central overheads. We have a team of 15 that works full-time in Edinburgh and that _excludes_ our development partner's group (contractors, sub-contractors, site management) as well as our lettings agent's group (letting, cleaners, accountants). There is a considerable amount of effort that goes into managing a residential portfolio. It's no wonder that most groups prefer to focus on commercial property.

When you start to factor all these points in... that 5.5% per annum that you were promised starts to look much less -- in some cases you'll 'lose' up to 50% of your Gross Yield. For this reason, many residential portfolios operate with a net yield lower than their cost of debt.

When we started investing in the mid-90s, it was the other way around, our net yield was 2-4% above our cost of finance. It was a great time to be investing. 20% down and our net yield serviced the mortgage with a little extra left over.

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With the yield you are in a position to calculate the total return (IRR) on the equity component of your investment -- explaining my views on capital structures as well as equity IRR calculations will have to wait for a future edition.

A quick scan on google turned up some options to help you if you want to read more -- this one looked interesting. Remember that, when we forecast growth, we will have a bias towards what's happened over the last three years.

With my investing, I want to consider a range of outcomes (likely and unlikely) and weight their likelihood. If I am comfortable with the implications of each outcome then I'll invest.

There are investments that have a great expected rate of return that I have passed on because I was concerned about the "implications" of a highly remote event. In finance, "implications" can include personal bankruptcy or a material reduction in standard of living. Our photo this week is Monica in Paris, being able to visit France is a luxury that we want to be able to keep in our lives.

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Now that you have a grip on the yield/total return -- you need to consider your alternative uses for the capital. I'll illustrate some examples...

Credit Card Debt -- this could be clocking up at 15-25% per annum. Your greatest investment is often paying down your most costly debt -- then cutting your cards into pieces. Credit cards are the bane of financial prudence -- Monica started a company in Colorado and we get 2-3 credit offers per WEEK.

Money Market Funds and Bank Deposits -- depending on your currency, you can earn 4-6% per annum for short term deposits. I never search for the last 0.1% and only invest with the largest banking groups. Seeing as I don't have any capital upside with this investment, I want the lowest possible capital downside.

Business Ventures -- I keep an allocation of my portfolio reserved for "exceptional deals" -- things that pop-up at short notice that have the potential for a large capital gain. When a great opportunity presents itself, you want to be able to take advantage of it.

***When you are paying off a large mortgage, car payments and/or credit cards then you will have to pass on opportunites that have the potential to give you the financial freedom to do what really matters to you -- generally, the things that we truly like cost very little.

For many of us, the true cost of leverage lies in opportunity cost as well as the emotional burdens. The interest rate is often the least of our worries!

Phew, a bit of a long winded way to say... Consider what else you can do with the money and consider the time/energy/emotions that each of those investment opportunities requires from you. Residential letting can be an intensive investment on many fronts.

Kicking back with a low risk portfolio is "boring" but over a 15-45 year time horizon boring starts to look pretty good!

Maybe I should have been an actuary...

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Now let's touch on some of your specific questions...

Q -- Should I rent at a loss? Double my exposure? Move into a massive house?

A -- Can you support three-years of your projected financial loss? Can you support one year of zero rental income? How long will your family remain financially solvent if you (or your partner) lose your job? Have you looked at your likely "total return" (equity IRR) across a variety of capital growth scenarios?

It's only been the last few years that investors (and bankers) decided that they would tolerate property deals that didn't cover their cost of finance. This is a relatively new phenomenon (outside of start-up VC) and should provide you with an insight into where current valuations are relative to historical norms (super high).

In 2005, I had more than 100% of my net worth invested in property -- at that level, I was seriously uncomfortable. So, I took actions to reduce my exposure to a level that I felt comfortable with. I think it was JP Morgan that advised a worried young investor to "sell to the sleeping point".

I sleep a lot better in 2007.

So... I was comfortable with the nature of my investment (prime Scottish residential) but I was uncomfortable with the quantum of my exposure (>100% of Net Worth).

What would I do?
I would likely purchase a house in the best neighbourhood that I could afford that had a price well _under_ the maximum that I could afford. With my personal investment, I need to stay well under the "sleeping point".

What should you do?
I have no idea but bear in mind that certain elements of the property market appeal directly to the way our minds are programmed. More concepts...

Envy -- in a rising market there are plenty of transactions that lead us to feel good about holding property. In a declining market, there are less transactions and we tend to fool ourselves about the true value of what we are holding.

Stories -- people love stories -- the property market abounds with stories of folks making money -- as well as characters that are experts at taking advantage of our desire to dream about easy money. We only hear about the good deals -- people don't brag about their dud investments.

Nominal returns -- NOBODY talks about the true cost of investing. We bought a condo in Boulder in 2004 for $360,000 and sold it for $409,000 this year (~5% return across the period).

Sounds like a good deal?
When you factor in cost of ownership, transaction costs (massive in the USA) and alternative uses for the capital -- it was my single worst investment across that period and Monica's family took a lot of the management hassle off our hands!

Still, it was a good deal "for me" -- there's more to consider that just the pure financial return.

Cycles -- if you are in your 20s, or even if you are in your late-30s like me, then we have no REAL memory of a truly crappy property market. 1989-1992 was poor in the UK and the 70s were a disaster all over (I am told). Going further back (see Irrational Exuberance, 2nd Edition) you'll see that property markets (like all markets) have periods were they snap back to trend.

Within my own investing, I want to make sure that I'll be OK if the target market/asset class snaps back to trend and overshoots way under trend. I have missed a lot of great deals because of my financial prudence. However, I've done enough decent deals to outperform my goals.

Security & Guarantees -- when markets turn down, I want to make sure that I'm not the first port-of-call when the banks start calling their security. In the early 90s, many US banks decided to exit the UK market -- remembering this lesson, we pay more to bank with people that are unable to leave our markets, providing money is not a commodity business and we choose our partners carefully.

Not exactly black and white, eh? For me it is a lot like athletic training -- best guesses based on imperfect and changing information. As well, there are exceptions for most of the "rules". Still, the rules have served me well.

Bottom line -- at this stage of the cycle, I wouldn't leverage past my ability to comfortably service the debt in an economic downturn.

Be patient -- you'll be saving and investing for the rest of your life. At some time over the next 10-15 years, there will be great deals that nobody wants to buy. When that happens, you will want to have the capital to take advantage of those opportunities.

As an investor, one of our greatest fears is missing out -- it's tough to sit on cash when everyone is leveraging up to the eyeballs.

Cheers,
gordo

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25 May 2007

Working Athlete Periodization & Prime Property


I've been on the road for a few days so our photo is another shot from the archives. I am missing Monica!

I've been a little jet lagged this week and took the opportunity to write up some thoughts on an alternative periodization approach. It's what I've been using for myself, and my crew, over the last few years. I'll explain the approach more fully in the Second Edition of Going Long. Joe and I will be working on the update this Fall and it should hit the stores in 2008. While the core of the book will stay the same, we have enough new information to merit a re-write. The second edition will be supplemental to the first -- an extension, rather than a replacement.

I read in The Economist that viagra could help reduce jetlag when flying East (no joke). Don't think I'll try it but it did make me smile.

The top end of the UK housing market is cranking along -- no signs of the slowdown that I was reading about this week in the US market (Toll Brothers). I've been thinking about the main drivers of the persistent boom in top end pricing -- declining long term interest rates, plenty of global liquidity and strong executive salaries in the financial - legal - accounting - insurance industries. The banks are offering very large mortgages to the right sort of buyers - up to 10x pre-tax income. On my trip, I've heard of multi-million, 100% loan:value mortages.

Edinburgh is seeing multiple pre-qualifed buyers competing on houses worth in excess of $3 million. This is a completely new situation. Five years ago, one of our companies was the first buyer to pay over $2 million for a townhouse -- today that same property is worth over $4 million ($6 million post-renovation). Too bad we sold that one! If you want to read about some seriously large housing appreciation then research the performance of the top end London market. In dollar terms, the last three years have been truly amazing.

Interestingly, the top end yields are reasonable in London, better than Edinburgh. I expect that we'll see significant rental growth in our key Scottish markets. For our highest quality product, we have seen rents move by 20-40% over the last 12 months. That's a big move for a sector that saw flat rents from 1998-2004 and isn't the experience of the broader market.

At a micro level, the market is being driven by an increasing number of top end buyers/renters. These clients are looking for high quality in locations that (by their nature) will always be cramped for supply. Combine that with a (well placed) reluctance to undertake their own refurbishment projects and you have a situation were the best properties earn a premium return.

By "best", I'm referring to the top 0.1% of the market. We stick to the most desirable properties to ensure full occupancy and high liquidity. We want to able to rent and/or sell in any market situation because an illiquid portfolio with empty properties can kill you in a downturn.

