Don’t Be a Sophist, and Why I Write 27 Page Letters to Clients
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Four times a year I write letters to IMA clients. In these letters I diligently walk clients through our research on stocks we own, including those we have recently bought and sold. I cover how we value them, why we own them, etc. I update clients on our thoughts on the economy and the market. I call these musings “seasonal,” not quarterly, letters. There is a good reason for that. Quarters follow a discrete calendar, while my writing muse has a mind of her own and keeps her own schedule. Also, I like to wait until our companies report their quarterly results before I write about their progress. I usually wait a month after the quarter ends before I start working on the letter. These letters are very in-depth and lengthy — some run as long as 30 pages.
It takes me two to three weeks, two hours a day, to write a seasonal letter.
Why do I write them?
I spoke to my friends in the investment industry who write letters to clients, and they told me that their clients rarely read their letters. Though there is no reading or speed-reading exam to become an IMA client, and these letters are not followed up by a written exam, I have found that the majority of IMA clients do read these letters. Just as companies get the shareholders they deserve, investment firms attract clients who are like-minded. IMA clients tend to be readers, and they have the intellectual curiosity to learn what is happening in their portfolios and why.
Let me tell you a story. I have a client who is a retired airline pilot. As we sat together in my office, I mentioned to him that I was afraid of flying. I fly a lot (pre-COVID), but every time I am on a plane and it starts shaking and chattering due to turbulence, I become a little bit more religious. I tell myself that these things happen all the time and that most plane crashes happen on the takeoff or landing. There is a turf war inside me between rationality and fear.
My client (the airline pilot) told me that when he’s in the pilot’s chair in the cabin, he’s not nervous. But when he flies as a passenger and the plane goes through a rough patch, he gets nervous, too. At first, I was a bit surprised by that.
Then I realized that the difference between being in the pilot’s chair and in the passenger cabin comes down to control and information. When you are the pilot you have control and information about what is happening.
When you’re a passenger, you find solace in the fact that Boeing engineers don’t just take trains but frequent these planes, too, and that the pilot doesn’t have his own parachute and thus has skin in the game. Also, that dying in a plane crash carries roughly the same probability as winning the lottery. (This is why I don’t play the lottery; I don’t want to irritate the probability gods). Also, this is why my family and I own the same stocks as our clients.
Much the same applies to IMA’s clients and their portfolios. We spend hundreds of hours analyzing each company in our portfolios. For IMA clients, without my letters these companies are just ticker symbols — clients are not even in the passenger cabin; they are down in a dark corner of the cargo bay. With my letters I try to bring them into the cockpit (though I still have control of the levers). I want them to understand what we see in each company, how we value it, and what our strategy is in with dealing with the uncertainties of the global economy. Arguably, when there is no turbulence these letters bring little value; but when there is turbulence, and there nearly always is, our clients (hopefully) won’t be nervous. Their portfolios will deliver them returns while helping them keep the volatility of their blood pressure to a minimum.
And there are other reasons to write these letters.
The letters allow me to scale my writing, while time doesn’t scale as well. (I wrote about this before). After IMA clients read a letter, very few have any questions for me. The few that do get me on the phone or send me questions that I answer in the Q&A section of the next letter (their choice). I guesstimate that I spent about thirty hours on the phone last year talking to clients (less than 30 minutes a week). IMA has about two hundred clients. If I spent 30 minutes on the phone with each of them four times a year, I’d be spending at least 400 hours a year or 8 hours per week on the phone with them. That is time I couldn’t spend on research.
I used to think that the difference between introverts and extraverts was their enjoyment of in-person interactions with others. Recently I’ve discovered that there is another important difference between them: Extraverts get recharged from interactions, while for introverts these interactions drain energy. Though I do enjoy social interactions, one hour on the phone consumes three hours of my energy (or the equivalent of six hours of writing, which is a relaxing, meditative experience for me).
Finally, I am so much smarter on paper than on the phone.
See, everyone wins!
The Winter 2020/21 letter that we just sent out to IMA clients was 27 pages long. Over the next few weeks I’ll share excerpts from the letter with you. These excerpts will not focus as much on fish (stocks) as they do on the subject of fishing. In the past I’d rewrite excerpts from these letters as articles, but I feel that the relationship with my readers has evolved to a level where I don’t need to do that.
The market is up a lot; it is expensive. Should we be selling? This is the number one question we’ve been getting from clients. So, should we?
We’ll give you several answers. We agree that the market is expensive. In fact, a few months ago we compared the euphoria and speculative mood of the market to the one in 1999. Back then, many stocks got so expensive they weren’t being valued on earnings, but on eyeballs.
Today, just like then, some high-flying names don’t have any earnings. The ones that do are valued on price-to-sales, because a price-to-earnings of 250 carries as little informational content as a 170 or a 500. Yes, the market is expensive and extremely speculative — but we don’t own the market. We own a portfolio of individually analyzed and still significantly undervalued companies.
