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The Lost Beauty of the Small State

Size is the enemy of more than just efficient fund managers...

IN THE aftermath of the latest Berkshire Hathaway annual general meeting, we made the observation last week that size is the enemy of investment performance, writes Tim Price on his ThePriceOfEverything blog.

Warren Buffett himself concedes this point; as he wrote in a letter to shareholders in 1989, "a high growth rate eventually forges its own anchor". Once a fund manager's assets under management become unwieldy, future returns are inevitably compromised.

When Peter Lynch left Fidelity's Magellan Fund in 1990, for example, after 13 years with the Group, the fund was at $13 billion in assets. By the time Morris Smith had left in July 1992, the fund was up to $20 billion. On Jeffrey Vinik's departure in June 1996, assets were up to $50 billion. By the end of the century, Magellan assets had grown to over $100 billion (the fund was closed to new investors in September 1997 and peaked at almost $110 billion in August 2000), only to see them fall back to $52 billion on manager Robert Stansky's departure in 2005, through a combination of investment losses and investor outflows. Once you become the market, you cannot beat the market.

Size isn't just a barrier to efficiency in asset management. Beyond a certain limit, size threatens operational performance in just about every facet of life. In the words of the late Dr. Albert Bartlett, emeritus professor of physics at the University of Colorado at Boulder:

"Continued growth past maturity for any entity becomes obesity or cancer."

Which is why, on 23 June 2016, this British citizen will be voting to leave the European Union.

The decision has little to do with whether the UK will temporarily be better or worse off outside the EU. It has everything to do with whether the project is any longer it for purpose, and has become too big for its own good.

The union we confirmed our membership of, in 1975, was something called the European Economic Community, also known as the Common Market. For a nation of shopkeepers, membership made complete sense. Britain has always thrived on international trade. But that is not what the EU has become.

Britain never signed up to an ever-expanding political union among vastly disparate states. And most of the 'Remain' campaigners warning of Armageddon if the UK chooses to leave the EU were also warning of Armageddon if we failed to adopt the single currency in the 1990s. The sad reality for them is that leaving the Exchange Rate Mechanism was one of the best things that ever happened to the UK economy.

The fundamental problem with the gigantism of the State, and the obesity – or cancer – of self-compounding central planning, was identified by Leopold Kohr. Kohr was an Austrian Jew who only narrowly escaped Hitler's Germany just before the outbreak of the Second World War. He had been born in Oberndorf in central Austria, a village of just 2,000 or so. Oberndorf's lack of size came to play a crucial role in Kohr's thinking.

Kohr graduated in 1928 and went off to study at the London School of Economics with the likes of fellow Austrian Friedrich von Hayek. In September 1941, Kohr began writing what would become his masterwork, 'The Breakdown of Nations'. In it he argued that Europe, far from expanding, should be "cantonized" back into the sort of small political regions that had existed in the past and which still existed in places like Switzerland, with a commitment to private property rights and local democracy.

"We have ridiculed the many little states," wrote Kohr sadly, "now we are terrorised by their few successors."

Kohr showed that there were unavoidable limits to the growth of societies, not least to the complexity that is a natural part of larger systems:

"Social problems have the unfortunate tendency to grow at a geometric ratio with the growth of an organism of which they are a part, while the ability of man to cope with them, if it can be extended at all, grows only at an arithmetic ratio."

But as the European Union and its common currency bloc grow ever larger, they smash horribly into Kohr's thesis, and whatever economic dynamism they once possessed becomes sclerotic.

Take José Manuel Barroso's 2012 State of the Union address as President of the European Commission:

"Globalisation demands more European unity. More unity demands more integration. More integration demands more democracy."

But the words he smears together in defiance of logic and plain common sense – unity, integration, democracy – have no meaning in his perfunctory Orwellian doublespeak.

What democracy does demand is the primacy of the individual over the unelected Brussels technocrat. European democracy is going to be disappointed.

And Eurozone economic policy is delusional. Despite the conspicuous failure of QE to reflate Europe's economy, Europeans are being promised more of the same. Despite interest rates having now become negative, the monetary beatings will clearly continue until morale improves. The EU's central bankers are in complete denial.

ECB Governing Council member Vitas Vasiliauskas, also the head of Lithuania's central bank, commented last week:

"Markets say the ECB is done, their box is empty. But we are magic people. Each time we take something and give to the markets – a rabbit out of the hat."

Vasiliauskas is the perfect embodiment of EU monetary policy. A showman foisting magic tricks on an increasingly sceptical crowd.

Investment markets don't endorse gigantism or central planning. They favour choice, flexibility and competition. Our own investment exposure to the Euro zone is extremely modest, focused almost entirely on smaller and nimbler businesses trading at attractive valuations, and we're unlikely to raise it any time soon. The people, workers and consumers of Asia, on the other hand, operate in a society not ossified by protectionist regulation and central planning. They want urgently to become wealthier, and we are very happy, by investing in them, to help them toward that end.

London-based director at Price Value Partners Ltd, Tim Price has over 25 years of experience in both private client and institutional investment management. He has been shortlisted for the Private Asset Managers Awards program five years running, and is a previous winner in the category of Defensive Investment Performance.
See the full archive of Tim Price articles.


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