It's been a very interesting trip for me.

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One of the challenges of using a traditional periodization model is that the cycles of volume don’t always fit with the realities of your life. Put another way, when you use a table to determine your training schedule, you are typically doing either too little, or too much. Of these two situations, “too much” is the most risky.

What follows is an approach that I’ve been using with my athletes for the last few years. The traditional approach to periodization that we used in my book (Going Long) is both proven and effective. This letter seeks to provide you with alternative ideas that have helped many of my athletes achieve greater consistency and satisfaction with their training.

Here are the key concepts:

1 – the Basic Week approach maximizes training consistency over multiple months and seasons. By aiming for a “little less” each week, you will achieve more over the long run.

2 – your Weekday training is determined by the reality of your life situation, primarily your obligations to work and family.

3 – your Weekend training is split between an Endurance Day (typically Saturday) and a Family Day (typically Sunday).

4 – The training on your Endurance Day shifts based on your experience, fitness, goal event and the time of the year. You progress the nature of this day gradually and in harmony with daylight, climate and your fitness. Early season the purpose of this session is to build “endurance”, the ability to complete your desired race duration. As the season progresses, you shift your focus towards “fitness”, the ability to perform across your desired race duration.

It is typical for novice athletes to focus on “endurance” for multiple season. I spent many years with endurance as my main (nearly, sole) focus. An endurance athlete never graduates from focusing on steady-state stamina – it is the fundamental component of athletic performance.

5 – On your Family Day, place the people that support your athletic goals first. This increases your emotional harmony and gives you a break from athletics. It also has a positive athletic benefit because you arrive at work fresh on Monday – keeping you employed (!) and increasing the quality of your Weekday sessions.

6 – By agreeing a training schedule with all key players in your life, you remove the constant struggle to “squeeze in” and “juggle” training sessions. You have an agreed structure that you’ll repeat for the rest of your life. This is a holistic approach that fits your training into the larger goal of a successful lifestyle.

When you set-up your Basic Week keep the following tips in mind:

1 – aim for a Basic Week structure that you can complete “no sweat” forty weeks per year. You want to have a structure that enables you to outperform on a weekly basis. This is an important part of building credibility with yourself.

2 – while the timing structure of your week should remain the same, ensure that you vary your training protocol (what you do in each session) every six to eight weeks. Your fitness will progresses from variable overload applied consistently across many years.

3 – twice a year, insert a period of unstructured training. At the end of your season take 2-8 weeks of unstructured training and in the middle of each year at 1-2 weeks of unstructured training. The closer you move to your maximum potential and the greater your athletic success, the more recovery you will need to insert into your year.

4 – every three weeks back off on the training load, even (and especially) when you think that you don’t “need” it. You are playing a long-term game where athletic fatigue creeps into the body very gradually.

5 – use benchmark testing to track your progress. Remember that multiple month plateaus are common; the rapid progression of the novice athlete is not the typical experience of a veteran to our sport.

Your ultimate athletic development is determined by your athletic consistency, not the nature of your toughest sessions. Protect your consistency and your fitness foundation; these are the keys to reaching your fullest potential.

Hope this helps,

gordo

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18 May 2007

Never Follow, Averages and Overtraining


This week I am going to expand my thoughts on both overtraining and effective investment. I'll also explain a little something about averages in training and racing.

Our photo is the "Dixie Chicks", three great ladies that came to Mitch's desert camp and made it fun for me. Their passion for the sport was contagious and they added a lot to the week.

An offer to gLetter readers from Albert at Coffees of Hawaii. From May 21-28, you'll be able to get 20% off everything on the website by using the code "gordo2007". Choose your order, then enter the code at checkout. My favourite product is the Hawaiian Espresso.

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Never Follow
A reader asked for some more information on my advice to never follow poor investment decisions (in people, in shares, in companies, in ourselves).

Read Hedgehogging by Barton Biggs. Tons of good stuff in there -- written by a man's who's world contains people where a net worth of $25 million is a reasonable starting point. The insight into the mind-set of the financial elite is interesting but the real value, for me, came from his reminders on investment strategies that work.

For example, in his firm they have a policy that they review every deal that falls X%. If they still believe that it is a good deal then they must double their position. If they can't convince themselves of that point then they sell immediately. You can apply this point to any situation in life -- I use it on people, discipline with human capital is more important than financial capital.

Tip Two -- Common mistakes that we make are: (a) giving more value to things that we already own (bad deals) ; and (b) over-estimating our ability to influence a situation (save an investment, improve an employee). These concepts are laid out quite well in Mauldin's book, Just One Thing.

Another issue that we face with our Bad Deals is that they distract us from doing what we are really good at. Put another way, we gain very little from turning a poor employee into an average employee. However, the star members of our teams (and portfolios) can impact total performance in a meaningful manner. The mere fact that we tolerate dead wood can hold back the star performers (See Collins, Good to Great).

Put simply, whenyo u think that you can fix the situation... you probably can't and, even if you can, you'll make more money backing your winners and investing in your strengths.

Finally, don't fool yourself into thinking that markets are transparent. My investment portfolio consists of:
>>>Money Market Funds (low fee, very low risk);
>>>CDs from very highly rated organizations;
>>>Ventures in which I play a positive role in enhancing equity value;
>>>My house.

That's it.

In the past, I have had the opportunity to invest in collective investment schemes that were managed by the partners of my old investment fund. That was a great deal, quite profitable and my role was limited. I also benefitted from the extended bull market in prime UK housing (that is continuing) -- I can't take much credit for that.

The partners' investment scheme and the housing boom succeeded by giving me leveraged upside, with limited downside -- they were options on future outcomes. Create, and take, options whenever possible. Consider where you can create options in your own life. I tend to keep a number of opportunities rolling at any one time. This gives me flexibility and exposure to a range of situations.

Another good lesson from Venture Capital is that if you invest long enough then you'll nearly always hit a home-run eventually. One homerun, when combined with fiscal discipline, creates many options for how you will spend your time.

It all sounds so easy, doesn't it. Well, there are probably a thousand qualified people for each seat at the elite finance table -- so you need to be smart; work your ass off; enjoy working and a bit lucky. From the outside, opportunity may appear to be what holds you back (the entertainment industry may appear like this to some). From what I've observed, most people lack the combination of work ethic and work enjoyment. I've given (and continue to give) people the opprtunity to learn/succeed. Even when you offer a hand up, most folks are content to stay in their current situation -- out of fear, inertia or some other driver.

Final thoughts... when you take the return of the financial services industry (as a whole), you'll see the participants strip out the excess return for themselves. It's a highly efficient market for the participants of "the game". That's my final book recommendation for today, The Game, by Adam Smith.

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Averages
What follows is a chat about simple averages -- not normalized, not weighted. Unless I specifically write otherwise, I always mean the simple average when I write.
E.M. wrote... I just heard your talk on power on Ironman talk podcasts and found it quite interesting... I am actually glad I did not look at the watts during the race because (from training) my expectations were to bike in the 240-250 range vs the 225-235 range.
A buddy that worked at Nasa once explained to me why we spend nearly all of our time above the average pace/watts/hr for a session. It has something to do with the fact that sometimes we go _really_ slow but we never go _really_ fast. He had a nifty equation that explained it all.
The above athlete's experience is what happens in the real world when we pace correctly... our actual average is lower than our training average for that goal effort. Specific to that example, sitting on 240-250w for the bulk of the race will result in an average 10-20w lower. Many athletes get caught in the trap of chasing average watts -- you can get a bit depressed, or very tired (!), with that strategy on race day. Dial in your sustainable effort and accept the power/pace/speed that results. Honest race simulation workouts help avoid surprises.

It is similar with running. For me to average 4 minute per K pace in a race, I need to be able to sit in the 3:50-3:55 per K range for the bulk of the race.

By the way, this discussion isn't meant to say that one needs to train faster -- rather, I'm pointing out that on race day, most of us find that our "steady" pace over 8-18 hours is slower than our steady pace over 20-60 minutes. I spend a lot of time helping athletes learn this point.

What feels "easy" for the first five hours of racing... just might be your sustainable pace/power/effort for the entire race. It certainly is for the first three hours of your day -- no need to open up by swimming at Half Marathon heart rates. You are killing yourself.

A final thing to watch for in training -- let's say you want to hold 128-135 bpm on a workout. Early in the day that might result in an average of 127-129 bpm. After you are warmed-up, say, 133 bpm. If you are seeing averages close to 135 bpm then you've been training above your target zone most of the main set.

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Overtraining
Coach KP and Dr. J were swapping ideas about overtraining, reaching for excellence and other ideas. It's always nice to "listen in" (via email) when a couple of smart guys share their experiences. Anyhow, after reading their thread, I talked it through with Mark Allen (I was in Santa Cruz this week). What follows is a mix of Mark, the guys and my own thoughts.

