It's that time of year in the US Northeast where the weather is changing from bitter cold to more bearable temperatures. Unfortunately, something about the shift in weather seems to make people more susceptible to coughs and colds. I readily confess to being a bit of a germaphobe, so it's hard for me not to cringe when people are coughing or sneezing around me. It certainly seems like I use even more hand sanitizer than normal this time of year. But sometimes I meet people who are even more militant about hygiene:
Me: *Cough*
Them: "ARE YOU SICK?"
Me: "No, I'm choking on something."
Them: "Oh, that's fine then."
Charming, to say the least! Lack of empathy aside, it struck me that you can really take the whole hygiene thing too far. No-one wants to get sick, but there's a point when it become unhealthy to obsess over every sniffle around you, and when hyper-vigilance probably detracts from your overall health and well-being. This is especially true since common coughs and colds, while unpleasant, are usually short-lived.
Much of this applies to investing. No-one wants to lose money, but it's bound to happen at some point all the same. Despite the analyst's best efforts, markets occasionally sell off, taking good companies with them. Maybe a company's fundamentals change. Or sometimes - again, despite one's best efforts - the original analysis is proven flawed. There is an optimal level of insecurity analysis that should occur when investments go sour: too little, and you risk missing important feedback; too much, and you turn yourself into the very bag of nerves that characterizes Mr. Market.
The second part of this is ensuring that you can bounce back from losses, whether temporary or permanent. At a recent investor presentation, ExxonMobil CEO Rex Tillerson said that in his 41 years in the oil business, he hadn't learned any more about his ability to foresee the price of oil. Instead, he has learned more about how to deal with the market's gyrations. Similarly, a robust investing philosophy ensures that no one event can knock you out of the game, as unpredictable as that event may be. Reasonable diversification is one solution. Avoiding leverage is another. I'm a huge fan of the Buffett admonition: "If you're smart, you don't need it, and if you're dumb, you have no business using it."
The final piece of this is committing to learning from losses, whether temporary or permanent. Nassim Taleb coined the term "antifragility" to describe things that gain from disorder. This is an even higher bar than merely being robust to disorder. Few securities, other than US Treasury bonds, seem to meet this criterion. Nevertheless, the investor who learns from mistakes over time is in fact benefiting from that disorder, and is thus long-term antifragile.
There's a saying: "If you want peace, prepare for war." I happen to think that rings true, even if it's often misused by people who have no desire for peace. I would paraphrase it this way: if you want profit, prepare for loss. Recognize that losses will happen at some point, and (1) prepare to approach them with equanimity and clear thinking, (2) prepare so that losses will be manageable, and (3) prepare to learn from the episode. This is the foundation for dealing with, and ultimately benefiting from, adversity in the investing arena.
Saturday, March 19, 2016
Saturday, March 5, 2016
Berkshire Hathaway: Come For The Returns, Stay For The Philosophy
The release of Berkshire Hathaway's annual letter to shareholders is always a wonderful opportunity to learn from Warren Buffett. As usual, the letter has already been picked over by the media and blogosphere, but I wanted to record some of my own thoughts. This post can be read in tandem with an older piece I did on Buffett's shareholder essays.
1) Simplicity. Buffett's letters are remarkable for their clarity. This is extremely unusual in a world where investment managers often aim to wow their clients with technical sophistication and jargon. Instead, with Buffett, we are left with the impression of someone who is able to take the complexities of investing and cut right to the core of the problem. Here's one example: Buffett notes that he and Munger expect Berkshire's normalized earning power to increase every year. This is a simple statement, but powerful in conveying that every investor can dramatically simplify his life and improve his returns by focusing on his portfolio's normalized earning power, rather than explicitly trying to generate high returns.
2) Dealing from strength. Buffett highlights Berkshire portfolio companies that pressed their advantage over competitors by making investments in new equipment. He notes, "Dealing from strength is one of Berkshire's enduring advantages." The source of strength is having dry powder when others don't, which requires patience and discipline. Buffett famously said, "Lethargy bordering on sloth is the cornerstone of our investment style." Similarly, there's a Munger quote that I love: "We don't mind long periods in which nothing happens...You look at [Buffett's] schedule sometimes and there's a haircut. Tuesday, haircut day." Instead of fretting about his portfolio, Buffett reveals that he spends ten hours a week playing bridge online - one way to combat boredom, which I've referred to in the past as the third emotion of investing. But of course the flipside of this is being aggressive when opportunities arise, and when competitors are unable or unwilling to act.
