TMF Interview With Nasdaq
Vice Chairman Alfred Berkley
With David Gardner and Tom Gardner
November 16, 2000
The abbreviation "Nasdaq" has come to mean "high-tech" for many investors, and the association that bears the name and oversees the exchange doesn't shy away from the characterization. Tom and David Gardner discussed investing theory, selective disclosure, margin, and more with Nasdaq Vice Chairman Alfred Berkley during a November 4 airing of The Motley Fool Radio Show. Here is an edited transcript of their conversation.
Tom: Al, you are the keynote speaker at the Nasdaq 2000 Forum. What were you talking about this morning?
Berkley: It was an interesting morning for me. We talked a little bit about volatility in the market and some of the work we've been doing at Nasdaq with the Bios Group out in Santa Fe, New Mexico, looking at the market through the point of view of complexity science and the point of view of game theory. Turns out there are three games going on in the market all the time.
One of them is a game of chance, one of them is a game of skill, and one is a game of strategy. If you've ever had any operations research courses or game theory, you'll recognize those as the three different ways human beings interact with each other. We map those to investors for games of strategies, to speculators for games of skill, and to gamblers for games of chance. We've got all three interacting with each other in the market, and you better know which one you are.
Tom: Let me ask you, does any one of those three have an advantage over the other two?
Berkley: In my opinion, the investor has a dramatic advantage. The speculator is looking at what the crowd around them is doing and it turns out we behave as humans beings, when we are speculating, much like herds of wildebeest.
Tom: Let me guess -- I'm coming up with my own mathematics here for the fun of it. I'm guessing that the game of strategy, the investor, is more likely to beat the market's average. The speculator who is going with the crowd is probably going to track the market generally because they'll get too high in great times and to low in bad times. And the gambler will get perhaps negative returns as we've seen from a lot of day traders over the last decade.
Berkley: I think it's a good thesis. I would say that because of the transaction costs in the market, both speculators and gamblers will lose.
I would say that because of the transaction costs in the market, both speculators and gamblers will lose.
Tom: Let's take a 30-year-old who's put some money aside who began investing in early March of this year and is thinking 10, 15, 20 years forward with the investments they're making, but is somewhat shocked to see their portfolio down, perhaps as much as 30% or 40%, depending on what sorts of companies they were investing in. What would your suggestion be to them?
Berkley: Well, I have a 30-year-old child. My daughter Cary just started the business of the law and I've had this conversation with her, so I'm glad to take it on. I think that most people who are working full time at a job ought to have most of their assets in professionally managed mutual funds.
I think that someone who is 30 should take a very long-term view. They should put money in regularly -- that's the great secret to having wealth when you retire -- and they should do it with an aggressive growth fund that has a good record.
Now, many people are attracted to investing in individual stocks because it's fun, and there is nothing wrong with that. I do that myself. Most of what I have is in mutual funds because I have a full time job trying to help the Nasdaq team give you all a good market, but I enjoy investing in individual stocks and when I do it, I try to do it with a very, very specific objective in mind and some understanding of what that company is doing.
Tom: What do you think of the stock investor or the mutual fund investor -- primarily the stock investor -- investing in, let's say, some of Nasdaq's greatest companies, who is also investing on margin? Good idea or not?
Berkley: Well, I use margin a lot myself but I think it exacerbates your risk, particularly if you haven't thought through whether you are speculating or investing.
I look at a company that I want to have a long-term holding in. If it's making a 20% return on equity or a 15% to 18% return on equity and my cost of margin is 8% or 9%, I will let that ride, because on half the investment, I'm making the difference between what I'm paying and what they are earning.
Tom: And without any numbers available, your personal thesis on how many people who are using margin today as individual investors really understand the risk that they are taking?
Berkley: Ten percent.
Tom: So the majority who are out there speculating in a way that looked good to them perhaps in 1996, 1997 and 1998, but are perhaps getting a wake-up call in 2000.
Berkley: Yes. Margin cuts both ways.