The lessons and benefits of being overtrained ALL accrue the FIRST time you go through that process and (if you are lucky) learn the nature of "bad fatigue". You will also see that fatigue is a state, not an emotion. The highest performing ultraendurance athletes have a low (to nil) emotional attachment to fatigue. I expect that the shorter the duration of the event, the more important a low emotional attachment to pain becomes.

Guys like Dave Scott, Mark Allen, Scott Molina, Peter Reid -- I imagine that they have low attachment to both fatigue and pain. I have no idea what _really_ happens in their heads but I know that my experiences meant that I was open to completely frying myself. My early warning signals sound "faint", or are ignored. My buddy Clas is even stronger than me -- therefore, his overtraining experience was, ultimately, deeper than mine.

In hindsight, I received all the overtraining "benefits" when I took myself to an over-reached state (see Going Long for an explanation of the difference). Basically, over-reaching is using race specific overload to create race specific fatigue in a desire to generate physiological and mental benefits. Over-reaching is an essential part of ultraendurance performance.

My lack of experience with "appropriate overload" led me to choose to go "too far" resulting in overtraining. It is really tough to see that you've gone "too far" until you get there.

Similar to learning how to differentiate pain, some people learn how to differentiate between types of fatigue. Good fatigue, silly fatigue, dangerous fatigue, fatigue that can be ignored and fatigue that shouldn't be ignored. Thing is... we are constantly changing and challenging ourselves to make decisions on uncertain information.

Many athletes relive, recreate, actively seek... highly stressful experiences such as overtraining -- they crave the chemical buzz associated with high stress. This pattern is a poor strategy for success but can produce high level results. A deeper level of success is available if we are conscious enough to learn from our mistakes.

Mark shared... picture a horizontal line -- at the left side is "out of shape"... at the right side is "maximum potential" -- one hundredth of an inch to the right of maximum potential is completely overtrained. Athletes that come closest to their maximum potential have the greatest risk of overtraining. I see this in my own athletes.

Here's the kicker... most people are so far from their maximum potential; so stressed out from their life choices; that to pile on the additional stress of "training right"; "physiologically optimal"; "true build training"; "going hard"; and/or "training like a pro". Achieves only two things...

#1 they get sick/injured; and
#2 they get very tired.

You are left with a person that faces simple exhaustion, rather than being overtrained. So they get nuked AND fail to get the benefits from pushing their limits. It takes many years of preparation to gain value in screwing up... a paradox of endurance training, I suppose.

To an athlete with an experience of being deeply overtrained -- effective training feels like being constantly undertrained. I've felt completely undertrained for the last thirty weeks, while using Mark's protocol. However when I think back, I can remember thinking very clearly that I was at my maximum limit for what I could absorb. It is just like looking back at a well paced Ironman race, at any given point could have gone "harder" however at the finish you know that you gave it your all.

I did an aerobic run test Tuesday morning before I met Mark. 5:59 average across three miles with last two miles at 6:00.36. The last three benchmark runs that I have done have all been life best performances across the distance (6 miles off the bike, 33-flat; Half Marathon off the bike, 1:16; Aerobic Test, 5:59). Everything that I am doing is contained in this blog -- there's no secret training happening. I'm doing less than previous years but (I suppose) absorbing more.

Most people fail by never giving themselves a chance to perform. Too much effort, too short a timetable, and a lack of preparation. Short bursts of mis-directed passion -- one night stands with "effort" rather than an extended courtship of "excellence".

That's all for this week,
gordo

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12 May 2007

Success, Discipline, Bad Deals and Bodhisattvas


The photo this week relates to my final topic of bodhisattvas. The other topics that I'll share ideas on are success/results; discipline/compromise; and bad deals.

Before we kick off a public service announcement on helmets and seat belts... the good weather has a number of my pals riding naked!

It is worth remembering that we never choose when we will have a life threatening accident. Helmets have saved me from two very serious head injuries. If you don't want to wear a helmet for yourself then wear it for your friends/family -- we are the ones that will be left to pick up the pieces when you sustain a serious injury.

If you insist on riding without a helmet then please, at a minimum, carry an organ donor card.

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Success vs Results
A friend recently remarked that while he 'lived' better than anyone that he knew, he believed that I enjoyed the way that I lived far more than him. There wasn't any envy in his statement -- just an observation on the difference between consumption and satisfaction.

There is, I believe, a related topic in athletics -- the difference between achieving success and achieving results. There are a lot of different aspects of this topic and I will limit myself to a couple of sub-topics this evening.

There are several training techniques that produce results while rarely leading to success. I'll share a few:

***Starvation training, exercise anorexia, depletion training -- whatever you'd like to call it. Over the short term, self-starvation can be performance enhancing. There are several successful trainers that actively push their athletes down this path -- results are achieved and others (including the athlete) are left to pick up the pieces.

***Overtraining -- a really interesting topic for me. Within my own training, I was successful, with a high quality of life during all of my overtraining phases. When I look around my friends and read case studies of world class athletes, I see that there are positive physical and mental adaptations that occur as a result of the lessons leading into an overtrained state. Pretty much everybody at the top of their sport has blown themselves up at some stage.

Having come out the other side of both these topics, I find it difficult to participate (in any way) in an athlete's desire to impair themselves. However, I do have empathy for the athlete that argues for his right to nuke himself. You'll certainly miss your health when it is gone, so it is best to ensure that you have a very good reason for venturing to the limit.

These topics present interesting ethical dilemmas that (I expect) healthcare professionals must balance on a daily basis. The balance between respecting a person's right for self-determination and my desire to surround myself with individuals that embody the life that I want to live.

At many levels, athletes look to their coaches/trainers/advisors/mentors for affirmation that their strategies are "what it takes". I'd caution you to consider if a solitary focus on results will, ultimately, lead you along the path of a successful life.

Speed, money, body fat percentage, net worth -- these may enhance our perceived quality of life but they do not represent quality of life. The more fixated we become on them, the more we'll miss them when they're gone.

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Discipline vs Compromise
Another buddy of mine shared an observation that taking care of his financial obligations was forcing him into a position of compromise with his training. He noted that he struggled with compromise -- the underlying sentiment being that he was results focused on his training and didn't want to back down from achieving in that field.

If you've been reading this blog for a while then you'll know that financial prudence is a fundamental belief of mine. When I am out of financial balance, I can't really think about much else. This presents challenges as I broaden my consulting practice to help people with their financial situation. In fact, I have a little sign beside my desk now... "assist without ownership". The sign is part of my drive to free myself from the illusion of controlling anything outside of myself.

I thought about my friend's comment and my first response (internally) was a quick retort that there is a massive difference between compromise and discipline. However, given a week to mull it over... I think that my buddy had it absolutely correct.

Changing our patterns is difficult
Changing our patterns takes time and effort
Meaningful change requires new methods of thinking
Without the catalyst of a crisis, most are unable to make meaningful changes

I think that my strong initial reaction was generated by my own pattern of thinking. Here is how I see it...

"I never compromise, I make positive decisions that support my desired goals. I'm doing what it takes to achieve success."

You can easily change this to...

"I am constantly compromising, all I do is say 'no' to myself. I try so hard to escape my failed patterns. Poor me."

Same thing...
Different mind set...
Different probability of success.

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Bad Deals
Whether it is a poor investment, a weak hiring decision or a failed relationship, we are all going to make a few bad deals in our lives. Due to space constraints and to protect the guilty (i.e. me!)... I'll skip the specific examples.

Here are the key things that have helped me deal with my most serious personal challenges:

Forgiveness -- not your spouse, not your business partner, not your employee -- forgive yourself for having made such a poor decision to start with. When I'm in a bad deal, nearly all of the angst that I feel comes from a mixture of fear and embarrasment for a self-generated failure. I made a poor choice -- I blew it -- things didn't work out as planned. To think clearly, to move forward in a positive manner, my first step is to forgive myself.

Effective -- you'll have a lot more success in your exit strategy if you focus on being effective, rather than being right. Seeing as you've (hopefully) managed to forgive yourself for entering into the deal -- there is no need to get the other party/company/boss/employee to admit that they screwed up as well. You don't need to be "right" -- you do need an exit that protects your position while preserving your ethics. If you are in settlement negotiations remember that your self-respect is the only asset that you truly own.

Tests -- while you are working towards a successful exit strategy, expect to be challenged emotionally with 'unreasonable' requests. I used quotes because it is important to remember that the other party is likely fighting for their own financial/emotional survival. In these situations, people can do some strange things.

Sunk costs -- in a bad deal, the time/money/emotions of the past are gone. What matters is having the mental clarity to make effective decisions about where you will invest your current (and future) time/money/emotions.

As a professional investor of 17 years, I can tell you that (as a rule) you will make the greatest return by never, ever, ever, ever following your money when a company is off plan. I watched us burn millions of pounds learning that lesson in the early 90s. A simple rule that is far from easy to implement.