To frame this discussion, I’d like to share an excerpt from the book I am working on. Just between us, it will be called Soul in the Game and will come out sometime in late spring 2021, published by Harriman House. If you would like to read an early draft and help me hunt for typos, let Barbara know at pa [at] imausa [dot] com and she will send it to you in a few months.
In ancient Greece and Rome, parents took their kids to study oratory skills from teachers called Sophists (the word sophisticated has sophist as its root). Sophists focused on the art of persuasion through both emotion and reason, and kids were taught to argue both sides of an argument. Stoics, on the other hand, put the emphasis mainly on reason (not emotions) in their communications.
The Sophist’s oratory skill was like a spear; it was a powerful weapon that could be used for good or for evil, thus students needed the morality taught by philosophy to know where to point it.
Stoics were extremely cautious about the Sophists — they thought the words you use to persuade others matter, since in persuading others you may impact your own thinking. In the attempt to persuade others through an appeal to their emotions, we use colorful metaphors; we dramatize the words we use. If we had two brains, one to talk to others and one to talk to ourselves, we’d be fine. But that is not the case; thus our words may turn on us and impact our own emotional state.
It is almost as though Stoics would not want to use the colors available in the rainbow to express their opinions but resort to only black and white. However, I see the value of their thinking. We need to examine the words we use when we communicate with ourselves. When something stirs up negative emotions inside us, we need to be careful when we describe the problem to ourselves. We want to make sure we are not being Sophists against ourselves.
The best way to do this is to write it out. When you lay each word on the paper, examine it. Instead of “My husband drives me insane,” you write, “My husband says the following … that upsets me.” (I am not quoting from my wife’s journal; I am reading her mind.) Instead of “The stock market collapsed,” write “The stock market declined X%.” Epictetus said something along the same lines. Instead of saying “Our ship is lost far at sea; we’ll never get home,” he suggested we go with “We are at sea, and we don’t know where we are.”
We take fancy words, string them together, and add dramatic, superfluous colors. Instead of calling a dish Basel Honey Glazed Wild Alaskan Salmon, Marcus Aurelius might suggest we describe it as “the dead body of a fish, with herbs and honey.” He writes, “Just in the same way we should act all through life, and where there are things which appear worthiest of our approval, we should lay them bare and look at their worthlessness and strip them of all the words by which they are exalted.”
We need to pull the fancy outer layer off our problems and strip them to their bones. Instead of “my life is horrible,” you create a list of things in your life that bother you, spelling them out as plainly as possible (don’t use big, colorful words; leave those for the Sophists).
A client called me. Let’s call him Todd, because that is his real name. He was somewhat confused on what to do. He explained, “Our stocks are up. The market seems to be crazy. There is rampant speculation everywhere. I am really concerned for our portfolio.” I told him the above story about the Sophists and Stoic Philosophers. We agreed that instead of focusing on the market — an ambiguous organism with thousands of stocks — we should really zoom in on one stock at a time, and then we’d see that our portfolio is not full of insanely valued, speculative stocks that are used as casino chips by Robinhood traders. Rather, it’s a diligently constructed collection of high-quality, significantly undervalued businesses (30- to 50-cent dollars).
I broke our portfolio down to “dead fish” basics, and we discussed our largest positions in thoughtful detail, just the way we would in a seasonal letter. Todd was relieved — the undramatic, black and white language of stoicism helped him see that there is a lot of value in our portfolio. Just as I see value in stoic philosophy when analyzing and valuing companies.
Alexander Borodin Nocturne
Today I’d like to share with you an except from String Concerto №2 by Russian composer Alexander Borodin (1833–1887). Borodin was part of the group composers called the Mighty Handful (or “The Five”). All members of the group were amateur Russian composers who wanted to create pure Russian music without European influence. They were proud to be amateurs (Borodin was a chemist). I think they looked at career composers (the likes of Tchaikovsky) the way professional investors (like me) look at economists: Economics is two, maximum three, classes in business school, not a career.
The Mighty Five, not to be confused with the Jackson Five, were Russian nationalists who tried to incorporate Russian folk songs, the tolling of church bells, etc. into their music. They wanted to create a pure Russian sound. They felt that Tchaikovsky and his ilk had borrowed too liberally from Western music. If the following excerpt sounds very Hollywoodish and familiar, it’s because it was turned into a song, “And This Is My Beloved,” for the 1953 musical Kismet.
Vitaliy Katsenelson, CFA
I am the CEO at IMA, which is anything but your average investment firm. (Why? Get our company brochure here, or simply visit our website).
In a brief moment of senility, Forbes magazine called me “the new Benjamin Graham.”
I’ve written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. (I’m working on a third — you can read a chapter from it, titled “The 6 Commandments of Value Investing” here).
And if you prefer listening, audio versions of my articles are published weekly at investor.fm.
