CONDÉ NAST PORTFOLIO EXAMINES A NEW BREED OF INVESTORS — THOSE WHO THINK YOU CAN GET RICH WITHOUT REALLY TRYING
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PLUS: PUTIN’S POWER GRAB; HEDGE FUND MONEY CHASES DEATH;
AND AN EXCLUSIVE INTERVIEW WITH MOTOROLA’S ZANDER

New York–In the December 2007 issue of Condé Nast Portfolio, contributing editor Michael Lewis profiles Blaine Lourd, who made a fortune as a broker before he decided that picking stocks was a sham. Now he and a few other investors are ignoring the markets, with the surprising result of beating Warren Buffett (“The Evolution of an Investor",” p. 176). Lewis describes how Lourd, a one-time broker for the rich and famous in Hollywood, became the world’s unhappiest man; he then decided to trade up to the ideas embodied by Dimensional Fund Advisors (D.F.A.), founded in 1981 on the simple idea that nobody knows. “Nobody knows which stock is going to go up. Nobody knows what the market as a whole is going to do, not even Warren Buffett,” Lewis writes. “Wall Street, with its army of brokers, analysts, and advisers funneling trillions of dollars into mutual funds, hedge funds, and private equity funds, is an elaborate fraud.” Lewis describes how a D.F.A. board member coined the phrase efficient markets and how the group sold its clients on passive investing: Instead of looking for trading opportunities and paying stockbrokers and fund managers, D.F.A. buys and holds “baskets” of stocks chosen for the sort of risk they represent. D.F.A. has grown from managing $5.2 billion in 1989 to an astonishing $153 billion this year, $90 billion of which came from individual investors through a network of professional advisers. “Of all these proselytizers, who is the most effective at taking an investor who thinks he can beat the market and turning him into someone who quits trading and hands his money over to D.F.A.?” Lewis asks Joe Chrisman, a senior D.F.A. employee. “That’s easy,” Chrisman says. “Blaine Lourd.” Lourd tells Lewis that things crystallized for him after reading Charles Ellis’ book Winning the Loser’s Game, in which he wrote, “Investment management, as traditionally practiced, is based on a single basic belief: Professional investment managers can beat the market. That premise appears to be false.” Lewis writes, “The problem wasn’t Blaine; the problem wasn’t even the firms he worked for. The problem was the entire edifice of modern Wall Street, in which some people—brokers, analysts, mutual fund managers, hedge fund managers—presented themselves as experts and were paid fantastic sums of money for their expertise.” Lourd tells Lewis, “I read this book and I thought, My whole life is a lie, and everyone around me is facilitating this lie.” In June 2006, he quit and set up Lourd Capital Management, taking with him all but a handful of his 200 clients at A.G. Edwards.  Lewis reports that 2006 was, by far, the biggest year of Lourd’s career, and the assets under his management are up 40 percent; while Lourd is still making money, his purpose in life has been turned on its head. Investors used to come to him for tips. Now the same clients come to him so he can prevent them from listening to tips. Lourd’s biggest problem is dealing with new prospects. “They come in here, and their funds have underperformed the market by 300 basis points, and the first question out of their mouth is, ‘Who’s your guy?’ We have to reeducate them: There is no guy. The guy is the market. The guy is capitalism.”

Also in the December issue:

“Putin’s Power Grab"” (p. 194). Contributing writer James Verini reports how Russia shocked the West last year when it seized a majority stake in Sakhalin II, the world’s most expensive energy production and transportation project from Royal Dutch Shell. The Siberian island of Sakhalin sits above an estimated 90 trillion cubic feet of untapped natural gas and 12 billion barrels of crude oil.  Sakhalin II includes a pipeline that runs almost the entire length of the island, and, at more than $20 billion and counting, is the largest foreign investment ever made in Russia. Verini reports how, in late 2006, Shell agreed to sell a controlling stake to Gazprom, the Russian state-controlled gas conglomerate, which had not previously been involved. Shell was “encouraged” to do this, he reports, by the Kremlin. Critics of Russian president Vladimir Putin have decried the sale, calling it a shakedown. Russia provides Western Europe with a quarter of its gas and oil, Verini notes, writing, “Putin could flip a switch, and families from Paris to Milan would go to sleep with their coats on tonight.” Gazprom controls close to 90 percent of the Russian gas market and maintains the largest distribution system anywhere in the world—a 97,500-mile network of pipes that stretches from the Baltic Sea to the Pacific. In 2006, the Duma, the lower house of Russia’s Federal Assembly, passed a law essentially making Gazprom the only legal exporter of Russian natural gas. Gazprom claims that although half its shares are owned by the state, about 500,000 private investors own the rest, and Putin’s own stake in the company is a matter of speculation. “Putin is the C.E.O. of Gazprom,” a U.S. diplomat working in Russia tells Verini, who reports that the country’s energy economy has allowed Putin to exert an ever-tightening grip on Russia, creating what some fear may become a kind of totalitarian republic. “Most people don’t think that Gazprom has the technical or managerial skills to manage these projects,” a former embassy official tells Verini. “We’re trying to build this to Western standards,” says Steve Burt, a Sakhalin Energy manager, but “the Russians don’t have any of these standards—or any standards, really. You can see, every day, pipelines blowing up in Russia. There are whole areas of Russia contaminated from leakage. They have all the regulations. They’re just not using them.” Verini writes, “Russia’s fate is bound with Gazprom’s to a degree that’s hard to fathom in the West. …If Gazprom hit the skids, it would be cataclysmic for Russia.”