Obviously, no-one sets out hoping to operate from a position of weakness, but prioritizing it as a strategic goal helps. As I've noted before, one of the mortal sins of investing is compounding earlier errors, and this typically happens when one is operating from a position of weakness and reacting to events in a haphazard fashion.
3) Business quality. For someone who is known as the doyen of value investing, Buffett makes surprisingly little mention of the prices paid for the businesses he purchased. Rather, he focuses on their quality. I'm not suggesting that Buffett ignores price; his discussion of insurance underwriting reveals, as always, a keen grasp of risk and reward, as does a note of caution on prices paid for bolt-on acquisitions. Nevertheless, his emphasis on quality, rather than cheapness, is telling. Despite his ability to be patient, Buffett is clearly not just waiting for cyclical lows. Unlike most investors who agonize endlessly over whether equities are cheap, Buffett continues to pour money into investments that he believes will pay off over the long run (Precision Castparts, Wells Fargo, Coca-Cola).
4) Optimism. We're bombarded by soundbites from pundits (and truth be told, investors) who usually appear smarter for being negative. Buffett, on the other hand, comes across as unusually optimistic (a view shared by his friend, Bill Gates). Having a long-term horizon helps, but Buffett's success is supported by Dimson, Marsh and Staunton, who lauded the "Triumph of the Optimists".
5) Come for the returns, stay for the philosophy. I'm guessing that most people start following Buffett and Munger because of the prospect of mimicking their investment success. I'm also willing to guess that most of those who stick around do so because they're attracted by the duo's integrity and life philosophy. In this year's letter, Buffett wrote, "There is no one more important to us than the shareholder of limited means who trusts us with a substantial portion of his savings." In a world of relentless asset-gathering masquerading as investing, Buffett's easy manner is why I, like many others, look forward to his letter year after year.
1) Simplicity. Buffett's letters are remarkable for their clarity. This is extremely unusual in a world where investment managers often aim to wow their clients with technical sophistication and jargon. Instead, with Buffett, we are left with the impression of someone who is able to take the complexities of investing and cut right to the core of the problem. Here's one example: Buffett notes that he and Munger expect Berkshire's normalized earning power to increase every year. This is a simple statement, but powerful in conveying that every investor can dramatically simplify his life and improve his returns by focusing on his portfolio's normalized earning power, rather than explicitly trying to generate high returns.
2) Dealing from strength. Buffett highlights Berkshire portfolio companies that pressed their advantage over competitors by making investments in new equipment. He notes, "Dealing from strength is one of Berkshire's enduring advantages." The source of strength is having dry powder when others don't, which requires patience and discipline. Buffett famously said, "Lethargy bordering on sloth is the cornerstone of our investment style." Similarly, there's a Munger quote that I love: "We don't mind long periods in which nothing happens...You look at [Buffett's] schedule sometimes and there's a haircut. Tuesday, haircut day." Instead of fretting about his portfolio, Buffett reveals that he spends ten hours a week playing bridge online - one way to combat boredom, which I've referred to in the past as the third emotion of investing. But of course the flipside of this is being aggressive when opportunities arise, and when competitors are unable or unwilling to act.
Obviously, no-one sets out hoping to operate from a position of weakness, but prioritizing it as a strategic goal helps. As I've noted before, one of the mortal sins of investing is compounding earlier errors, and this typically happens when one is operating from a position of weakness and reacting to events in a haphazard fashion.
3) Business quality. For someone who is known as the doyen of value investing, Buffett makes surprisingly little mention of the prices paid for the businesses he purchased. Rather, he focuses on their quality. I'm not suggesting that Buffett ignores price; his discussion of insurance underwriting reveals, as always, a keen grasp of risk and reward, as does a note of caution on prices paid for bolt-on acquisitions. Nevertheless, his emphasis on quality, rather than cheapness, is telling. Despite his ability to be patient, Buffett is clearly not just waiting for cyclical lows. Unlike most investors who agonize endlessly over whether equities are cheap, Buffett continues to pour money into investments that he believes will pay off over the long run (Precision Castparts, Wells Fargo, Coca-Cola).
4) Optimism. We're bombarded by soundbites from pundits (and truth be told, investors) who usually appear smarter for being negative. Buffett, on the other hand, comes across as unusually optimistic (a view shared by his friend, Bill Gates). Having a long-term horizon helps, but Buffett's success is supported by Dimson, Marsh and Staunton, who lauded the "Triumph of the Optimists".
