C L I E NT N O T E
JOHN OLIVERS GUIDE TO INVESTING
Friends,
This summer, John Oliver told you nearly everything you
need to know about investing.
For those of you who are unfamiliar with Mr. Oliver,
heres some detail: British-born comedian, political
commentator, and host of HBOs Last Week Tonight a
late-night news satire program that covers politics and
current events. Think of the series as a weekly version of
The Daily Show, with more cursing.
Each week, our host takes about 20 minutes to address
and critique a current event. These segments are witty
and well-researched, and they rarely leave any prison-
ers. Regardless of whether one agrees with the shows
stance on the issues, I find it refreshing to see a news
program take such a politically irreverent approach to
its reporting and analysis.
THE MINEFIELD OF FINANCIAL ADVICE
The topic of the segment and this note, hereby named John Olivers Guide to Investing, identifies three large hazards
that individuals will encounter on the path to financial independence:
1) Excessive fees;
2) Active management investment offerings (versus passive management);
3) Conflicts of interest related to financial advice within the financial services industry.
The hazards above represent the most significant threats to the individual investors achievement of his or her long-term
financial goals. I wholeheartedly agree with Mr. Oliver. As he explains, ones awareness of these issues will go a great
distance in preventing a major derailment towards achieving these goals. This note explores each of these hazards in
more detail.
A WORD ON BREXIT
In his book Against the Gods: The Remarkable Story of Risk, Peter Bernstein
traces the roots of modern actuarial analysis to an influential study entitled
Natural and Political Observations made upon the Bills Of Mortality. The
study was published in 1662 by John Graunt, who analyzed data on births
and deaths in London between 1604 and 1661. The work was a break-
through in the use of sampling methods and the statistical techniques
frequently used today in risk management, insurance, and academia.
For the purpose of this short essay, I mention Graunts Observations not
because of its influence on modern statistics, but for its conclusions on life
expectancy in England during the 17th century. This was during the height
of the plague, and the conclusions turned out to be quite accurate. Based
on the analysis in Observations, what was the probability that a resident of
17th century London would live to the age of 36? In 1662, the odds of a
newborn surviving to 36 were 16% - an 84% likelihood of dying before 36.
Fast forward: In 2012, an English citizens likelihood of living to 36 was 99%.
These facts help illustrate Catallaxy Capitals view on the dreaded Brexit.
For most of us, only a handful of generations ago our retirement plan was
death! Thanks to the rapid progress in science, technology, and innovation
the vast preponderance of which has been fueled by democracy, en-
trepreneurially-driven innovation, and the rationality of capital our worlds
standard of living has improved at an equally rapid pace.
Increased life expectancy represents just one of the improvements that we
have witnessed in our lifetimes, and we continue to experience more each
and every day. Despite these continued improvements, our hardwired
instinct for survival remains the same as it was when our ancestors decision
to run from that strange noise in the bushes often meant life or death. We
should be thankful that our predecessors ran away from these uncertain
situations instead of sticking around to observe them. After all, this is why
were here today. However, our instinct to flee in the face of uncertainty is
also one of the reasons why investing can be so challenging.
Catallaxy Capital, LLC
SUMMER, 2016
Which brings us to the main topic of this months note:
investing la John Olivers Last Week Tonight.
The June 12th segment opens with some tongue in
cheek examples of mistakes individual investors make
in saving, investing, and receiving financial advice. It
then critiques the universe of financial advisors, the
financial services industry, and its product offerings. The
piece ends with a humorous clip that individuals can
reference on saving and investing for retirement.
For me, the most memorable features of the segment
include a discussion on elf-spotting certification, giant
dominoes, and a stock-picking cat. The full 21 minute
segment can be found by following this link. I hope you
enjoy it.
For the United Kingdom specifically, weve seen something like this be-
fore. On September 17th, 1992, the U.K. devalued its currency by 25%
against the U.S. Dollar. At this time, France was preparing to vote in a
referendum to ratify a Treaty for the creation of the European Union. The
next day, in response to Brexit 1.0, an article in the New York Times noted:
you are now looking at a Europe that will be substantially different from what
most people were expecting only a few months ago ... Europeans are going to
have to go through an enormous soul-searching on every level.
This excerpt sounds familiar, doesnt it? While the terms have changed
back then it was Euro-sclerosis(!) the tone of uncertainty and fear we
see today in the aftermath of the Brexit drama seems more like a version
of the same song, with a different verse.
Make no mistake: as long as we are invested in our world financially,
socially, and culturally we will be faced with discord and uncertainty.
These themes are sharply present following the U.K.s decision to leave the
European Union, just as they were in the aftermath of Brexit 1.0. But con-
sider the following: in July 1992, the price of the U.K.s FTSE All-Share Total
Return Index stood at 823, and global GDP per capita was $4,285. At the
end of July 2016, global GDP per capita has more than doubled to over
$10,000, and the All-Share Index stood at 5,967 up over 725%, and
nearly 500% in USD terms. This historical outcome is no fluke.
I know as little as anybody else about how the U.K.s decision will play out.
But as long as decisions such as these are made in the spirit of democra-
cy and sovereignty, without hindrance to the functioning of innovation
and entrepreneurship that this spirit supports, the pessimists are swimming
against a very strong tide.
What does the Brexit mean for your investment portfolio? For the long
answer: read this box again. For the short answer: nothing. Dont sweat
the Brexit.
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1 EXCESSIVE FEES
The aim of a long-term investment plan is to grow
and/or preserve wealth through the compounding of
returns. In the Prudential Investments ad featured in
John Olivers Guide, compounding is illustrated by a
small domino falling onto larger (and more menacing)
dominoes. Put another way, the longer the timeframe,
the larger the amount of wealth generated by the
same level of return. For example, 5% of $10,000 is $500,
while the 5% of $1 million is $50,000. As our host notes,
compounding is wonderful over long periods of time,
but fees can compound too. Ultimately, compounding
of fees leaves less for the long-term investor to enjoy.
To illustrate the effect of compounding fees, the Guide
uses an example of an investment that returns 7% per
year, with a 2% fee. Over the course of 50 years, the 2%
annual return difference results in an ending difference
of nearly two-thirds (61%):
$10,000 beginning investment for 50 years
[2% annual return difference, ending balances]
$350,000
$294,570
$300,000
$250,000
$200,000
$150,000
$114,674
$100,000
$50,000
$0
7% Gross Return per 5% Net Return per
Year Year
Source: Authors calcualtions
Ouch. Fees are one of the few things investors can
control in investing, and the reality of compounding
fees is one of the reasons low-fee investment managers
such as Vanguard have had so much success in recent
years with this simple message. As the 2% difference
highlighted above suggests, higher fees will result in
lower wealth over long periods of time, all else equal.
For the individual retirement investor (in fact, for all in-
vestors): watch those fees. But even more importantly
with respect to fees, and as the next two hazards
demonstrate, make sure the value you receive is in
excess of the price you pay.
A TIMELY EXAMPLE OF POOR ACTIVE MANAGEMENT
Our risk appetite indicator is near neutral levels and its positive momentum has faded, suggesting positioning will give less support and we will need better mac-
ro fundamentals or stimulus to keep the risk rally going, but market expectations are already dovish and growth pick-up should take time...As a result, we down-
grade equities tactically to Underweight over 3 months, but remain Neutral over 12 months. We remain Overweight cash and would look for resets lower in equi-
ties to add positions.
- Goldman Sachs, August 2 2016
Translation: Our subjective conclusion from a narrow, selectively chosen data set is that stocks might fall, so sell now, but buy more if they do...
Does this seem like a strange way to invest long-term, or is it just me?
Catallaxy Capital, LLC
Client Note
2 ACTIVE MANAGEMENT
In 2012, the British newspaper The Observer ran an ex-
periment pitting a team of investment professionals, a
group of primary school students, and a cat named
Orlando against each other in a stock picking contest
for one year. Participants could choose up to five in-
vestments within the benchmark index, and could re-
vise their choices every three months. The hypothesis
tested here may remind the reader of a quote from
Burton Malkiels A Random Walk Down Wall Street:
A blindfolded monkey throwing darts at a newspapers
financial pages could select a portfolio that would do just
as well as one carefully selected by experts. - 1973
Orlandos method was very scientific: every three
months, he would play with a toy mouse near a grid of
numbers representing companies in the FTSE All-Share
Index (also mentioned in the Brexit essay). The first five
companies on which the toy mouse fell during his play
would represent his picks for the quarter. The results:
The Observer Stock-Picking Contest Results
2012 Return [%]
16.0%
13.6%
14.0%
10.8%
12.0%
10.0%
$179,896 8.0%
6.0%
3.5%
4.0%
2.0%
0.0%
-2.0%
-4.0%
-3.2%
-6.0%
Amount Paid in Index Average Orlando the Professionals Kids
Fees Cat
Source: Quartz
Mr. Olivers point with the Orlando anecdote is that
over short periods of time (and in investing, one year is
indeed a very short period), returns as good as random.
If this is the case, he asks, why bother with active man-
agement and its high fees?
The active versus passive question has received a large
amount of attention, and the decision of whether to
invest actively or passively (against a broad bench-
mark) will be one that every individual investor will need
to make. Therefore, active management deserves
special attention. Page three focuses on some of ac-
tive managements key considerations.
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 Client Note

