Greed Is...Good?

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest." – Adam Smith

Dear Fellow Fool Funds Shareholder:

In this letter, I’m going to set a minefield for myself, and then attempt to walk through it unscathed. In short, I am going to embrace a quality that many people consider to be quite negative. Not only that, but I am going to make the claim that the proper application of this human characteristic is actually quite noble, and largely beneficial to mankind.

The minefield begins here: I believe that greed gets kind of a bad rap. For starters, greed is included among the seven deadly sins.

The Seven Deadly Sins

• Wrath
• Greed
• Sloth
• Pride
• Lust
• Envy
• Gluttony 

And just because we’re in the process of creating lists of seven:

The Seven Deadly Snacks

• Death by Chocolate
• Devil’s Food Cake
• Pineapple Upside-Down Cake
• Razorblade Apples
• Candy From Strangers
• Fruitcake
• Bacon by the Pound

Look at the list of deadly sins again. (OK, only after you marvel over the second list a little more.) They all sound horrible, right? Envy? Envy sucks. Envious people are miserable to be around. Gluttony? OK, sure, gluttony can be fun, but long term it’s pretty gross. Go down the list and none of them seem that great.

But I propose that greed is more like a wonderful characteristic with a marketing problem. Its most notable spokesman is Gordon Gekko, a character with almost zero redeeming qualities, someone who couldn’t say “puppies are cute” without seeming disagreeable. I am not speaking of avarice (which is a more appropriate derivation of the original Latin avaritia). Nor am I defending people who steal or use government influence to cut themselves special deals or defraud. Those kinds of behaviors are despicable, and they come at a cost to society. Our funds have found precious few investing opportunities in places like Russia, Nigeria, Pakistan, or even India, in no small part because of the high level of corruption prevalent in those countries. Rampant corruption is costly to society. Greed, on the other hand, elevates it.

(Speaking of fraud, this past month former Enron CFO Andrew Fastow finished serving his prison sentence. Welcome back to society, Mr. Fastow. Please don’t touch anything.)

If you change the word “greed” to “self-interest” it takes on an entirely different connotation. Self-interest is noble. Know what causes North Dakota farmers to grow winter wheat? Self-interest. What else would cause someone to go out and work in fields, in North Dakota, in the winter? It’s not because they’re thinking how much some guy in San Francisco will enjoy some focaccia made from their harvest. Nope, they plant, work the soil, and freeze half to death in pursuit of money.

Warren Buffett is greedy. Steve Jobs was greedy. Wilson Greatbatch, the inventor of the pacemaker, was greedy. Bruce Springsteen, the inventor of New Jersey? Loves him some money. Loooooooves it.

Are these bad people? Not in the slightest. These are folks who would have made more than a few 2011 Most Admired People lists. Steve Jobs’ death earlier this year was marked by public outpouring of sorrow normally associated with presidents or Beatles, and yet it’s widely understood that one of Jobs’ goals was to keep running Apple until it was the most valuable company in America – a marker that demonstrates a heightened level of self-interest on his part. Warren Buffett looks at his net worth as a scorecard. As a group, these men have earned money in excess of the GDP of many countries. And the economic, social, even environmental benefits that have accrued to society as a result of their talents and efforts are manifold higher.

The Cookbook
So I’m not afraid to say it – I enjoy earning money. I view it as a pretty important gauge of success. I doubt that any of us on the portfolio management team think any differently. If we did, I sincerely doubt that Fool Funds would have ever come to exist. Now, if we were solely motivated by money, our business would look dramatically different. Dramatically. That’s because we have a copy of the Cookbook.

The Cookbook offers asset managers a recipe for making oodles of money, but not necessarily in concert with their clients. Here is a sampling:

1. Launch funds in hot sectors, or at least large ones. If you want to maximize assets under management, the best ways to do it is to launch funds that meet investors’ demand for the flavor of the month (a dotcom fund in 1998, a China fund in 2005, a gold fund in 2011), or that focus on the segments of the market that regularly attract the most assets (i.e., domestic large-cap companies).

2. Launch several funds at once, close the ones that are underperforming after three years. Brag about having X% of your funds beating the Lipper Average. Repeat.