As a human being of 38 years, I can say that the strength of my relationship with Monica stems from the self-knowledge and self-commitments that flowed from the errors that I made in previous relationships. To get a different outcome, I had to change my approach, rather than my partner.

Finally, for what it's worth, my most valuable life lessons have come as a result of bad deals. The financial and emotional costs that I've paid have returned huge dividends through improved decision making and perspective about my life situation.

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Bodhisattvas
If you click the link then you'll get a proper definition of a bodhisattva -- I like Jack Kerouac's, "a brave wise being or a great wise angel". I think that I had one of these mythical creatures in my house the other day.

Allow me to explain...

The photo that leads the blog this week is my father-in-law as a young man. As you can see, he was a military man and worked on a carrier flight deck.

A few months after that photo was taken, Robert was involved in an accident where he was sucked into a jet intake. His buddies pulled him out of the engine and he was dead on the scene. The engine blades sliced his shoulder quite badly and he lost enough blood for his heart to stop. Fortunately, the crew managed to revive him.

He's never really explained to me what dying was like -- I doubt that he'd be able to find the words and, even if he did, how could I understand. Anyhow, after they managed to get him stable from the first accident, his shoulder became infected and it wasn't looking too good for him. Interestingly, when he describes this period of his life he focuses on his friend in the hospital, playing checkers and laughing daily. Dying was quite beneficial for his mental outlook!

I attended Robert's 70th birthday party and he explained a few things to us. He didn't really give a speach, rather he shared a few ideas that had been helpful to him. It was a bit like being handed thirty zen koans. I only remember a few things from his talk but he's been threatening to publish his memoirs.

The observation that stuck with me was his statement that he is constantly surrounded by mirrors.

When I am at my most "clear", I don't seek to overcome, or fix, myself. Rather, I use self-acceptance to create empathy by seeing myself reflected in others. Some traditions talk about being "one" with the world -- so far the best that I can manage is a little empathy. It's a start.

Another of the things that he shared is that the accident super-charged his ability to "feel", specifically, to experience love. A person that is supercharged on love has some interesting characteristics -- Robert's emotional circuit breakers can get overloaded and he's prone to crying when he's really happy -- which means that he cries at just about anything because he sees beauty in most things (other than the Bush administration but he's working on that).

Like a lot of my best teachers, simply being with him leaves me feeling better. He's got quite a bit to teach me but I know it all already. My head likes to file everything in sequential or opposing terms. Some knowledge doesn't quite fit that way.

Back next week,
gordo

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01 April 2007

Vegas & Greed


Our photo this time is the swim exit from the race that I did at Lake Havasu -- I just got the snaps and something about this one appeals to me. Right now, I'm sitting in St. George, Utah and the lads are out riding.

Yesterday was a fun day of training and we saw some amazing sites. The main reason that I wanted to train in Vegas was the Lake Mead Recreational Area. It is one of my favourite places in the world to ride and offers a little-bit-of-everything in terms of terrain. The Silverman triathlon is run out there and, some day, I hope to do that race. Maybe I can convince Frank to invite me to help him host a training clinic next Spring...

If you do race then I suggest that you eat, drink and relax for the ten miles that start at the summit just past Highway Marker #20. Denny gapped me pretty good through that section while I relaxed and ate. However, those calories came in very handy later in the day when we ran in the Valley of Fire. If you're racing then the return leg will be "interesting". A few days ago (with a nice tailwind), I big-ringed the return to Henderson -- I don't recommend that for race day but it was fun training.

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Sam suggested that I share details of a conversation that we had when he was in Vegas with us. It was about heart rate training and I'll provide the summary.

So you've got this cap? What do you do under the cap? How do you train?
>>>Train exactly like you do normally. Simply make sure that you abide by the cap.

How hard do I go?
>>>The cap means that, effectively, you...
Run -- Steady or lower
Bike -- Mod-Hard or lower
Swim -- Fast or lower
>>>Focus on longer, steadier efforts. If hills spike your heart rate then slow down, change gearing and/or stick to the flats.

So I stick with low heart rate training?
>>>This is not low heart rate training -- this is smart endurance training without the heart rate peaks that are generated by ego or lack of experience. It takes outstanding endurance to place a lot of steady-state training within a week.

Rapidly rising heart rates -- why?
>>>Generally, these are caused by a narrow fitness base. It's not problem, it is part of the natural process of building your endurance base. It is important to remember that if you are sitting at, say, 145bpm while walking up a hill... you are placing 145bpm worth of stress on your body. It doesn't matter if you are running or not... you are placing a decent level of aerobic stress on your system. As an example, I still need to walk hills and my max aerobic test is faster than many athletes' 10K times.

Learning to transcend our egos is useful for many situations other than just endurance training.

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At the other end of the training spectrum from overtraining, over-reaching and fatigue is something that we might call speed-greed. I've seen many talented athletes come to triathlon with low expectations of their personal performance. By successfully managing their expactions, they receive a lot of satisfaction from their early race successes (every finish being a success).

Success, breeding ever increasing expectations... these expectations clouding the relaxed fun that was experienced early in their athletic career. Increasing expectations eventually exceeding perceived relality... leading to crisis. This disconnect between expectation and reality is a leading cause of emotional breakdown and quitting.

A philospoher noted that we can only be deceived when we want something. When things aren't going to plan, I consider how I'm fooling myself with misplaced expectations.

From Utah,
gordo

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02 September 2006

Value & Return

If you are reading this entry then you are part of my extended circle. We might never meet or… we might swap an email or two… or we might meet at a race. Last week in Penticton, I was fortunately to meet quite a few new people. If you did then thanks for coming up and saying "hi". The combined effect of everyone greeting me was really positive.

Some of you probably sensed that I wasn't really missing my Tri Forum -- to be honest, I wasn't missing it at all! I appreciated having the extra ten hours per week of time. Still, chatting with a few folks made me come to realize that it is a great vehicle for us to get to know each other a bit. As well, the value received by everyone (including me) is hundreds of times the effort that I put it. The internet provides massive communications leverage when used appropriately.

So the Tri Forum will return, eventually. We're going to rebrand to something like the gForum and get the rotating yin-yang sign in there somehow. I'm leaving that to my web-guy. How long to get it all running? I'm not really sure but it will be coming back -- I need to wean myself off some alternative boards that run the risk of infecting my mind with chaos and noise! Just like big cities, popular sites often reflect the disfunction apparent in many societies (reflecting the fear and lack of self-love of many participants).

Race week was a hoot and I nearly lost my voice from talking so much on Wednesday. M started laying ground rules on me for my own protection. You see, once I get rolling, I am liable to stand around in the sun for hours offering ideas on topics such as run durability and training with power!

Now that more people know what I "do for a living"… I find myself engaged in conversations about investments, property and finance. When my business and triathlon lives were black boxed from each other, I never really had a whole lot of conversational overlap.

Not surprising but very interesting (to me at least) how conversation is guided by association. I need to keep working at listening better because people tell you quite a bit about themselves as soon as they start talking. Five more years and I hope to be much more accomplished.

M has this gift for making people feel comfortable so she does quite a bit of my listening for me. In our relationship, we delegate roles to the person that does them the best -- in that sense we are quite "traditional" in our marriage. Our skills fall clearly into male/female generalizations and we like it that way.

However, with listening, I see the ability to get a real edge on life. Not so much an edge over the competition, but an edge over myself in being able to "see" what's really happening around me (seeing is the first step towards controlling). For me, listening is linked to observation. When I am hearing others quite well -- I am also able to observe myself clearly. This observational skill leads to good emotive control which greatly increases my influence over the world around me. In a sense, we can control people by listening to them.

After a two year break from the Okanagan, I was amazed at all the development that had taken place. I hope that I get a chance to live through another economic cycle where the Fed cuts rates way low following a stock market crash. It all seems so easy in hindsight. Of course, I need to watch my personal “fear of missing out” that we all share. Envy and Sellers’ Remorse are big drivers.

They have a saying in Hong Kong that when your secretary starts writing cheques for IPOs then it is time to exit the market. What I noticed in Penticton was that _everyone_ was talking about property. If you are new to investing then here are some concepts that you might find useful.

An example:

Let’s say that I own an apartment that rents out at $1,000 per month. We’ll say that there is no mortgage against the property and my maintenance costs are $2,000 per annum. So I net $10,000 per annum from the property. Further let’s say that I paid $100,000 for the place, so my yield is 10% per annum. In an environment of 4-5% deposit rates that is a nice return. You are getting a great income return on your capital and have the upside for future appreciation.

However, in many markets residential and vacation yields are closer to 5%. So let’s adjust the assumptions a bit and say that I have a mortgage of $80,000; the yield is 5% and the cost of debt is 7%.

