Now that you know the simple rules of structuring a great growth portfolio, let’s take a break from the rules and the numbers while I tell you the story of a group of my students who were able to more than double the returns of the market during the bull market years of 1998 and 1999, simply by following the rules you just read about in the previous chapter. They did so well that I was almost fired as their instructor. Why? Because the academic community teaches its students that they cannot outperform the market averages without taking on more risk than the risk of the market. And here was a class of students that were knocking the socks off the professional money managers out there in Investment Land. Those of you from the world of academia will certainly relate to this story.
The definition of “stupid” is when smart people do dumb things. This is my very own definition, and you’ll see how it comes into play toward the end of this chapter. The good thing about smart people is they have the ability to realize they are being illogical, and they also have the ability to reverse their periods of insanity, which you will also see later in this chapter.
I began the doctoral program at a university that was able to differ itself from the mainstay type of school in that you didn’t have to be a full-time student in order to enter the program. This school had two time periods in which the courses were taught. One schedule consisted of weekend classes. Yes, full days on Saturday and Sunday. Each class on the weekend schedule lasted several months, with each class meeting one weekend per month. This schedule allowed you ample time to prepare for the next class.
The second schedule consisted of six days in a row of classes. The student attended class from 8 a.m. to 5 p.m. each day and at the end of six days, you were certainly worn out. This schedule had one drawback. You had to do all your preparation work in advance, and if you weren’t prepared you couldn’t begin the class.
When you signed up for the six-day course, you received a big box in the mail three months before the class. What was in the big box? It included the text or texts for the course, ancillary books that had to be read prior to your first class, and a three-ring binder that was fatter than my 4-foot 9-inch, 240-pound grandmother, who couldn’t speak English because she was from the old country. There were also some surprises in the box that consisted of miscellaneous course material that had to be finished prior to class. The binder included instructions for a research paper that had to be sent in to the instructor prior to the beginning of class. The nice thing about this three-month preparation period was we had full access to the instructor via phone and e-mail prior to the beginning of the course.
How long did it take to prepare for the first day of class? About three months, which is why you were sent this big box three months prior to class.
My very first class was a finance class. This class was filled with middle-aged folks with half of the folks coming from the teaching profession and the other half coming from the world of business. Folks from the teaching profession were there to obtain the Holy Grail of all degrees, so they could compete for jobs in the academic profession in colleges and universities as heads of departments and deans or associate deans. The degree was needed in order to begin the path to the top of the academic world.
The business folks were already successful in their respective segments of industry and were in this school in order to learn some of the theories of finance that they could take back into the business world in order to put new ideas into practice.
The greatest part of this school is that our instructors were folks that had Ph.D.s or doctorate degrees and were working in the business world. Thus, my instructors had mastered both the academic world and the business world. Yes, we were taught by people who knew both sides.
Barbara was one of those gals who immediately garnered attention when she walked into a room. She had blond hair, piercing blue eyes, a type-A personality, all the confidence in the world, and a diamond ring that was heavier than my box full of course material. When guys such as myself are young, we would never, ever dare to even approach a girl such as Barbara. But I was older and much more confident with myself when I saw her, but still was able to muster just a smile and a very quick hello.
One of the items we had to prepare for this class was a 30-minute presentation on the subject we were researching for our dissertation. The presentation had to relate to finance, so some of the students who weren’t majoring in finance had a problem right off the bat. Barbara was the first one up to present and her major was definitely not finance. However, she pulled her presentation off so well and set the bar so high that you could smell the fear of the other 15 or so people that had yet to present.
When Barbara was finished, the instructor laughed for several minutes and while still laughing said in his rather thick accent, “Which one of you crows are going to compete with that?” Nobody raised their hand, but I said, “Sir, I think you mean chickens, not crows.” He started laughing really hard and said, “OK, Mr. Belmonte, you’re up right now, and for being such a wise guy, expand your presentation to one hour. Let’s see how well you can think on your feet.”
Well, here I was being asked to speak on my favorite subject, which is Clean Surplus and Warren Buffett. I had already come equipped with a PowerPoint presentation on my laptop and going for a full hour was going to be a day at the beach.
I don’t want to pat myself on the back, but after my presentation, the bar was now raised higher than the tallest basketball player could jump. My classmates demanded that the presentations should be put on hold until the next day so they could all have more time to prepare.
The class continued for another five days and things went well. The instructor was fantastic and went into detail on some of the theories of several Noble Prize winners: Markowitz’s modern portfolio theory, Tobin’s separation theory, and Sharp’s capital asset pricing model, as well as some theorists most folks never heard of. I had a great time since I knew all about these theories. The instructor and I would go back and forth in friendly fashion and have little discussions regarding portfolio formation. It was one of the best classes I ever took. However, some students, not being finance majors, were ready to jump out of the one-story window.
The next to the last day of class the instructor went over the outline of the four-hour final exam, during which time several folks passed out. Well, not really, we just heard a lot of moans and groans. You see, on the doctoral level of education, final exams are very rare. Usually, the students must prepare a very detailed research paper, but this instructor was different. He wanted a four-hour final exam and that was that, and from what the instructor went over, this exam was going to be unbelievable to say the least.
It was then that Barbara, having formed her elite study group of only her choosing, came over to my work table and with her piercing blue eyes and one hand on her hip asked if I wanted to be in her study group.
You folks reading this will recognize this high school tactic of the two groups of people. There was the “in crowd” and there were the rest of us. Just a note here: This behavior goes on until you die, so get used to it. But once you adjust to it, it can be a lot of fun because everyone knows it’s a game, including Barbara.
