Moralism and the Facts — The Pillars of Paul Cabot's Investment Strategy

We conclude our week-long feature on Passion for Reality: The Extraordinary Life of the Investing Pioneer Paul Cabot, with an excerpt from the epilogue. In these excerpts, Yogg considers some of the core values that shaped Cabot’s investment strategy and what it might mean for today’s investors:

Two modes of thought shaped Paul Cabot’s approach to investments and the conduct of his business: moralism, inherited largely from his fam­ily and the culture of Boston; and empiricism, a demand for the facts, a trait he was probably born with but which was reinforced by his education and his experience in the stock market. He was not unique in this, but Paul also had the self-confidence and the passion to challenge the prevailing business culture and move to change it.

When confronted with wrongdoing, Paul often displayed the mindset of a Massachusetts Puritan of an earlier era, even though his lifestyle was far from puritanical and he was not overly religious. When he discovered price manipulation of trust shares, he gave a speech that sounded in parts like a jeremiad. When the perpetrators tried to have him silenced, he “flamed up. (He) got so goddamn mad.” It was truly righteous anger. Echoing the early Puritans, he believed that if sinners were tolerated, they would—at least figuratively—bring God’s wrath down on the entire com­munity. Referring to the abuses of the British trusts of the nineteenth century, he declared in 1928 that “unless we avoid these and other errors and false principles we shall inevitably go through a similar period of disaster and disgrace. If such a period should come, the well run trusts would suffer with the bad as they did in England forty years ago.”

Most of the specific abuses that Paul objected to—price manipulation, dumping unwanted securities into mutual fund portfolios, unnecessarily complicated and deliberately confusing capital structures—were breaches of fiduciary duty, instances in which a manager put his own interests above those of the client. Takeovers in which a financially-driven conglomerate took over businesses it did not fully understand were another concern. There was a sense in New England and elsewhere, both before and during Paul’s day, that people should stick to their business, do what they do best, and not buy something merely because the acquisition would increase reported profits. He compared the takeovers of the 1960s to various past financial scandals, “all born of greed and lust for power.”

Paul’s lack of greed complemented his moralism. He was known for his frugality and even ridiculed for it. While writing this, I heard for the first time the story of how he raced a neighbor to the back of a Needham supermarket to grab the last loaf of discounted day-old bread. But being frugal and unostentatious meant he had no need for great wealth and was not even tempted to break the rules governing a fiduciary’s conduct. Unlike many financial executives during the 1982–2000 boom and since, he lived in the same world as his clients—wealthier than most but not or­ders of magnitude wealthier. It also meant he was not likely to get caught up in the greed-driven, frenzied last stages of a bull market….

Paul’s integrity would not benefit his clients without analytical com­petence that produced strong investment performance. His mantra, “First, you’ve got to get the facts. Then you’ve got to face the facts,” combines empiricism, determination, and intellectual honesty. This is not just a skill; diligence with other people’s money and intellectual honesty are ethical values as well. Before the financial crisis of 2007–2009, investors bought and the ratings agencies rated bonds backed by subprime mort­gages without getting and facing the facts on what they were buying and rating. They rarely studied the actual mortgages. Paul knew in 1928 that real success demanded intelligence, thorough investigation, and patient research….

Like Buffett, Paul Cabot resisted the pressures of bull markets. Even though he did at times try to capitalize on market momentum, he did so carefully and to a limited extent. He never lost sight of the market’s long-term prospects and value until, when in his seventies, he became overly discouraged and pessimistic. The qualities of patience, independence, and steadiness which he strove for were those most likely to produce superior long-term results, and those against which investors in the boom-and-bust 1980s can be judged as lacking….

Paul Cabot’s entire career demonstrates that putting the clients’ inter­ests first can be a sounder path to business success than a focus on growth and personal enrichment. Not only can the drive for extreme wealth lead to business failure, it can endanger the entire economy, as the 2007–2009 financial crisis, primarily a housing and mortgage crisis, demonstrated. In the 2000s, politicians sincerely committed to the promotion of homeowner-ship among the poor allied with opportunists in politics and finance to make mortgages available to borrowers with little chance of repayment….

Paul’s personal frugality, dispassionate view of markets, dedication to clients, and diligent and intellectually honest research practices are good lenses through which to view the financial crisis. Those who made loans that could not be repaid and sold them through investment banks, with the blessing of ratings agencies to careless investors, were enriching them­selves at society’s expense. The ratings agencies and investors were derelict in their duties by not digging up the facts on the securities they were rating and buying. Nearly everyone, but especially the home buyers, was caught up in a real estate market that they thought could only go up. Th e invest­ment bankers who had a responsibility to ensure the quality of the mortgage securities they originated and sold failed in their fiduciary responsibility. Many homebuyers and lenders engaged in fraud, as did others involved at each stage of the process. Almost nobody was “able and honest.” Many were neither.

Paul’s comments after the 1929 crash are almost haunting, since they could have been used verbatim to describe the situation after 2008: “All common stock investors lost, irrespective of the care with which their investments were made.” Research could not have prevented these losses unless no equities had been bought. A review of the statements of “leading economists, research organizations, and businessmen during the past eighteen months” will show how little we understand the economy and markets. “In spite of all the research work that has been done, . . . common sense still remains the intelligent investor’s most reliable and useful asset.” At the time, few experts fully understood the events of 2007–2009, or of 1927–1929, even though in retrospect they may seem inevitable. Only com­mon sense and the ability to resist the psychology of the crowd can truly protect the investor. Though even Paul could not avoid significant losses, through alertness and detachment he was able to escape the total ruin suf­fered by some of his competitors.

Paul was not well known enough to have influenced the thinking of many during the period after 1982, this writer being one of several excep­tions. But he did have an impact on the era in which he was active. In spite of his volatile personality, he was not only imaginative but careful, dili­gent, and wise in his professional life. What made him special and espe­cially effective was his spirit. In this book I contrast his personality with the classic image of the Bostonian, especially the image expressed in the popular novels of his day such as The Last Puritan and The Late George Apley. Marquand has Apley say, “I am the sort of man I am because envi­ronment prevented my being anything else.” Paul reflected his environ­ment but was not limited by it. He took received wisdom and tradition and put his own imprint on it by thinking hard, getting the facts and facing them, and following them where they led.