Where does that leave us?
$5,000 in rent
$2,000 in expenses
$5,600 of interest

This leaves a net cash outflow of $2,600 or a net yield of -2.6% against value.

I was 80% debt financed so my down payment was $20,000. My return on equity in this case is equal to -13% on equity (ouch).

However, in a property market that is rising by 10% per annum we would have “received” a valuation increase of $10,000. So our net position would be a cash outflow of $2,600 but an asset appreciation of $10,000 – a net move of $7,400 on our equity investment of $20,000 (+37% on equity, yippee).

Further if we manage to convince the bank to stump up some further debt finance against the increased valuation then we won’t even be out of pocket. When inflating valuations combine with high liquidity, it seems like easy money and it is, sort of.

The trouble starts to come when valuations stagnate and/or you get caught with the bank asking you to cover the cash shortfall out of your pocket. In those situations, things can start to look pretty crappy…

Three years rent is $15,000
Three years expenses are $6,000
Three years interest is $16,800

The accumulated cash deficit would be $7,800 (a 39% reduction in our initial investment value – or – a 39% additional increase in exposure).

At a 5% deposit rate, we would have forgone a 16% (compound) interest – the money we could have earned by having the cash in the bank instead of in property. The swing is equal to 55% of our initial investment – on an asset that didn’t move at all over three years. So while we may get our money back in three years – we had to pay 39% holding costs and missed out on 16% interest.

These calculations are interesting to me because often we fail to factor in additional cash calls when we think about an investment. In the second example above, you’d be shelling out each month to cover the deficit – but – the value of the property would not be increasing.

Many people purchase vacation and/or larger primary residences under the assumption that they worst they will do is “hold their value”. In those situations, there is no rental yield on the property so the income gap is even higher. As well, vacation properties are (by definition) non-essential purchases. So our ability to sell is much more volatile.

When we are holding a non-yielding asset that requires maintenance, there is the cash outlay that we have to pay as well as the opportunity cost of the capital being tied up in the asset.

I wanted to lay out a simple example because I was sensing that many people now believe that property investing is a one-way bet, the worst you do is a nil return. In fact, like any depreciating asset – in a downturn you can find yourself locked in and paying money out.

Another common point of view is that it is worth owning any property that we will use ourselves. Well, that depends. I spend quite a bit of money renting properties around the world. The calculation that I do is to compare the total number of nights that I use a property with the capital cost (plus the running costs; plus the hassle) of owning that property year round. If you own then it is tempting to tell yourself that you can always rent it out. But do you really? Most potential renters will want to use it at the same time as you (holiday and peak times). Even if you are renting to friends, tenants are a pain.

Finally, beware that we all have a deep fear of missing out. Hearing about other people making money... Seeing other people own assets… …these things triggers automatic “envy” responses in many of us. So we’re hardwired to want to own “our” assets.

It takes a massive amount of discipline to sit on cash and wait.

Property can be a great investment. I simply get nervous when a see a lot of new people entering a field late in the cycle with an attitude that they can’t lose.

In a flat market, much of the “cost” is hidden from view. Property stagnates more often than it tanks and if you aren’t in a prime-prime location then you can be faced with crystallizing a short term loss or shelling out for a few years through a dip in local conditions.

In my business we have two mantras that we live by. We want to be able to: (a) sell in any market condition; and (b) find tenants in any market condition. This greatly limits the locations where we can invest and means that we pass on seemingly attractive deals in secondary locations. We invest a bit slower but the risk profile of our portfolio is reduced.

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13 August 2006

Summer Financial Reflections

I'll get to my Good, Better, Best post in a while. I've completed the outline and want to spend more time that usual putting my logic together to "make my case".

===

I've been mulling over a few things this year and watching the major economies -- from a distance, on a weekly basis through the Economist, FT and Wall Street Journal. I've also been reading a selection of research that some pals send over from time-to-time.

Interest rates -- globally, I've watched every central bank tighten throughout the year. This time last year there were some outstanding long term swap rates around -- oil prices, inflation fears, a more rational outlook and easing global expectations have made those disappear.

Housing -- despite rates moving up just about everywhere, prime housing is surprisingly robust. Within our portfolio (Prime Scottish Residential), we continue to see 10% per annum growth. The high end, in most places I go, is performing very well.

Inflation -- everyone talks about how we live in a low inflation environment. I simply don't see that. Now my life is quite a bit different that most folks -- my largest single expenditure is airfares. and -- following that -- rental accommodation. Step back from me, though...

What is the largest single expenditure that most people will make in their lives? Think about it relative to personal NAV at the time.

Housing.

Now if you "own" your house then you've likely seen fantastic growth in your equity over the last six years. You may have also moved up the housing ladder possibly by increasing your personal leverage. I know many folks that have done that.

Consider your debt service obligations as a percentage of total family expenditure -- how have these changed over the last six years?

If you don't own then consider rent as a percentage of total expenditure -- how has that changed?

One of the things that I learned when working in venture capital was sensitivity analysis. Basically, we would dream up scenarios to see how our investments would fare under various outcomes. We also wanted to see what would blow out the banking covenants and/or leave us bust.

Here's one that I've been mulling --
***Knock 20% off the value of your real estate investments
***Set all your asset backed debt service costs to 10%
***Set all your unsecured debt service costs to 15%

Are you still solvent?
Lose your job -- how many months until you lose your house?

If you are under 30 then this scenario may seem far too drastic.
If you are over 50 then you'd merely call this a recession.

This table is great -- outside of the US, you get even wilder historical interest rate data. It's worth looking at the prime rate across your business career -- then look at across your parents' careers.

If you have a similar spread to my peers then you'll see why so many of our parents' generation were hammered in the late 70s/early 80s. The only experience they had was similar to our own. Now they had their parents' memories of the Great Depression but that was ancient history and they were in a new era...

Most of my adult friends have very little direct personal experience with the combination of asset deflation/wealth destruction and high interest rates. There are vague memories but times have been so good, for so long and their investments are so blue chip... that they simply can't fathom anything other than continued asset inflation.

===

It will be interesting to see where we are a year from now.

War in the Middle East -- high energy costs -- terrorism -- a contraction in consumer demand driven by negative wealth effects -- tightening global monetary policy...

Now there is a lot of very good news out there. Most of my peers continue to do very well -- the people that purchase and rent our properties are continuing to do well.

It's just that I can't help but run my scenarios -- and I sense that much of this feel good factor is being driven by the massive run up in global real estate values. Nothing warms the heart quite like our own home increasing in value. It seems so "real".

What drove these values so high, I wonder?
***Rapid monetary growth driven by low central bank rates
***Increasing loan to value ratios
***Increasing loan to salary ratios

Leave everything the same as it is right now -- assume no further inflation, no deflation -- merely a benign scenario where we all move sideways for a while. If you aren't too leveraged then not a big deal for a few years. However, if you are highly leveraged on low yielding assets then there could be a liquidity squeeze.

Who knows what's going to happen. I certainly don't.

I've simply beeing watching (from a distance) global liquidity as well as risk. I have the benefit of moving around the world quite a bit so I get a feel of what things are like in many different regions. While successful property investing is very "local", the concepts that I have outlined above are pretty much universal from my travels in Asia, America and Europe.

I read all the articles on the US Dollar being overvalued but in terms of purchasing power, the States leads all of the "first world" places that I've visited (France, UK, Canada).

New Zealand still has a value-for-money edge over the States but that's driven mainly by a lower housing cost than an equivalent US city. I'm spending all of December in Australia and will enjoy having a look around there.

So that's what I mull over when riding long and not thinking about triathlon training. A rather long winded way to say that you might want to check your room-for-error with your personal leverage situation.

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07 June 2006

Who Owns an Ownership Society?

Earlier this week, I was reading a WSJ article about how US Corporate Profits were at an all-time high. I think the article noted that the record high was achieved in nominal terms and as a percentage of GDP.

Anyhow, that got me thinking... Who are the main beneficiaries of these record profits? Where’s all this cash going? Who is it benefiting?

Top Management – Perhaps I am only reading about the most extreme cases of management pay but it seems to have totally broken from the realm of sanity. It’s not a case of folks aspiring to get out of flying Economy Class – rather I read of people justifying packages set at a multiple 100s of times what is paid to the folks that are working underneath them. I sit and listen to some of my peers talking about the simple convenience of personal jets. The quantum of the wealth creation for the elites in the financial services area is far beyond what you can imagine. Like drafting in elite male ironman races... it's a topic that "those that know" are often reluctant to discuss.

It appears like there is collusion between directors, managers, institutions and the media. Even “activist” shareholders appear to be part of the skim. Heck, I’ve made a career sitting in the middle.

