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The Shire Green

December 8, 2012

And the Black Gates of Mordor. Drama. In 1895, Alfred Nobel stipulated that most of his estate of more than SEK 31 million (SEK 1,702 million or US$256 million in today’s dollars) would be converted into a fund and invested in “safe securities” and that the income from the investments would be “distributed annually in the form of prizes to those who during the preceding year have conferred the greatest benefit on mankind”.

Of course, no one knows better than Mr. Nobel that great fortunes are made by a great purpose and single-mindedness in a cause that against all odds and often with many disappointments and failures becomes a great result or a great discovery or an enduring enterprise. However, as investors, we have a different problem. We don’t know today what the great companies of tomorrow will be and should we be fortunate enough to find one and then be fortunate enough to buy it – all of it if possible – then eventually we or our heirs will have the same problem that we have now of investing our capital in “safe securities” which to us, and undoubtedly to Mr. Nobel, means 100% capital safety guaranteed – we want to keep our money and our capital safe and intact – and obtain a hopeful return that exceeds the rate of inflation (although that cannot, in general, be guaranteed and we know that too).

That looks like two rules (capital safety plus inflation protection) but there is, in fact, only One Rule – 100% capital safety guaranteed – that defines completely and without reservation “safe securities” and we can say in mathematics and economics and, memorably, in the spirit of the times, that it is the “One Rule that finds them and in the darkness binds them” and tends (for reasons that we understand) to give us back more than what we bargained for. Please see our Posts on The Perpetual Bond™ and, of course, our many discussions of the so-called “risk/reward equation” which has provably no force as an investment discipline and passes no tests but wind, so to speak.

The One Rule is, in fact, quite simple and has only two tenets. The first is that an investment is just and only the “purchase of risk” and, like anything else that we might buy with our money (or capital, in this case), we ought to know the price of it, that is we ought to know the “price of risk” and, secondly, the “price of risk” (as stated for equities but the same for bonds, houses or properties or anything else that we might buy) is (by definition) the least stock price at which a company is “likeable” (Goetze 2009). Please see our Post, The Price of Risk, August 2012, to understand how “likeability” is defined, determined and verified.

Mr. Nobel’s intuition and experience were, therefore, absolutely correct and unassailable more than one hundred years ago and long before the artifacts and superstitions of modern investment lore have fallen upon us and define investing today, and defy that purpose and drive us to embrace the Black Gates of Mordor, so to speak (please see the Postscript).

In 1901, the term “safe securities” was, in the spirit of that time, interpreted to mean gilt-edged bonds or loans backed by such securities or backed by mortgages on real estate but with the changes brought about by the two World Wars and their economic and financial prelude and aftermath, the term “safe securities” was reinterpreted in the pale light of the prevailing economic conditions and new theory of the 1950’s to give the Nobel Foundation’s Board of Directors a free hand to invest not only in real estate, bonds and secured loans, but also in most types of stocks. Their situation would be quite different today had they only found and bought any of the aforementioned winners of today then and kept them. Alas. It is the common problem of all investors and absent luck and happenstance the solution is to see more clearly what is now.

Post-1901 when the first prizes of SEK 150,000 each were awarded and amounted to about 4% of the capital every year, the prize amounts declined steadily thereafter but with this new freedom to invest, along with the long-fought-for tax-exemption granted in 1946, it was possible to reverse that trend and, on average, keep pace with even increasing inflation. The real value of the prize amount was restored in 1991 and the amount of the 2011 Nobel Prize was SEK 10 million. But, then, in the five years since the end of 2007 the funds (and the awards) have lost 20% of  their value (Reuters, December 4, 2012, Nobel Foundation turns to hedge funds to restore prize money and Bloomberg, December 4, 2012, Nobel Prize to Get Hedge Fund Boost After Awards Sink 20%).

Mr. Lars Heikensten, the head of the Stockholm-based Nobel Foundation, has said that  “If we can choose hedge funds that we trust, then we can get better returns for given risks. When we look at the analysis we see that we can get more return with less risks by doing that.” (Bloomberg)

But that’s the problem, isn’t it. Where is the hedge fund that will guarantee 100% capital safety and a hopeful return above the rate of inflation? Where is the trust and where is the road to hell that is not paved with good intentions?

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of  investment lore. We have just one product

The Perpetual Bond™
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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