Q & A with Clark Winter,
Author of THE EITHER/OR INVESTOR
HOW TO SUCCEED IN GLOBAL INVESTING, ONE DECISION AT A TIME

Q: Why did you write The Either/Or Investor?
A: There are many reasons why I might not have written it. I am not trying to drum up business. But many people who have listened to my talks with clients at the various firms at which I worked asked me to write this book, because it addresses issues that I believe in. Here is my path of reasoning: Most people who invest are smart enough to get better result than they do, but they focus too much on the relative merits of one investment over another, and not enough on the issues that can affect the viability of an investment. I believe that before you can make a sound investment decision, you have to know how to make sound decisions, and before you can make sound decisions in general you have to learn how to see the world around you without biases, and before you can see the world around you without biases, you have to educate yourself to what is going on in the world, and before you can do that, you have to see the world as a set of choices. The Either/Or Investor is about those choices, and how to look at them.

Q: Are there other reasons?
A: Yes. Before 2001, an entire generation of investors had grown up “knowing” that markets only went up and that if you held onto your stocks or your mutual fund, you were bound to make money. But then a combination of the bursting of the telecom/Internet bubble, and the events of Sept. 11, 2001 changed the world. Investors woke up one morning and found out that the world had changed, that the financial markets had changed, and that worst of all, they had changed. They went to sleep young with lots of money in their brokerage or mutual fund accounts, prepared for a rich full retirement, and woke up old, risk averse and poor, with their accounts sorely depleted. Partly, I wrote The Either/Or Investor both to explain these changes and to help investors understand how to overcome them.

Q: Is The Either/Or Investor only for rich people, or is it for anyone?
A: It’s really for anyone who wants to do better. The vast majority of Americans are long-only investors. They buy equities and hold on to them, on the assumption that the markets will always go back up. If you had done that for the past five years, you would have lost a lot of money compared to investors who went abroad looking for better returns, or investors who learned to invest in bonds through the carry trade, taking advantage of the fact that many countries were moving along the path of reform and that as a result, their bond ratings were improving rapidly.

Q: What is compound misery?
A: Conventional investment books try to sell you on the benefits of compound interest, the idea that if you put money aside regularly, the interest and dividends you earn, constantly reinvested, will make you rich. That’s entirely true, but on the other side of the coin is what I call compound misery. Have you ever wondered why the U.S. has a negative savings rate? It’s because life has a habit of getting in the way of savings, whether they are compounded or not. A divorce, an illness, the loss of a job, a child’s education, an unforeseen medical expense or any one of a thousand other things can easily wipe out those carefully nurtured savings, so instead of selling investors on a path to easy riches, I decided to acknowledge up front that making money is difficult. Also, most investing books preach the idea of making money continually, but the reality is, most market gains are highly concentrated within small periods, and the rest of the time markets are either stagnant or in decline. You cannot wait around for those few good periods, but instead, you have to look for ways to keep your money constantly deployed.

Q: Most investment strategists focus on asset allocation. You don’t. How come?
A: Asset allocation is about spreading risk. It has been around since the 1950s, when the investment management industry grew up after World War II. It is a model designed to prevent managers from getting into trouble with their clients. It is not a model designed to maximize returns. The best investors, in the words of George Soros, find a waterfall and place their bucket under it. That is, they find a single investment and use it to propel their wealth. That does not mean that you can’t allocate assets while you are using a bucket, in order to spread out some risk. For example, when energy prices began to rise in 2005, you could have invested in the oil majors via equities, in the sovereign bonds of the oil producing nations, in oil service companies, in the currencies of oil-producing nations, which were appreciating against the dollar, in the real estate of those same countries, or in about a half dozen other ways. You could have built a portfolio along conventional lines that would have done much better than any conventional portfolio, because you had a single waterfall ñ rising energy prices -- filling your bucket like the Spindletop gusher.

Q: That’s all fine, but what about the future? Energy prices can go up or down. How do you find new buckets?
A: I use a handful of what I call investment drivers, almost all of which are non-financial, to create investment themes, which are the next potential waterfalls. Let’s take two drivers -- The Path of Reform and Demographics - and put them together. The Path of Reform is a way of characterizing the changes that many emerging nation governments have instituted since the mid-1990s. These reforms include attention to property rights, which help to attract foreign investment; the rule of law, which helps to attract expatriate money back home; investments in infrastructure, which makes it easier for goods and services to move both inside a nation and through its ports and airports; and sound fiscal management, which helps a country get a better bond rating, and in turn, a cheaper cost of borrowing, which makes debt service cheaper, and allows a country to lower taxes. Now, combine that with demographics -- not how old people are getting, but rather, their rising incomes, their need for education, their need for improved health care, and their desire for better housing -- and you can see booms in financial service investments, real estate, medicine and hospitals, agriculture and luxury goods, just to name a few. By combining drivers, it is possible to find new investment ideas fairly easily.