Somewhere the obligation to all stakeholders in many organizations appears to have been lost. I sense a relentless drive to increase productivity per head and keep a lid on wage costs. Many of us accept this as a requirement of a capitalist society. But is it really? My preference is to work within a corporate culture that works for the benefit of all stakeholders in society.

Perhaps I am over-reacting, I think to myself. Perhaps it is best, it is most efficient, to have the sole goal of industry to maximize near term profitability?

But then I think to myself... who really benefits if this is the case?

At this stage, some might say that the shareholders benefit. Others might point out that with the growth of institutional investors and mutual funds; we've become an ownership society.

We are told that as an ownership society, we all benefit and in a long bull market you will actually believe this. However, I know the difference between Net and Gross IRRs.

Something bothers me about the “society is wealthier” argument. Even if it is, are the "owners" actually calling the shots? Not a chance, they have been difused, then pooled into collective investment schemes managed by the Persuaders.

You see, I've worked in a few businesses that exist between "your" ownership and “you”. In some cases, the businesses added material value to the value of your investments -- so you might argue that these situations made society more efficient. However, in other instances, once you adjusted for transactions costs, fees and financial "friction"... well, you'd have been better investing in US Treasuries. While you might have been better, somewhere a Financial Persuader's NAV would have been impaired.

Across a wide portfolio, over a long time horizon -- I am confident that there is far more value extraction than value addition. I'll leave it to other to make the case in numbers.

When you look at the value of your investments, don’t confuse asset appreciation with value addition. Many people make this error.

There is (and has been) a massive wealth transfer towards a new stakeholder in our society, The Financial Persuaders. More than half of the brightest and hardest working people that I've come across in my life fall into this category, including me! My most marketable skill is being able to speak, write and sell the language of financial persuasion. I had excellent teachers and was a quick study. My mentors have been more broad than simply Ironman triathlon!


Easy for me to say, right? I've used my skills to enrich myself. Well, there is a great speech that one of the Founders of Vanguard gave at West Point (Bogle West Point Vanguard will google you there). It's worth a read – his enrichment was a wee bit more than mine…

When you start thinking about kids, you start thinking about their standard of living. What struck me was not the comparison to the way I chose to live my life. What struck me was the comparison to the way kids grew up in the 50s. To match that quality of life requires a massive move up the socio-economic ladder (or a move to Christchurch or Tasmania – societies that have a history of simplicity, low envy and moderate consumption expectations – they are changing, just changing slower).

Despite…

** all the wealth creation,

** all the growth in real GDP per head,

** all the increases in consumption by the West,

** the massive run up in personal debts


In the most "advanced" areas of America, it appears to me that only the children of the elites will match the quality of their grandparent's childhood.

That wasn't the way it was presented in finance class.

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14 May 2006

Who's In Charge?

Four or five years ago, I read a book called Consilience by Wilson – you can google “consilience wilson byrn” to read what I wrote back then.

The book touches on a wide range of topics but the two that have stuck with me:

a – genetic modes of expression: our genes determine who we are; nurture/environment impact us in determining the extent to which our preprogrammed traits are expressed.

b – free will: our brains are a sophisticated array; if you understand the inputs and biases then you’ll be able to predict thought/actions. We are far less “free” than we realise – many (most?) of us are prisoners of our programming.

The concept of a lack of free will can be a bit daunting. Many of us certainly pride ourselves on the control we are able to exert over our lives. Athletes honing our bodies; parents passing their “good traits” through spending time with their kids; and other areas.

As I’ve touched on earlier, I’ve been studying behavioural psychology because I want to make better decisions in my own life. To do that, I decided that I needed to understand how people generally make decisions. Some of you have asked for the titles of what I’ve been reading. Well here are a few to get you started.

** Fooled By Randomness, Taleb
** Influence, The Psychology of Persuasion, Cialdini
** Hedgehogging, Biggs
** Irrational Exuberance, 2nd Edition, Shiller
** How to win friends and influence people, Carnegie
** Deep Survival, Gonzales
** Collapse: How societies choose to fail or succeed, Diamond
** The Wisdom of Crowds, Surowiecki
** Freakonomics, Levitt & Dubner

All of the above were excellent on their own. Taking them together and viewing them through Wilson’s concepts made it even more evident to me that we make many decisions without thinking. We also make a lot of “poor” decisions. Even when we try to make good decisions, we are up against some strong automatic programming.

One of the clearest examples of automatic responses is people that get angry for no apparent reason. I’ve had a few (short term) training partners and (even shorter term) acquaintances that fit this profile.

Without exception – they:
** greatly underperform when stressed
** lack consistency in their approach to life
** wonder why progress is so difficult in their lives
** truly wish that they had better emotive control

Maybe they are stuck? However, my own experience is that while we’ve been dealt a certain hand, it is up to us to play the cards. Specifically, how our genetic traits are expressed will be based on the people/environment around us and our own actions (or inaction).

Even the most “unconscious” and belligerent people that I know have moments when they are clear, reasonable people.

Within these moments of clarity is where we must take action to note our nature and build patterns/reinforcing actions that help us head the direction that “we” want to go. I think the new age folks call this following our “true selves”. To me, it’s simply tapping into the moments where we are most sane and not running on autopilot.

The books above talk a lot about the nature of our autopilots. If you can’t see it in yourself then you’ll certainly be able to spot it those that are close to you.

When I notice the self-sabotaging traits in those close to me… I look within to see how I am doing the same thing to myself. Odds are, the people around us are quite similar to ourselves.

My success in athletics is built on making fewer mistakes than the guys that I am racing – errors in pacing, nutrition, training, intensity, preparation, race selection – the entire package. The further an athlete strays from an extremely dedicated process, with low attachment – the more space he creates for his competition.

In watching my own approach to athletics and seeing my blindspots within my sport – I have learned valuable personality insights that I can apply back to my finance and investing careers.

THE KEY – the patterns that we create in one area of our lives are likely to be found across ALL areas of our lives.

As a recreational athlete, the lowest stress project that you are managing is likely your athletic career. The patterns that you create in sport exist in your workplace; your home; your bedroom.

That is one of the best things about coaching adults – I don’t have to “teach” anything. My athletes and I learn a tremendous amount about ourselves from the endless case studies that each season provides.

With my highly motivated athletes – I help them practice relentless moderation with periods of goal specific overload.

It’s no different in business.

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Back to decision making…

Much of what I’ve done in my life (academics, finance, project management, athletics and coaching) involves making informed guesses with imperfect information.

While I work in finance, I don’t consider myself a professional investor in the classical sense. To me, the classical investor (the institutional investor) is running a portfolio and making daily decisions on asset allocation and specific purchases. I’ve never been attracted to that – possibly because it seems like a mugs game to me. Margins are low, as well.

When I was doing buy-outs, we’d make zero to four investments a year. Our record was pretty good but not surprising given that we had superior information; good people; and solid advisors. It was a time of limited competition, favourable economics and great returns. It was also a lot of fun – “buying” is something that nearly all people have in-built “joy” in doing.

People love to buy. Nobody every wants a bull run to end. Easy money is popular with the masses. Our decisions today are heavily weighted on our experience of the last three years.

Conversely, people HATE to lose, even a little. We find losses highly stressful. When under stress nearly all people will make poor initial decisions.

This is why I’ve decided to wait and see with my personal investing. I’ll probably miss out for a while but that’s OK. I plan on being around for a few more years, yet.

Next up, why I changed my mind on affirmative action.

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12 May 2006

Castles on the Sand

I’ve spent the last two weeks in Naples, Florida. In case you aren’t familiar with Naples, it is in the south west corner of the state. The old part of the city is beautiful and there are long white sand beaches on the Gulf Coast side.

This morning, I went for a spin around the best part of town, riding past what must have been $2 Billion of real estate assets. Beautiful landscaping and meticulously kept gardens made it a serene setting for an easy ride.

Having done a little market research on the top end of the local real estate market, I have noticed a large implied land premium that is built into high end properties down here. This struck me as risky given:

** Most of the properties lie between 3-7 feet above mean sea level;
** Naples is in the hurricane belt;
** Many of the best properties are built on sand bars and surrounded by water;
** Annual property overheads in a moist, warm, salty climate like Naples (air con, insurance, taxes, maintenance, gardening…) run between 1.5-2.25% of capital values;
** The local climate alternates between very dry and very wet – challenging conditions when you are built on sand with limited fresh water resources; and
** The medium term impact of global warming could make environmental factors more challenging over the next 15-25 years.

While the governor’s brother is in the White House, I imagine that the state has a get-out-of-jail free card. However, that’s not always going to be the case and I can see a scenario where federal taxpayers get “re-building fatigue” for folks that want to live in low lying lands on the Gulf Coast.

I didn’t look into property yields but imagine that this is a situation where the “rent or buy” equation swings towards rent. The exception probably being a condo purchase if I was going to use the place extensively and it was a small part of my portfolio.