Tom: Now this is our controversial zinger question and here it comes. The Nasdaq houses some of the world's most powerful companies: Cisco (Nadsaq: CSCO), Microsoft (Nasdaq: MSFT), Oracle (Nasdaq: ORCL), Sun Microsystems (Nasdaq: SUNW), Amgen (Nasdaq: AMGN), and a lot of other technology businesses. But the Nasdaq also, as you look across the many, many companies, has some smaller microcaps [stocks] over-the-counter. Why not focus more on quality in the Nasdaq than quantity and actually raise the listing requirements so that you have the top 400 companies or the top 200 companies but clear some of the bottom group out?
Berkley: Ah, the easy, paternalistic answer: "Let me protect you from something."
We're not into that. We're into operating a free market. Who are we to say as bureaucrats whether a company is good enough or not? I used an example in the session this morning -- the classic example of bureaucratic decision-making when, in 1983-ish, the great Commonwealth of Massachusetts, totally different administration than we have now, decided in its infinite wisdom that no citizens in the state of Massachusetts could invest in that fly-by-night Apple Computer (Nasdaq: AAPL).
That's the kind of decision we don't want to be making and it's one of the fundamental decisions that [founding Nasdaq President] Gordon Macklin made when the Nasdaq was established: It's the investor's job. You have a chance to make it or you have a chance to break it. We want to give you a level playing field to have that happen.
Most people who are working full time at a job ought to have most of their assets in professionally managed mutual funds.
Tom: Let me ask the ultimate free market question, then. Why have any listing requirements at all?
Berkley: We do find, as a matter of policy, that we have to protect the reputation of the market a bit. I talked about this philosophical dichotomy this morning. Our instincts would be to have no listing requirements at all. But there's so much money involved in America's markets that on the margin there are just enough crooks to need us to have something that says "This is a real company."
Now you don't have to have earnings but you might have to have assets or market cap. You don't have to have assets, but you need to have earnings. Some combination of nine variables on our website will show what we think might give you some assertion that this is a real company.
David: Al, as I listen to you talk I'm picking up some of your vision for Nasdaq. I heard free market, I heard "We're not going to regulate." Let me ask you, what does the Nasdaq brand stand for in your mind?
Berkley: We know exactly what the Nasdaq brand stands for. It stands for growth and innovation and we want to be the market in people's minds where you come for growing and innovative companies. Now let me correct you on one thing: We do regulate, very aggressively. We regulate broker-dealers through [National Association of Securities Dealers] regulation and we regulate them in three dimensions.
They can't just say anything to you just to buy stock. They can't just trade ahead of you -- there are trading rules and they have to have a certain amount of capital [so you can] be sure when you send your money or stock certificate in, that they are still there when you clear. So we have sales practices, we have trading practices and we have capital adequacy that we regulate. The SEC regulates the disclosure of the company's information and we'll step in and regulate the other three that I mentioned over and above that if necessary.
Tom: Let me ask you about regulation and disclosure since we've talked a lot about that subject on this show and on our website in the last six years. What do you think of the SEC's full disclosure policy that just went into effect? How is it affecting the Nasdaq marketplace and are you a proponent of it?
Berkley: We are certainly a proponent of everybody being able to have accurate and fair information. I think the public policy issue, which I think you're hitting on and which everybody is addressing now, is "Will there be unintended consequences?" By and large, a large part of this debate centers around what is material... Everybody deserves access to material information.
The economics of the business says that we're much more likely to have better analysis on the very large companies. The question is whether our research and analysts can afford to do research on the smaller companies. Now we have some alternative sources of information, including your programs, and we have lots of magazines that have come up and we have lots of chat rooms and so forth that have come up to provide alternate information.
We do think there is a value for companies to be able to communicate to analysts of that information, not scooping front runners of that information. We would like to see more analysis, more thought about the competitive interaction of companies. In other words, we would like to see individual investors have access to the same kind of hand-tinkered insights that the large institutions get in that very manual labor intensive effort called Wall Street research.