5) Come for the returns, stay for the philosophy. I'm guessing that most people start following Buffett and Munger because of the prospect of mimicking their investment success. I'm also willing to guess that most of those who stick around do so because they're attracted by the duo's integrity and life philosophy. In this year's letter, Buffett wrote, "There is no one more important to us than the shareholder of limited means who trusts us with a substantial portion of his savings." In a world of relentless asset-gathering masquerading as investing, Buffett's easy manner is why I, like many others, look forward to his letter year after year.
Saturday, February 27, 2016
Adventures In The Bargain Bin
I was at my local grocery store last week, and noticed that salmon fillets were 50% off. I stood in front of the display for a good two minutes, racked with indecision. I like salmon. It's usually more expensive than other meat, and it's rare to see it on sale. I vaguely recalled a Buffett quote about being happy to buy merchandise when it went on sale. And yet, I just couldn't bring myself to buy it. The fact that salmon is rarely on sale suggested to me it might not have been the freshest fish. Also, that store doesn't have the best reputation for selling the freshest meat & produce. And so I walked away.
I've written before that it's one thing to be a value investor, and another thing to be a cheapskate. But the salmon episode got me thinking: why couldn't I pull the trigger on what appeared to be something on sale? Two issues seemed key:
1) I couldn't be sure of the fish's quality. I looked up the Buffett quote when I got home: "Whether we're talking about socks or stocks, I like buying quality merchandise when it's marked down." The word "quality" is very important in that quote. The salmon price mark-down was in fact signalling something about the quality of the merchandise, and I didn't like the signal I was getting.
2) The consequences of being wrong could be deeply unpleasant. If you buy a cheap pair of socks and discover the elastic is already worn, the worst that happens is that you've wasted a few dollars and have to toss the socks in the trash. Not true of food, though: if the salmon had been less than fresh, it probably wouldn't have been life-threatening, but could easily have made me miserable for a day or two!
My adventures in the bargain bin have some clear implications for investing. Value-oriented investors are often drawn to stocks that have been beaten up, but it requires some genuine judgment to assess if price declines are warranted. Similarly, they may shy away from companies trading at lofty multiples, believing that valuations are excessive, even if the underlying company has excellent fundamentals. As with fish, this judgment depends on accurately evaluating the quality of the stocks and the consequences of being wrong.
Assessing quality is aided by the following:
a) Deep fundamental research. This should be a prerequisite, of course, but without this kind of work, it becomes far too tempting to use price as a signal of quality.
b) Stress testing/scenario analysis to understand if quality is genuine. I'm reminded of a great Ben Graham quote: "The risk of paying too high a price for good-quality stocks - while a real one - is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to "earning power" and assume that prosperity is synonymous with safety." I suspect there are many investors in the natural resources complex who have become painfully aware of the truth of Graham's words over the past 12-18 months.
c) Long ownership or familiarity with a company/industry. Most people value a long-term investment horizon because when done right, it is easier to implement and more profitable than a trading strategy. As Phil Fisher wrote, "Finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colorful practice of trying to buy them cheap and sell them dear." This long-term ownership, however, serves another important purpose. Over time, the analyst has the opportunity to observe the company through different economic conditions, and develops an understanding of its economic sensitivity. Following a business for a long time reduces the risk that one will mistake cyclical earnings for true earnings power.
Finally, it's worth noting that one's willingness to take a risk should depend on the severity of a negative outcome. Socks with loose elastic are harmless, rotten fish less so. As Sanjay Bakshi points out in a wonderful speech, the eventual consequences of risk-seeking or risk-blind behaviour can be dire in many aspects of life. This is certainly true for one's long-term financial well-being. Sometimes, when something smells fishy, it's best to just walk away.
I've written before that it's one thing to be a value investor, and another thing to be a cheapskate. But the salmon episode got me thinking: why couldn't I pull the trigger on what appeared to be something on sale? Two issues seemed key:
1) I couldn't be sure of the fish's quality. I looked up the Buffett quote when I got home: "Whether we're talking about socks or stocks, I like buying quality merchandise when it's marked down." The word "quality" is very important in that quote. The salmon price mark-down was in fact signalling something about the quality of the merchandise, and I didn't like the signal I was getting.
2) The consequences of being wrong could be deeply unpleasant. If you buy a cheap pair of socks and discover the elastic is already worn, the worst that happens is that you've wasted a few dollars and have to toss the socks in the trash. Not true of food, though: if the salmon had been less than fresh, it probably wouldn't have been life-threatening, but could easily have made me miserable for a day or two!