2a - Allocation [not stock picks] drives outcomes on all profits above a net-of-fee high water mark
(HWM). In this structure, the HWM prevents any incen-
Asset allocation is defined here as the mixture of stocks,
tive fee on returns that only serve to offset losses in pre-
bonds, and other assets within the investors portfolio,
vious years. In other words, with the HWM, the incen-
and the variants within each of these asset classes.
tive is only paid on fresh cumulative profits over the life
For stocks, variants include those such as large- of the fund, and any management fees previously paid
capitalization vs. small-capitalization, domestic vs. in- are included in its calculation.
ternational, or value vs. growth. Amazon, for example,
Continuing with this (egregious) hypothetical, lets as-
can be characterized as a large-cap growth stock,
sume that Mr. Buffetts new fund (aptly named Buffetts
while Exxon Mobil would fall into the large-cap value
Opportunity & Freedom Fund, or BOFF) opens its doors
category. For bonds, variants include those such as
to new investors on January 1st, 1990. The shrewd Mr.
long-duration vs. short-duration, or local vs. foreign cur-
Buffett, recognizing the funds structure as the personal
rency. Other assets include commodities, real estate,
wealth accumulation vehicle that it is, figures that the
and basically anything else that is neither a stock
30% per year price-per-share growth experienced by
(which represents ownership in a company) nor a bond
Berkshire Hathaway over the preceding 25 years (since
(which represents a loan to company).
the companys IPO) is good enough, and decides to
The headline point above has been established by invest the fund in his existing company, Berkshire Hath-
researchers and practitioners alike (see here, here, and away (BRK.A).
here), but the incremental importance of asset alloca-
The funds sophisticated institutional, tax-exempt inves-
tion is still debated among larger, institutional investors.
tors are excited at the opportunity to invest alongside
However, for long-term investment portfolios from
Buffett in this new endeavor, but they also recognize
which an individual hopes to (or already does) use to
the risks of putting all of their eggs in one basket. They
generate income, the black and white outcome for
place $10,000 with BOFF, $10,000 in an S&P 500 index
the individual maintain wealth or run out of wealth
fund with an annual expense ratio of 0.05%, and
will be determined by the size of the portfolio, its with-
$10,000 in BRK.A. Twenty-five years later, at the end of
drawal rate, and its asset allocation not its specific
2015, BOFFs investors open up their statements:
allocation to individual stocks.
2b - Active can work if its diversified $10,000 Invested in Three Assets (BOFF, S&P Index, & BRK.A)
1990-2015
A simple survey of history demonstrates that some indi-
S&P 500
viduals can consistently outperform the market for long BOFF
Fund
BRK.A