3. Remember your Baskin Robbins. 33 flavors. Make sure you have value funds, blend funds, growth funds, income funds, short funds, target date funds, regional funds, industry funds, and so on. Don’t worry about whether you have an edge in any of these segments, or if they even make sense.

4. Charge 12b-1 fees and loads. This means more money for the fund company, but even more importantly it’s what fund companies use to pay brokers who put their clients into their funds.

5. Participate in IPOs when your fund is small. If your fund can be allocated shares in hot IPOs when it is small, these can potentially juice returns, since such gains can have an outsized impact on the fund’s reported returns, something that they cannot repeat once the fund grows.

6. Retain a rubber-stamp board, permissive lawyers and accountancy. Because their job should be to help you do anything you can to maximize your own profits.

7. Always be closing. Raise money all the time.

8. Never be wrong. Your benchmark is your friend. If you deviate too far from it, you’re going to lose clients. Much better to keep your portfolio weightings close to those of your benchmark and make tiny bets away, at most. That way you won’t be out of step with the market.

There’s plenty more to the Cookbook, but you get the idea. We could make millions using it. But we won’t, because we are unwilling to do so. We won’t do absolutely anything for money. We just won’t. I doubt that any of the people I listed above would either.

Does that make us weird?
Gosh, I hope not. I do fear that this position has put us outside of the norm of some parts of corporate America. In a recent essay entitled “Fannie and Freddie Fantasies,” William K. Black made the claim that perverse executive compensation schemes were “criminogenic,” a term that I’d never heard before yet immediately understood. He argued that Fannie Mae and Freddie Mac, two government-sponsored companies at the center of the housing market implosion, had executive compensation systems in place that encouraged fraud and invited abuse.

Would I call the mutual fund industry “criminogenic”? Heavens no. But there should be no doubt at all that the mutual fund business does better not when it maximizes shareholder return, but when it maximizes assets under management. As I’ve explained in the past, such a laser-like focus on raising assets doesn’t necessarily benefit shareholders.

Happy New Year! (What do you think will happen?)
We have turned another page in the calendar, and in the world of finance we’re greeted by the annual rite of various pundits making their predictions for what will happen in the market for the upcoming year.

If you ever have absolutely, positively nothing else to do, go back and look at some of the forecasts made in the past. In August 2008, Bloomberg surveyed some Wall Street analysts on their year-end 2008 predictions for the S&P 500 (yes, less than five months hence), with the predictions ranging from a low of 1350 to DeutscheBank’s Binky Chadha predicting 1650. The market at the time was trading at about 1280. The actual year-end number for the S&P 500 was 903, on its way down to 666 a few months later. None of these professionals even forecast a decline, right at the cliff’s edge of the largest market collapse in decades.

Are these people idiots? Probably not, but they do have crazy jobs. I don’t wish to mock, because my own record for prediction is spectacularly bad, which is why I don’t engage in the practice.

I’m comfortable in making four predictions for 2012:

1. People will make lots of predictions, even people who know better.
2. Many more will act on these predictions, even people who know better.
3. The overwhelming majority of these predictions will be wrong.
4. Some of the people making them will be crazy.

You may be aware of the story of New Hampshire’s Old Man of the Mountain. It’s the image on New Hampshire license plates, and on the back of the New Hampshire state quarter. It’s also gone, having collapsed in May 2003. People had been preparing for, and actively trying to prevent its collapse since 97 years prior. Obviously, since it was a rock formation hanging out over the air, erosion, tectonic movements, or one of a thousand different forces would inevitably lead to its demise.

But saying “it’s gonna collapse” is vastly different from saying “it’s gonna collapse on May 17, 2002.” The latter statement is the hallmark of a charlatan. Yet this is the Wall Street prognosticator stock-in-trade. Looking for a late New Year’s resolution? How about “I will ignore short-term predictions”?

Did you know?
There are a few additional items of interest. First we’re holding our quarterly conference call on Tuesday, January 24, 2012, at 6 p.m. Eastern time. Anyone is welcome to listen in, and we welcome your participation. Please email us at RSVP@foolfunds.com to reserve your spot. If you have a question you’d like us to try to answer during the call, please send it to askbill@foolfunds.com.