My adventures in the bargain bin have some clear implications for investing. Value-oriented investors are often drawn to stocks that have been beaten up, but it requires some genuine judgment to assess if price declines are warranted. Similarly, they may shy away from companies trading at lofty multiples, believing that valuations are excessive, even if the underlying company has excellent fundamentals. As with fish, this judgment depends on accurately evaluating the quality of the stocks and the consequences of being wrong.
Assessing quality is aided by the following:
a) Deep fundamental research. This should be a prerequisite, of course, but without this kind of work, it becomes far too tempting to use price as a signal of quality.
b) Stress testing/scenario analysis to understand if quality is genuine. I'm reminded of a great Ben Graham quote: "The risk of paying too high a price for good-quality stocks - while a real one - is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to "earning power" and assume that prosperity is synonymous with safety." I suspect there are many investors in the natural resources complex who have become painfully aware of the truth of Graham's words over the past 12-18 months.
c) Long ownership or familiarity with a company/industry. Most people value a long-term investment horizon because when done right, it is easier to implement and more profitable than a trading strategy. As Phil Fisher wrote, "Finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colorful practice of trying to buy them cheap and sell them dear." This long-term ownership, however, serves another important purpose. Over time, the analyst has the opportunity to observe the company through different economic conditions, and develops an understanding of its economic sensitivity. Following a business for a long time reduces the risk that one will mistake cyclical earnings for true earnings power.
Finally, it's worth noting that one's willingness to take a risk should depend on the severity of a negative outcome. Socks with loose elastic are harmless, rotten fish less so. As Sanjay Bakshi points out in a wonderful speech, the eventual consequences of risk-seeking or risk-blind behaviour can be dire in many aspects of life. This is certainly true for one's long-term financial well-being. Sometimes, when something smells fishy, it's best to just walk away.
Saturday, February 20, 2016
What Manchester United Can Learn from Yahoo
These are dark days for Manchester United fans. Darkness is relative, of course - the club remains an icon of sporting history, with a passionate fan base second to none. But, as the line from James goes, "if I hadn't seen such riches, I could live with being poor." The team's desperately abject performance in a loss to FC Midtjylland underscored the poverty fans have become accustomed to. For United fans, there is perhaps no greater fear than the looming possibility that a cycle of greatness has ended, and the club is on its way to become the new Liverpool - a mighty club rendered irrelevant, forced to watch as its great rivals chip away at its success.
I spend a lot of my professional life trying to understand when sentiment has swung to extremes in financial markets, trying to be even-keeled when panic appears at odds with positive fundamentals. In an age when sports fans take to Twitter with vicious speed, demanding management and personnel changes at every little blip, my attempts to be sanguine are frequently challenged. While Man City's capture of Pep Guardiola is a knife to United's ambitions, I do think some are being too quick to anoint Guardiola's future City side as champions. But sometimes public opinion is spot on. I can't really explain why the Louis van Gaal era has shuddered to a halt so abruptly (to be honest, it never really gathered steam, despite the occasional flicker of promise). But it's safe to say the last few months have been truly hard to watch, both as a Manchester United fan, and a fan of the game. An excellent, if depressing, post by Paul Gunning perfectly captured my sentiments. And as the spectre of "Liverpoolisation" lurks ominously, I thought this week of another fallen giant of yore - Yahoo.
I'm not a tech analyst, so I haven't followed the demise of Yahoo in gruesome detail. All you need to know, however, is that the stock market currently ascribes negative value to Yahoo's core business. If that sounds crazy, here's a little piece by the New York Times explaining what that means. Basically, the stock market is saying that the only thing valuable about Yahoo is its stake in Chinese e-commerce behemoth Alibaba. Even if the market has gotten the valuation wrong, it's a damning indictment of Yahoo.
Where did Yahoo go wrong? Venture capitalist Paul Graham wrote a piece in 2010 taking a stab at the root causes. I highly recommend it - it's both short and fascinating. He identifies two major issues, easy money, and Yahoo's ambivalence about being a technology company.
First, the curse of easy money: "By 1998, Yahoo was the beneficiary of a de facto Ponzi scheme. Investors were excited about the Internet. One reason they were excited was Yahoo's revenue growth. So they invested in new Internet startups. The startups then used the money to buy [banner] ads on Yahoo to get traffic. Which caused yet more revenue growth for Yahoo, and further convinced investors the Internet was investing in." The story ends with Yahoo neglecting its search business because of its booming banner ad business. What it failed to realize was that the search business was far more sustainable, and that Google was eating its lunch there.