Of course, I am willing to fly to New Zealand or Australia for weeks at a time. From a property investment point of view, I like the markets of Tasmania and the South Island of NZ over the next 10-25 years.

If you live in the Northeast USA then you can’t exactly fly to Nelson, NZ for your Easter vacation. So, I can see the attractions down here in Florida. It’s a very beautiful part of the world.

Anyhow, I plan on using the US Gulf Coast as a leading indicator on how global warming might impact property values. If you are in your sixties then this probably doesn’t impact you all that much. As an investor under 40, it is a consideration for me.

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Last week was seriously hot and humid here. It was an excellent reminder of the challenges of tropical training. I slipped back into the lessons that I learned in Hong Kong.

I’ve been reflecting on the training program that I subjected Baron to in late 2004 before Hawaii – his in-race meltdown was completely my fault (sorry buddy). It is a good reminder that coaches must continue to “do” in order to be able to successfully advise their athletes. I’ve spent thousands of hours in hot weather training and failed to remember what I’d learned. By writing it down now, I hope to do better next time.

To know, but not to do, is not to know.

My hydration rate is creeping up to 1.5L per hour now and that is for training prior to 10am. I’m still losing weight through the workouts even at those intake levels.

Reflecting on my personal hydration challenges as well as my Kona training camp, it amazes me how Molina was able to go 8:31 in Hawaii. He doesn’t do well in the heat at all. I think he told me once that his secret was to get in 8:11 shape.

Personally, I have another theory – fatigue management. Many coaches and most athletes think that endurance sports are about over-coming pain – believing that the magic elixir lies in developing superior pain management. Articles, and training programs, that are built on pain are highly popular because they appeal to athletes’ (misplaced) biases.

Pain management is likely a factor for traditional endurance sports of 2-120 minutes duration. Beyond six hours, I think it swings greatly towards fatigue management.

In my experience, we are fatigue limited, not pain limited. When we slow, our brains are shutting us down because they are tired of being tired. Well paced ultra-events simply grind the psyche down. Certain athletes learn how to cope with, and train their ability to endure, extreme fatigue.

The goal of fatigue management being to completely remove the emotive brain from the decision process of whether to stop, go, speed up or slow. That is my experience of “athletic flow” and a key component of the bigger picture that lies behind my preferred approach.

More on that, perhaps, at a later date.

Back to Florida… between 10am and 5pm, we can only do light cycling or swimming. The local pool at the Y is geared towards aqua-jogging so real swimming isn’t an option there. M made friends with the head swim coach so we now have two hours of long course swimming available 4x per week. That’s a big bonus because that pool has a reasonable temperature.

I have a half finished piece of behavioral psychology / decision making. I have another easy day on Sunday so, perhaps, I’ll get a chance to finish it off.

Right now, it’s back to work.

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25 April 2006

Global Liquidity

Part One starts below. This is Part Two.

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Ever wonder what a guy thinks about when riding into a headwind for hours on end? Well, sometimes he thinks about global liquidity. My head is a strange place to be at times.

Where does money come from? Or most interestingly, what causes money to disappear rapidly?

If you have read a good book on the major drivers of global liquidity then please send me the details. I’m very interested in this topic.

When I started my finance career in the early 90s many of the major US lenders decided to close their European loan books – immediately, pretty much regardless of cost. There was a legacy of poor loan decisions, many teams were dismantled and the assets sold off. The fact that global markets are flush with easy money, on soft terms, has me wondering about the impact and timing of the next credit downswing.

Starting my career in London, the debt markets were very poor and we could barely make any deals work (not that I really knew how to make anything work back then). Thankfully, we didn’t have a lot of duds in the existing portfolio. However, the duds that we did have were under a lot of pressure. We lost quite a bit of additional capital supporting businesses and management teams, which ultimately failed. Collectively, following our money was a poor investment decision. There were a couple of exceptions but these only appeared once we had realised how much capital we were throwing away (and adjusted our refinancing pricing radically).

From the top down, we behaved like we were investing 100% of our own capital – rare within much of the financial services industry. This “emotional” attachment to the capital can work against you at times but, overall, is a big plus in my view. We learned from our mistakes and spread that information internationally throughout our group.

I was the absolute lowest guy on the totem pole and my team was highly conservative – at least half of us rank alongside the most conservative investors that I’ve ever known. Eventually, we started to get a few deals away that looked attractive to us. Others in the field were far more aggressive and we thought them to be a bit nuts. With the tail wind of a bull market and falling interest rates, we all made money.

In VC the rules of the game are stacked in the house’s favour with the partners taking 20% of the upside and the investors bearing the downside risk. There is isolation between funds and illiquidity for investors, so a couple of poor years don’t bring the whole thing crashing down. With hedge funds, the partners can make a lot more money sooner but with VC, the best firms are able to lock-in a stable long term income stream on top of the carried interest over future investment profits.

Anyhow, where is this going?

I’m quite fascinated by the credit cycle within various classes of assets as well as the drivers of global and regional liquidity. Having worked & lived many different places, this seems to be a key driver in short- and medium-term asset price fluctuations.

When there is a lot of liquidity around, times are very good for nimble financial investors. In the UK, we haven’t had a really bad credit squeeze since the early 90s. When I see lackluster consumption and increased government expenditure set against a background of increasing taxes and high personal leverage, I wonder it the cycle is set to swing against us. If that happens then it will be a good time to be liquid and/or have access to a well-funded investment vehicle.

I wonder what impact it has when a group of smart people think similarly.

I look around at certain deals that are getting funded and sense that actual returns are bound to disappoint. Once a bull market slows (or stops), leveraged long vehicles get hammered (in any asset class).

Within quality deals, I sense that actual returns could be 5-8% per annum lower than projected but outstanding when compared to how the asset class is going to perform over the next 5-8 years. Current expectations being unreasonably influenced by recent history.

I speak with investors about property sector return expectations and find many of them far out of line with long term historical real return performance. As an example, many institutions are targeting 15-20% per annum rates of real return from asset backed investments. You can play the game, or you can have a word with the smart people that are backing you and ask if they really believe the managers that show them those numbers. I’ve always felt that it is better to be open and conservative than to simply cook the model to show the desired result. Of course, that doesn’t exactly help when you are fundraising and competing against superior marketing horsepower.

Pushing for unrealistic return expectations has the impact of forcing good, conservative management teams to bump projections to the limit in order to get quality, lower risk deals approved. It’s tempting to think that you’ll end up with higher returns from higher expectations but I’m not so sure. We might simply be increasing the standard deviation.

Anyhow, I’m kicking all of this around because my current vehicle is proving a bit tough to invest at present – greed is dominating fear in the Scottish property sector and we’ve been out-bid on a number of deals in 2006. Having lived through this before, I think that is a good thing because the deals that we have locked up are going to be stars and (due to compounding effects) a good opening year provides an equity return platform that benefits the entire life of the vehicle. On the flip side, if you screw up your early investing then you are likely stuff for the entire vehicle life.

We are compensated on actual deals done (rather than capital committed), so our investors pay no penalty for the fact that we have plenty of additional capacity at present. It does create an interesting conflict for us in that we have a clear financial incentive to do any reasonable deal (via our management fee). However, we also have our personal capital at risk, the capital of most of our good friends as well as the capital of the man that got me started in finance. Personally, I have no interest in being associated with a mediocre investment vehicle. I’d much rather be small and highly profitable than large and average.

So that’s what I’ve been mulling over for much of April. It was interesting to be able to think at a location that is distant from the noise and influence of the market.

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24 April 2006

Decisions & Choices

I am currently chilling in the waiting area at Los Angeles International. Not a bad place to kill eight hours. Monica wanted me to get a “day rate” at an airport hotel but $100 bucks for a shower seemed a bit extreme. Especially because I only left the condo a few hours ago – took the red-eye to get here.

Man-o-man I have a lot of stuff rattling around in my head. This seems to happen when I have an extended period of note writing. I seems like I have fifteen pages of stuff to get out. Well, a long layover is a good time to get it all down.

I’ve been working my way through a buddy’s business school book list. At least I think that is where the list came from as it seems like the sorts of books that I would want to be reading and discussing if I was at business school. My reading goes in phases with certain themes running through it. If I like a certain book then, typically, I read as much of the references/recommended reading that looks interesting to me. A few years back, I become interested in philosophy, history of the great religions and spirituality. Read a stack of classical texts and that was quite a bit of fun. Learned a lot about myself.

At the start of April, I felt so lucky to have the opportunity to read a lot. As the month progressed, I realised that it wasn’t so much the opportunity to read; rather it was the opportunity to think that I was enjoying so much. That’s probably why reading appeals so much. The book needs to be interpreted through me and by me. My own biases, filters and experience indicating how I perceive the text.