Now I had just one chance to snub the leader of the pack, so I looked at her with a smile and said, “Why, thank you for the invitation, but I really don’t intend on studying for the final as a four-hour written exam really shouldn’t be all that difficult.”
The looks on all their faces were precious. Yes, I did feel sorry for all my new friends, and we all had a great time studying together. Barbara became a dear friend to this day, but this is not what I came here to tell you.
Landing a teaching job at a University in South Florida is difficult. I know, I know, we all hear about the lack of teachers and the large classes, and so on, but think of it this way. When teachers retire, they all move to South Florida. Armed with a Ph.D. or doctorate degree, they soon get bored with retirement and decide to teach one or two classes per semester just to get out of the house or take a break from the golf course. So, they will take a part-time teaching position for very little money.
Barbara came over to me after the final exam and asked if I thought about teaching while I was getting my doctorate degree? I had taught for a year when I was an engineer and I enjoyed it very much. I graduated from a very prestigious engineering school and had a wonderful opportunity for a career in teaching. Even though I loved the job and the hours, I felt I needed to explore the world.
I looked at Barbara and said that I had thought a little about it, but it was very difficult getting a job. She immediately wrote down three names and three phone numbers at three different universities and said, “Here ya’ go. This is for helping me have a good time in finance. If you can do that, then you’ll be a great teacher.”
I called the three names on Barbara’s list, got three interviews, and three job offers. Yes, Barbara knew all the important people in the world of academics, and I found out later that she was very influential.
During my first interview I was asked if I had the credentials to teach international finance. International finance is all about hedging currencies, setting up asset-based lending, options, futures, and currency swaps. I told the dean that I was very familiar with all of the above. He then looked at me square in the eyes (he was a former Marine and I’m sure he used that look with his kids) and asked, “Do you know anything about investing?” Well, that’s a “duh” question, as you all know by now, so I looked him square back in the eyes and said, “I certainly do. What are you thinking?”
What he was thinking was starting a new program at his university. It was to be called a Student Managed Investment Program. The actual name was Portfolio Management I and Portfolio Management II. This was going to be fun. I had just begun teaching, and here I was with my own office and head of a separate subdepartment consisting of one person, which, of course, was me.
The students had access to $50,000 of the school’s endowment money. My job was to teach them the intricacies of investing. And I did just that. Teaching this class was a great situation. I taught the students about investing, and they did a lot of research for me that became part of my doctoral dissertation. The students were making money for the school’s endowment, I was getting research done, which meant I had time to go to the beach (remember the beach factor), and the students were learning things that they could ever learn in any other college or university in the entire world. They were learning how the greatest investor in the world picked stocks for his very famous portfolio, Berkshire Hathaway.
Could things get any better? Highly unlikely, but what I found out was they could be a lot worse.
Sometimes it rains. And sometimes the rain is accompanied by damaging winds and really big hailstones.
One bright day, I was headed to my office as happy as a songbird. This was early 1999, and the market was having a great run. Everybody was happy.
My office was next to the office of the head of the finance department. As I walked by and said hello, he beckoned me into his office. “Joe, the dean wants to see you in his office in half an hour. I can’t let you go up there (the dean’s office was up in heaven someplace) without telling you the reason for the meeting. The dean doesn’t know I’m telling you this, but he and the board want to fire you because your students are making too much money. If they are making too much money, it must mean you are teaching them very risky strategies.”
Talk about big hailstones, but I had an advantage. The dean didn’t know that I knew the reason for the meeting. I went out to the trunk of my car and got out a very, very thin book called Research of Clean Surplus Accounting.
I went up to the dean’s office, smiled, and said hello. Before the dean could say anything, I pulled out my little book and said, “Dave, did you ever hear of Warren Buffett?” He nodded in his dean-like manner and said, “Yes of course.” I said, “Did you ever hear of Clean Surplus Accounting?” He replied, “No, I have not.” I told him that this little book I had in my possession contained the only academic research papers on Clean Surplus Accounting in the entire world. I added that Clean Surplus Accounting was the topic of my dissertation, which had been approved by my dissertation committee. (A dissertation committee consists of four Ph.D.-type folks who must approve each step in the dissertation process. They are NEVER wrong in the eyes of academia). I concluded by saying, “Dave, Clean Surplus is the method used by Warren Buffett, the world’s greatest investor. And Clean Surplus research is what I am teaching my students.”
Dean Dave looked at his watch and at two of the board members who were also in the room. The dean of the business school then said in his most authoritative voice, “Well, this meeting was scheduled for an hour-and-a-half. I think we’re finished so why don’t we all go to lunch?” We went to lunch, and I never heard another thing about the students making too much money, and the dean never found out that I knew.
The program ended that spring because there was political infighting at that time. Dean Dave was eventually forced out, and the new dean wanted everything that Dean Dave had developed dissolved. This was academia at its worst. However, I will always appreciate and have respect for Dean Dave for being able to recognize that he was wrong and, in a moment, make things right again. That must have been his Marine training. I was happy I was able to finish the two semesters with the students, several of whom went into the field of investing and had and continue to have great careers. All the students were offered jobs after graduation because of this one class.
The school year of the class was fall 1998 and spring 1999. The student’s portfolio was up a risk-adjusted return of 62 percent with names like Dell, Microsoft, Oracle, Merck, Intel, Cisco, and Pfizer. Not exactly the high risk that was perceived by the board. The market was up about 20 percent during that time frame. The students kicked butt, tripling the returns of the averages.