This leads to Graham's second point, which was that Yahoo was ambivalent about being a technology company. Yahoo insisted on calling itself a media company, with negative consequences. "What Yahoo really needed to be was a technology company, and by trying to be something else, they ended up being something that was neither here nor there. That's why Yahoo as a company has never had a sharply defined identity...The worst consequence of trying to be a media company was that they didn't take programming seriously enough... In technology, once you have bad programmers, you're doomed."
Which brings us back to United. The club has increasingly positioned itself as a "global brand". Similar to Yahoo's loss of identity, Manchester United seems to have forgotten that it is first and foremost a football club. CEO Ed Woodward has proven himself adept at signing bumper commercial deals for the club. Yet the tail seems to be wagging the dog more and more. Recent reports suggest that Wayne Rooney could be on his way to China, assuming the club can "offset his potential departure with an eminent replacement their global partners would approve of to promote their products." Pause and let that sink in for a second. If that is true, it is diabolically misguided. The decision to replace a senior player should be driven entirely by footballing considerations. Yet Woodward's apparent obsession with "marquee players" seems to be spurred by commercial incentives, and possibly his desire to solidify his reputation as a deal-maker. A bit too much of the investment banker, then, about Woodward.
Perhaps easy money has tainted United the way it tainted Yahoo. The circumstances are different, of course: this isn't the Internet bubble, and I'm sure Woodward works very hard to sign those commercial deals. But the focus on "global superstars" worthy of a "global brand" is unsustainable. Commercial partners appear to be salivating to capitalize on United's global cachet, but that won't last long if the club's leadership neglects the footballing core of the club. Furthermore, rather than hawking the brand at every turn, I believe it makes more sense to think of Manchester United as a luxury brand. The best luxury brands are obsessed with maintaining their aura, which is their greatest asset. Similarly, the fanatical support of a global fan base is a valuable asset that should be treated with the utmost care. I cringe when United players are forced to promote movies on their Twitter feeds. Don't get me wrong; I of all people understand there are commercial considerations. But Manchester United the commercial juggernaut is at serious risk of killing the golden goose that is Manchester United the football club that produced Charlton, Best and Law.
Ultimately, there is only one group who can change the club's direction, and that is the Glazer family, who control its ownership. I've cautioned in the past about blaming the Glazers for all of United's ill fortune, while being critical of the club's ownership structure. But we've reached a crucial juncture for the club. While the Glazers may never understand the importance of the club to fans around the world, I can only hope they have an interest in protecting the long-term value of their investment. If they fail to grasp the seriousness of the situation, it may be a long time yet before United fans can reclaim the riches of the Alex Ferguson era.
I spend a lot of my professional life trying to understand when sentiment has swung to extremes in financial markets, trying to be even-keeled when panic appears at odds with positive fundamentals. In an age when sports fans take to Twitter with vicious speed, demanding management and personnel changes at every little blip, my attempts to be sanguine are frequently challenged. While Man City's capture of Pep Guardiola is a knife to United's ambitions, I do think some are being too quick to anoint Guardiola's future City side as champions. But sometimes public opinion is spot on. I can't really explain why the Louis van Gaal era has shuddered to a halt so abruptly (to be honest, it never really gathered steam, despite the occasional flicker of promise). But it's safe to say the last few months have been truly hard to watch, both as a Manchester United fan, and a fan of the game. An excellent, if depressing, post by Paul Gunning perfectly captured my sentiments. And as the spectre of "Liverpoolisation" lurks ominously, I thought this week of another fallen giant of yore - Yahoo.
I'm not a tech analyst, so I haven't followed the demise of Yahoo in gruesome detail. All you need to know, however, is that the stock market currently ascribes negative value to Yahoo's core business. If that sounds crazy, here's a little piece by the New York Times explaining what that means. Basically, the stock market is saying that the only thing valuable about Yahoo is its stake in Chinese e-commerce behemoth Alibaba. Even if the market has gotten the valuation wrong, it's a damning indictment of Yahoo.
Where did Yahoo go wrong? Venture capitalist Paul Graham wrote a piece in 2010 taking a stab at the root causes. I highly recommend it - it's both short and fascinating. He identifies two major issues, easy money, and Yahoo's ambivalence about being a technology company.