periods of time. This observation lends itself to the ar- Initial Investment $10,000 $10,000 $10,000
Return p.a. 9.1% 9.6% 13.3%
gument that real skill exists in the area of asset/security 2.0% mgmt. fee,
selection, and puts a dent in Mr. Malkiels monkey quip Fees
20% of profits (net
of mgmt. fee,
0.05% -
at the beginning of this section. high-water mark)
Ending Value $87,461 $99,587 $227,413
However, just as we can point to active managers who Fees (% of total return) 64% 2% -
$300,000
have beaten the market, history has not been so kind
to those who took large, active bets on the Enrons, the $250,000

Baldwin Pianos, and (more recently) the Valeants of $200,000

the world in the spirit of outperformance. Investment $150,000

returns exist in the future, and separating the winners $100,000

from the losers is a challenging task for all investors, $50,000

including professionals. For the individual investor, di- $0

1990 1995 2000 2005 2010 2015
recting ones focus to asset allocation maximizes the
BOFF S&P 500 Index Fund BRK.A
odds of meeting ones goals for the portfolio, and min-
imizes the risk of costly (and often irreversible) errors. Source: Berkshire Hathaway Annual Report (2015), authors calculation

2c - Active can work if its not overpriced
What if Warren Buffett ran a hedge fund? After all, Mr.
Buffett is a clear example of a successful active inves-
tor, and possesses a spectacular track record.
Let us assume that in an alternate universe, Mr. Buffett
starts a hedge fund. The price of entry for this exclusive,
actively managed portfolio includes the standard fees
that a typical hedge fund manager commands: a 2%
management fee on assets, plus a 20% incentive fee
As tortured an example as this is (Mr. Buffett would nev-
er start a hedge fund), the point should be clear: ex-
ceptional long-term results from active management is
possible and should not be dismissed as a legitimate
investment option, as long as the price tag associated
with it is reasonable. But the price tag can present a
significant hurdle. Over the past 25 years, not even
Buffett the Hedge Fund Manager could outperform a
low-priced passive index fund after accounting for the
standard fees associated with active management.