Second, we mailed out our 2011 Annual Report in the last week of December. If you’re a shareholder, you should have received it by now unless you live in Uzbekistan. If you’re not a shareholder and would like to read it (seriously, we’re pretty proud of it), please click here or go to FoolFunds.com and find it under the Forms & Literature tab. (I know, we probably could only make that tab less enticing if we named it “Matlock.” I promise it will be worth your while.)

Third, Tim Hanson wrote an open letter to the Board of Directors of Yahoo! imploring them to consider the path charted by activist investor Daniel Loeb. As an aside, do you know how many acquisitions Yahoo has made since it came public? 42! That’s probably fine if you have a well-defined business at the core of your company, something Yahoo! lacks.

You can click here to read Tim’s letter, or you can find it at FoolFunds.com under the “Commentary” tab. There, you’ll also find our most recent “Wandering Fools” (Hong Kong), as well as our most recent “Question Authority”. One of these articles has a bad word in it. (We were quoting a title! Totally legal!)

Monthly results

The Independence Fund was down slightly in December, losing 0.82%. This was fractionally worse than its benchmark, the MSCI World Index, which declined 0.02%. For all of 2011 we outperformed the benchmark, we still had negative results for the year (-3.34% versus -5.02% for the benchmark). As was the case for most of the second half of 2011, the U.S. market outperformed most other countries during December.

We sold a few holdings throughout the month in order to make room for investments we found more attractive. We closed our investments in Little Sheep Group (the Chinese restaurant chain that is to be acquired by YUM! Brands), Hellenic Exchanges, and MFC Industrial (if you were wondering, the aftermath of these three sales were victory lap, somber head shake, and shoulder shrug, respectively). This allowed us to buy into some gems we feel we’ve unearthed from all around the globe, including Arcos Dorados (Argentina), Baidu (China), Bladex (Panama), and CrucialTec (South Korea).

The year ended fairly quietly for Great America, with gains of 0.46% for the month of December vs. returns of -0.12% for the benchmark, the Russell Midcap Index. December paralleled the rest of the year in that small- and mid-cap equity performance mildly trailed that of larger capitalized stocks. If you recall, one of the recurring themes in our monthly letters early in 2011 was the fact that we found more general value available in larger cap domestic companies, so this was a positive development for Great America.

We didn’t have cause to move a lot of money around in December, but we did initiate small positions in Yahoo! and Illinois Tool Works, and sold our holdings in Varian Medical Systems and Dresser Rand Group. We continue to find extremely compelling opportunities in the U.S. markets.

The Epic Voyage Fund declined 2.78% in December against a 1.27% decline for its benchmark, the Russell Global EX-U.S. Total Return Index. The most significant contributor to that decline was Sterlite Industries, an Indian industrial company that produces aluminum, copper, and zinc -- three commodities India is going to need in droves as it develops its infrastructure. While we continue to think there’s a promising long-term opportunity for Sterlite, the world is currently not optimistic about the Indian economy. As we have noted from time to time (to time), we’re perfectly happy to buy top-flight companies when the markets are running away from them.

One of the biggest positive contributors to fund returns was Coca-Cola Hellenic. Thanks to a combination of eventual price appreciation and tactical purchases as the stock dropped, this company went from being our biggest money loser at the end of November to the biggest gainer by the end of December. This, you may remember, is the Greece-based Coke bottler that might actually be worth more if it changed its name to something more reflective of its growth prospects, like Coca-Cola Russia and Nigeria (which should give you some idea about the brand value in the word “Greece”). We sold our position in Little Sheep Group and opened a small position in another Chinese restaurant chain, Country Style Cooking as well as in smelter Aluminium Bahrain and longtime Independence Fund holding DuzonBizon.

Global markets, particularly emerging markets and Europe (a submerging one?), have seen significant capital flight in 2011. We remain excited by the prospects of putting money to work at some of the prices currently available to us.

As always, the Fool Funds team and I thank you for your trust in us.

Foolishly,

Bill Mann