My theme has been (very broadly) behavioral psychology and decision patterns. It serves two purposes for me – in finance, I’ve become increasingly interested in how people make decisions – both how we make lousy decisions and how certain people/groups are able to make good decisions. Similarly, in sport, I’ve been wondering exactly the same thing. What are the factors that lead to people losing their heads? Why do certain people consistently make better decisions than others?

As well, I’ve been thinking about decisions versus choices. Decisions being key junctions/transitions/points that will have a material impact on our lives.

Things like:
***University choice
***Business school attendance
***Major investment purchase (house probably the largest for most of us)
***City we live in (many don’t consider)
***Marriage
***Kids
***Career

I didn’t approach these thoughts primarily from a personal viewpoint. Rather, I’ve been thinking about it from an investment perspective. Why do some teams and individuals make better decisions than others? I’ve been fortunate to work with one individual that has made consistently good investment decisions over 20+ years. What can we learn from studying people that, on average, tend to get it right?

As for my own investing, I’ve probably been more lucky than smart. Just like having a couple of great deals early in a fund’s life, the biggest stroke of luck in my life was starting my career working for the best investor that I’ve ever known (call him Bob). That wasn’t a “decision” of mine as I needed a job. However, I did make the “choice” to work as hard as I could so that he’d keep me around.

Bob hired more outsiders than any person that I’ve ever come across. If you happened to see the movie, The Usual Suspects, then that is a good metaphor of what my first investment team looked like – I wish I had a photo because it is telling. We were six partners (three female), four nationalities and 75% of the team had worked internationally. Polar opposites of our main competitors.

Why did Bob hire such diversity? One of my recent books might argue that he had seen that better decisions would result from diversity. However, I think it was simply good commercial sense in that you often get “more” from hiring a good outsider. The biggest advantage being far better value and he loved getting a deal (people under market value, deals under market value, playing the game). So in seeking bargains on very bright people – he ended up with a powerfully diverse decision making team.

That interests me because most of the leaders and senior executives of the financial services industry are quite homogeneous in their background, outlook and training. As a group, that leaves the industry prone to making some big errors at times.

My personal portfolio is heavily in cash right now. I’ve been considering what to do with it. Pricing errors can lead to great entry prices – if you get your timing reasonably correct. In my view, if you wait to get it “right” then you wait too long – in VC we tended to sell a bit early and buy a bit late – shame we had to sell some of the best businesses at all, really.

So there is the search for return. There’s also the flip side… so long as you preserve capital in the down periods, you’ll do pretty well over the long term. How best to reduce my chances of a major error?

Great line from a recent read is that the best thing about investing our own capital is that we don’t _have_ to make any decision. We can simply keep looking at the pitches until we see one that we really like. With a brain, and society, that are hardwired for “action” I need constant reminding of that point.

There is a saying in the buy-out business that often the best decision is the deal that you didn’t do.

Bob’s currently raising a distressed debt fund. That brings me to my second major theme of my Hawaiian technology retreat…

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03 December 2005

Discount Rates

So are you saying to look at our new P3 Carbon and current account balance and say that "I have $10,000 invested/saved, this P3C is $4000, so that's 40% of NAV" and ask ourselves if it's really worth 40% of NAV to get that bike.

I've been in the habit of viewing things in terms of opportunity cost - ie given my expected return, spending $4,000 a P3C costs ~$100,000 (in 2005 dollars) at the age my parents are now...
I prefer to look at what things cost today, right now. Looking too far into the future can be a bit of a trap.

Let’s say you are earning $60,000 per annum, taking home about $3,350 per month after taxes. I pulled those figures out of the air but let’s assume. If you can save $600 per month then that implies monthly expenses of $2,750.

$10,000 in the bank is about 3.5 months of expenses and 17 mths worth of savings. $4,000 on a bike represents – 1.5 months of expenses and a half year worth of savings.

Now you’d need to consider it for yourself but in terms of return on investment in triathlon, you’d likely get a lot more performance from spending that money on six weeks of full-time training than a bike.

However, the bigger picture is that (based on my assumptions) you’re considering sinking six months work into a depreciating asset. Six months work is a heck of a lot of effort, now the bike will give you pleasure but is it really that much more pleasure than what you are riding right now?
When I was in my 20s my big goal was to get myself to the point where I could take an entire year off from work. I had various plans on where I’d spend that year (drinking in Greece; sailing the world; climbing the seven summits). The plans changed and developed as I did.

A few years back, I read that Bill Gates liked to hold one year’s expenses in cash on his company’s balance sheet. That really appealed to me because it was similar to the goal that I’d set myself.

These goals can be a trap in themselves because do we mean one year’s expenses…
…covered in capital
…covered in unearned income
…indexed, covered in unearned income
…indexed, adjusted for future dependents, covered in unearned income
…indexed, adjusted for future dependents, covered in unearned income, assuming market crash
…just like fitness, there is always more

I probably think way too much about this stuff but that’s the way I have always been about most things that can have a direct impact on my life.

We each need to decide for ourselves. Generally, most folks don’t get past that first line so it is an academic discussion. I joked with a buddy recently that the only people that truly understand discussions on sports psychology are the folks that don’t need it. Same with most fields – nutrition, personal finance…

Another trap is to build liabilities in line with assets – leverage is useful and having the skills to assemble/package assets is deemed valuable these days, because it enables folks to make money from packaging financial products around those assets. It is amazing, the premiums paid to folks in the financial services industry.

There is value from simply having control of a stack of assets – even if you are leveraged to the hilt. In certain market conditions, a company (or guarantor) is far safer being technically insolvent than having a lot of security cover. By having nothing, you’ve got nothing to lose – if you can live with that then there can be freedom there – quite a few elite athletes live that way for a few years. That life doesn’t work for me though because I value security and personal freedom very highly.

Thinking about it. There’s an element of being able to say “no”; or perhaps “not yet” in savings. Delayed gratification, or gratification from delay. Saving, eating right, going to bed early, under scheduling our lives – the pay off can appear to be later but, for me, is simply a more relaxed “right now”.

Anyhow, I got a bit sidetracked from the point.

Discount rates – in my life no purchase really mattered that much to me until I had one year’s cash flow saved in the bank. Once I had built the discipline to get myself to that point (in my mid-20s), I had the skills to manage my savings/expenditure so that I was always covered as I chose to increase (or decrease) my personal burn rate. Being a good administrator would be similar.

Now being a good entrepreneur is often completely different. However, entrepreneurs value the ability to work/create more than personal security. They are “winning” every day they are at the office. There is nothing that they’d rather be doing than working (only met a few guys in this league).

Motivation is something that I think about quite a bit because I always assume that other's motivation is similar to mine. That the world is seen through my eyes by others and that is mostly incorrect. Most folks see things totally differently. In fact, many (most) having too much going on in our heads to see much of anything outside ourselves.

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01 December 2005

Make vs Spend

Sorry, just want to make sure I understand - you are saying to evaluate the financial opportunity cost in terms of (a) percentage of your personal Net Asset Value - ie. the impact that this decision is likely to have on one's long-term wealth, both in terms of capital draw-down and lost income to invest and (B) in terms of the ability to maintain one's standard of living (or at least a reasonable one).
When I left Hong Kong I knew that my income was going to fall _a lot_. However, my expenses were going to fall as well. What I didn’t realise was the magnitude of the change.

What happened was that I was spending less than 10% of my Hong Kong rate even while traveling in Australia/New Zealand. I was also able to buy a house in Christchurch for about one-year-HK-rental equivalent (early 2000, a nice time to buy property just about anywhere). Now not every VC is willing to live on couches and with the parents of adult friends while he figures out what he is going to do. Still, it worked for me.

On the income side, I took advantage of some coaching opportunities. They didn’t bring in a lot of cash but… they brought in a lot of cash relative to my triathlon cost of living. So while they wouldn’t make a good use of my time when I was in Hong Kong, they made a lot of sense when I was on the road.

The result was that once I subtracted my tri-life expenses from my tri/coaching/unearned income, I realised that I had a much larger multiple of capital available to finance myself. I’d based my initial estimate on Hong Kong expenditure but I discovered that by leaving Hong Kong I was able to eliminate nearly all my overheads.

Most people have no idea where they are really spending their money. They simply spend until they run out each month.

Also, beware of the trap of mistaking “standard of living” for “quality of life”. Most folks ratchet up their standard living (expenditure) in line with (or ahead of) their income. As a result, they are never able to accumulate any capital and are held captive to their perceived income requirements.

When you start to evaluate expenditure relative to NAV, rather than income – it can change your view on whether things are “worth it”. Folks that aren’t good at saving don’t really like to face this method of personal accountability. I know some folks that spend a multiple of their NAV on traveling to races (or clothes, or vacations, or whatever) each year.

Scott once told me that it’s not what you make, it’s what you spend. As with many things he told me, good advice.

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