Catallaxy Capital, LLC 3


3 CONFLICTS OF INTEREST & ADVICE
The third and final hazard in John Olivers Guide to Re-
tirement Investing is concerned with the financial ser-
vices industry and the threat of advice that is hardly
in the investors best interest. The segment gives plenty
of examples, from Suze Orman attacking annuities
salespeople to Mr. Oliver describing his teams experi-
ence unearthing a countless number of hidden fees as
it set up a retirement plan with a well-known financial
institution. Anybody can label themselves as a finan-
cial advisor, but the threats to individuals financial well
being from conflicts of interest exist with even the most
established advisory institutions (the latest large scandal
indicted Merrill Lynch for misleading clients).
The threshold issue of conflicts of interest and financial
advice can be evaluated by examining the nature of
the advisors compensation. Is the advisor a fiduciary
whose economic interest relies on the provision of ef-
fective advice, or is the advisor somebody who has an
economic interest in their recommendations through
commissions or other fees? The latter setup increases
the risk of sales posing as true advice, which is why Mr.
Oliver emphasizes the importance of working with a
fiduciary who will always act in the clients best interest.
How Catallaxy Capital Earns its Fee
- Quantifying goals, crafting a long-term, holistic financial plan, and funding the plan with a long-
term portfolio
- Coaching clients to continue working the plan through all the cycles of the economy, and all the
fads and fears of the market
- Analyzing/interpreting the economy and current events
- Timing the market, calling tops and bottoms
- Identifying consistently top-performing investments
At face value, this may appear to be a plug for my
own practice, but the intention here is to highlight a
general value proposition that also exists among a
large number of independent advisory practitioners
besides me. These practitioners act with integrity, pro-
vide much-needed perspective, and commit them-
selves to focusing on the planning and investment
items that they know they and their clients can control.
These principles resonate with Catallaxy Capitals core
philosophy, and reflect the belief that investments must
be managed according to a date-specific, dollar-
specific plan that is wholly unique to the client. This
goals-driven, fiduciary-based philosophy provides bal-
last during the inevitable storms of fear and uncertainty
that come with long-term investing, while always ensur-
ing that the clients best interests come first. Because
there is no economic interest in the solutions recom-
mended to help achieve a clients financial goals, an
Catallaxy Capital, LLC
Client Note
ADVISORS: WHERES THE VALUE?
The three hazards discussed in Mr. Olivers segment
give rise to an important question: if fees are a net
negative for investment returns, if active management
provides questionable value in the long run, and if fi-
nancial advice has the potential to be inappropriate
because of conflicts of interest, then what is the value
of working with an advisor?
On the issue of the true value that financial advisors
provide to their clients, I cannot comment on the com-
plete universe of financial and investment advice in
general. Nor would I want to, for the reasons outlined
in item 3 of Mr. Olivers Guide many have little value.
Because of the relative ease with which financial advi-
sors can establish a business or practice (its as easy as
getting an elf-spotting certificate), value propositions
can and will differ quite largely between each.
However, on behalf of all fiduciary, fee-based planners
and advisors specifically, I believe the value we provide
in helping clients achieve their long-term financial goals
is well in excess of the price tag. Here is why:
For the sake of example, below is a simplified version of
Catallaxy Capitals value proposition.
20%
80%
0%
0%
0%
independent, fee-only, fiduciary-based practice has a
better chance of sustaining a relationship of advocacy
and objectivity with its clients. With this structure, value
is created in the service of the only the client.
There is only one caveat in my defense of the advisor
characterized here. This caveat concerns costs, which
as we saw in Section 1 can compound over time if
fees are charged on a portfolios total value. To pre-
vent a clients costs from compounding, Catallaxy
Capital charges a flat, retainer-based fee whereby
costs become less burdensome as assets grow. With
this fee structure, our interests are even more aligned.
Okay, I admit it that last paragraph was a shameless
plug. Thanks for reading!
Kindly,
Eric Meyer, CFA (eric@catallaxycapital.com)
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