Q: What is a binary?
A: A binary is a two-sided decision point. It is designed to reduce seemingly complicated ideas down to easy-to-manage choices. For example, when you are deciding whether or not to make an investment in a non-U.S. equity, which do you choose, a company headquartered in a nation with strong rule of law, or one with weak rule of law? Do you choose companies that are at the top of the heap or the bottom of the barrel? Do you choose investments based upon Fear or Greed? The Either/Or Investor helps readers sort through these and a total of more than two dozen other choices that separate smart investing from risky investing.

Q: What are the four basic rules of investing?
A: The Four Basic Rules of Investing are: 1) Don’t lose money; 2) Don’t invest where big investors invest; 3) Find a waterfall and put your bucket under it; and 4) Open your mind. Each one of these will make you a better investor, even if you pay no attention to the binaries. Here’s why: Once you begin to lose money, you need an ever higher rate of return just to break even, which forces you into ever riskier investments that will have an ever-greater possibility of blowing up. Second, if you read that a big investor has made an investment, if you follow on, you will be getting an inferior price while at the same time making him richer and yourself poorer. Third, although every investment strategist preaches asset allocation, which means putting some money into many different asset classes in order to diversify risk, the most successful investors always find a single investment and put all their assets into it, and then watch it like a hawk. It is easier to become an expert in one thing than mediocre in many. Finally, the world is changing constantly, so that if you approach investing, or any kind of decision-making, without an open mind, you are likely to miss opportunities that are staring you right in the face.

Q: What does “Visible yet Incomprehensible” mean?
A: Whether it is investing, policy analysis or your own personal life, there are only three decision states. These are what is Knowable and Understandable, that which is Unknown and Unforeseeable, and that which is Visible yet Incomprehensible. A Knowable and Understandable event is something such as an earnings report, upon which you can make an investment decision, or a job promotion you are expecting. An Unknown and Unforeseeable event is something like the attacks on New York and Washington, DC on Sept. 11, 2001, or winning the lottery. There is opportunity in both types of events, but it is the type of opportunity that can be understood by everyone, so by definition is limited to the fastest and smartest. An event that is Visible yet Incomprehensible is something such as pension reform or the Avian flu. Everyone knows that there is both risk and opportunity apparent, but nobody really knows how much, or what are the best ways to take advantage of them. Those who can figure out solutions to Visible yet Incomprehensible problems are those who create the great fortunes.

Q: What is an OODA Loop and how does it help investors?
A: OODA is an acronym invented by Col. John Boyd, a famous fighter pilot and pioneer in aerial combat techniques. It stands for Observe, Orient, Decide and Act, and it is the mechanism by which people can learn to make accurate decisions more rapidly. Whether you are investing or making basic life decisions, the ability to observe, orient decide and act faster than your competition has a profound impact on your success. Boyd taught that each OODA cycle led to a new cycle, or loop, and that decision- makers used the OODA technique constantly to gain superiority in their decision-making skills.

Q: What is an anomaly?
A: Most investors believe in a concept called “perfect information,” which is that the price of all securities reflects everything that is known at the time about them. It turns out that this is not only not true, but that information gaps in the marketplace are both common and very large. They can exist for short intervals or for a very long time, depending upon how many people understand the gap. For example, the carry trade -- wherein investors borrow in a low interest environment and invest in a high-interest environment -- should technically never exist, since the yield curves of bonds are known to everyone. Yet for the several years, many investors earned large amounts of money by borrowing in countries where money had been cheap, such as Japan, and investing in countries such as Brazil, where interest rates started out sky high. As Brazil’s bond ratings improved and its bonds became increasingly less risky, investors who did this carry trade could follow the yield curve downward and make extremely high returns, which they did. The returns rose, yet the risk actually diminished. That is almost the textbook definition of an anomaly.

Q: What is the single biggest mistake that investors make?
A: Probably the biggest mistake that ordinary investors make is in trying to be as good as the best investors. It isn’t necessary. If an investor can earn money consistently -- making money on most, but not all investments, and losing small on the rest -- and stay ahead of inflation, over time such an investor will do very well. The way I explain it is to say that six might be three and three, but it is also ten minus four. If you seek consistency rather than excellence, and acknowledge that you are not going to outpace the market on every investment, you are exhibiting the decision-making maturity that will turn you into a better investor.

ABOUT THE AUTHOR:
Clark Winter is the newly appointed Chief Investment Officer at SK Capital Partners, a transformational buyout firm. He is the founder of Winter Capital International, an independent advisory firm that structured multi-manager portfolios, which was acquired by Citigroup. Winter has served as the chief global investment strategist for Citigroup Global Wealth Management, Citi Private Bank, and Smith Barney. He was director of portfolio strategy and managing director of Goldman Sachs & Co.