“Think Disruptive” (p. 170). Andy Grove, co-founder of Intel, has been working with his colleague at Stanford Graduate School of Business, Robert Burgelman, to examine how large companies can defeat the law of big numbers. “Successful businesses sooner or later encounter a situation in which the reward for their success becomes a punishment of sorts,” Grove writes. “The reward is that they get big. The punishment is that when they get big, it gets harder and harder for them to grow.” In looking at various companies that have been hindered by their own success, Grove and Burgelman found that, under certain conditions, a firm can create a new growth spurt for itself by entering an entirely different industry. The target industry must be stagnant and populated with firms that cling to doing business the way they always have. The corporation that enters this environment with an innovative product or service can shake up the status quo and reap big profits. The duo calls this phenomenon cross-boundary disruption. “I’m talking about established giants seeking to transform markets other than their own. It’s Apple jumping into music. It’s Wal-Mart entering health care. Or … it could be General Electric building an electric car and taking on the energy industry. These are companies big and powerful enough to solve intractable, industry-wide problems and produce lasting change,” Grove writes.

“Never Say Die” (p. 186). Staff writer Alexandra Wolfe investigates how hedge fund money is helping to legitimize research in extreme longevity, a field once relegated to the fringes of science. “The quest for immortality, or at least to live far longer than we ever have, isn’t new,” Wolfe writes. “What’s different now is that longevity research is attracting the attention of mainstream investors, including hedge fund managers and C.E.O.’s, who are casting their eyes toward a broad array of theories and regimens in hopes of extending their lives, thus giving them more quality time to spend with their fortunes.” But recent breakthroughs in genetics, stem cell research, cellular regeneration, cancer therapy, and bionic medicine have given new credence to longevity advocates, reinvigorating their ranks and luring serious types who might otherwise have been turned off by the field’s “weird science” aspect. Wolfe reports that Viacom chairman Sumner Redstone has declared that he plans to live at least 50 years beyond his current age of 84, with the help of a life-extending juice he drinks every day. British physician and longevitist Richard Reyes, whose influential acquaintances include American hedge fund manager Louis Bacon, has a client list of businesspeople happy to shell out $50,000 a year for his services. PayPal founder Peter Thiel recently pledged up to $3.5 million to an organization headed by the British longevity guru Aubrey De Grey, a Cambridge-educated Ph.D. who is experimenting with mice to see if the aging process can be reversed by cellular regeneration. Ellison Medical Foundation, financed by Oracle co-founder Larry Ellison, funds basic biomedical research into aging with an eye toward treating age-related diseases, though the organization adamantly distances itself from the notion that aging can be “cured.”

“Why He Went Nuclear” (p. 214). Before he was the infamous father of the “Islamic bomb,” A.Q. Khan was just another midlevel scientist working at a research job in Amsterdam. In an excerpt from The Nuclear Jihadist, to be published this month, authors Douglas Frantz and Catherine Collins tell the story of how Khan betrayed his employer and set out to create a worldwide bazaar in lethal weapons. “A.Q. Khan emerged as the father of the so-called Islamic bomb and mastermind of Pakistan’s nuclear-weapons program. He established a private network for smuggling bomb-building technology and equipment to Pakistan, and then he reversed the flow and sold the same lethal secrets to Iran, North Korea, Libya, and, international investigators suspect, at least one still-unknown customer,” they write. “For decades, the Central Intelligence Agency and European authorities watched as Khan stole the world’s most dangerous secrets and parlayed them into a global nuclear-weapons bazaar. Khan’s story remains in the news as the United States and other Western nations confront a defiant Iran over its nuclear ambitions, which have been nurtured by sophisticated technology courtesy of A.Q. Khan. In fact, should a rogue nation or terrorist group ever launch a nuclear attack, it is likely that the trail of destruction will lead back to Khan and his start at the lab in Amsterdam.”

“Trouble Sticks to Teflon Bob” (p. 85). Contributing editor John Cassidy examines how Robert Rubin, the economics guru of the Clinton administration, predicted Bush’s tax cuts would cause a disastrous deficit. And he was right—until he wasn’t. “During the Clinton administration, he championed spending restraint, tax increases for the wealthy, and deficit reduction, a policy stance that came to be known as Rubinomics,” Cassidy writes. “But now it appears the economy has thrived, despite Bush’s having done the opposite of what Rubin prescribed.  Does that mean that Rubin was wrong or that Bush was simply lucky?” Cassidy reports that Rubin believes the Bush administration has been very fortunate. “In his view, it’s only the Chinese buying of American Treasury bills and the unusually high corporate profits bringing in unexpectedly high tax revenues that have averted economic disaster,” Cassidy writes. “At some point, those trends will end, and large deficits will reemerge, forcing Washington to address tough challenges the Bush administration has ignored, such as reforming Social Security and Medicare - and the drift, inevitably, will once again favor Rubin.” Privately, Rubin has mentioned the possibility that history might soon repeat itself, Cassidy reports. “Circumstances change,” Rubin told an acquaintance recently. “That is the nature of the markets and the economy.”

 

“On the Razr’s Edge” (p. 210). Three years ago, Motorola C.E.O. Ed Zander engineered a sharp turnaround, introducing a line of hot-selling, drool-worthy mobile phones. But earlier this year, Motorola’s share price tumbled, and Zander got an unexpected call from Carl Icahn. Contributing editor Kevin Maney talks with Zander about how his company can get its cool back, what’s wrong with the iPhone, and what to do when Icahn’s on the line. Zander tells Maney, “Last December, we realized that the products we had weren’t what customers wanted, so we had to cut prices. That was a big hole in the January announcement,” at which point Icahn called Zander on his cell phone.  “Icahn’s team felt that money should be redistributed to the shareholders in order to get the stock up again. We didn’t think so. And we had a lot of pleasant meetings. … Carl is a very smart investor, but I’m not sure he has experience running companies.”

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