First, the curse of easy money: "By 1998, Yahoo was the beneficiary of a de facto Ponzi scheme. Investors were excited about the Internet. One reason they were excited was Yahoo's revenue growth. So they invested in new Internet startups. The startups then used the money to buy [banner] ads on Yahoo to get traffic. Which caused yet more revenue growth for Yahoo, and further convinced investors the Internet was investing in." The story ends with Yahoo neglecting its search business because of its booming banner ad business. What it failed to realize was that the search business was far more sustainable, and that Google was eating its lunch there.
This leads to Graham's second point, which was that Yahoo was ambivalent about being a technology company. Yahoo insisted on calling itself a media company, with negative consequences. "What Yahoo really needed to be was a technology company, and by trying to be something else, they ended up being something that was neither here nor there. That's why Yahoo as a company has never had a sharply defined identity...The worst consequence of trying to be a media company was that they didn't take programming seriously enough... In technology, once you have bad programmers, you're doomed."
Which brings us back to United. The club has increasingly positioned itself as a "global brand". Similar to Yahoo's loss of identity, Manchester United seems to have forgotten that it is first and foremost a football club. CEO Ed Woodward has proven himself adept at signing bumper commercial deals for the club. Yet the tail seems to be wagging the dog more and more. Recent reports suggest that Wayne Rooney could be on his way to China, assuming the club can "offset his potential departure with an eminent replacement their global partners would approve of to promote their products." Pause and let that sink in for a second. If that is true, it is diabolically misguided. The decision to replace a senior player should be driven entirely by footballing considerations. Yet Woodward's apparent obsession with "marquee players" seems to be spurred by commercial incentives, and possibly his desire to solidify his reputation as a deal-maker. A bit too much of the investment banker, then, about Woodward.
Perhaps easy money has tainted United the way it tainted Yahoo. The circumstances are different, of course: this isn't the Internet bubble, and I'm sure Woodward works very hard to sign those commercial deals. But the focus on "global superstars" worthy of a "global brand" is unsustainable. Commercial partners appear to be salivating to capitalize on United's global cachet, but that won't last long if the club's leadership neglects the footballing core of the club. Furthermore, rather than hawking the brand at every turn, I believe it makes more sense to think of Manchester United as a luxury brand. The best luxury brands are obsessed with maintaining their aura, which is their greatest asset. Similarly, the fanatical support of a global fan base is a valuable asset that should be treated with the utmost care. I cringe when United players are forced to promote movies on their Twitter feeds. Don't get me wrong; I of all people understand there are commercial considerations. But Manchester United the commercial juggernaut is at serious risk of killing the golden goose that is Manchester United the football club that produced Charlton, Best and Law.
Ultimately, there is only one group who can change the club's direction, and that is the Glazer family, who control its ownership. I've cautioned in the past about blaming the Glazers for all of United's ill fortune, while being critical of the club's ownership structure. But we've reached a crucial juncture for the club. While the Glazers may never understand the importance of the club to fans around the world, I can only hope they have an interest in protecting the long-term value of their investment. If they fail to grasp the seriousness of the situation, it may be a long time yet before United fans can reclaim the riches of the Alex Ferguson era.
Friday, February 5, 2016
Relationships as Emotional & Intellectual Diversification
In a recent post, I discussed some strategies for dealing
with volatility in financial markets. I was reading a blog post by Robin Rifkin
this week, and realized that I’d focused exclusively on what one could do at
the individual level. Reading Rifkin, it became clear that a strategy I’d
missed was to surround oneself with people who were able to be calm in the face
of market vicissitudes. Finding a community of thoughtful investors should
certainly be a priority – and this includes both the living and the “eminent
dead”, as Charlie Munger calls them.
I almost wrote about finding a community of “like-minded investors”, though, and that struck me as a dangerous turn of phrase. I’ve written before about the risks of dogmatism and herding. In some ways, portfolio theory offers a useful analogy. A portfolio is improved by including assets that are uncorrelated. Similarly, one’s emotional and intellectual life is improved by diversity (within reason, of course. In a portfolio, you don’t want lack of correlation for its own sake – naturally, you want assets with positive future returns. In life, people who offer emotional and intellectual diversity may have other flaws that make it less worthwhile to associate with them. And of course the analogy has its limits. In portfolio theory, the Holy Grail is finding negatively correlated assets. If I had a friend who was delirious happy when I was very sad, I’d find that either rude or downright bizarre!)
Friday, January 22, 2016
You Are Not Your Investments
Have you ever noticed that parents, especially those with small children, can be incredibly touchy? Reprimand their kids, and they quickly get huffy because they think you're criticizing their parenting indirectly.
People are the same about investments. Bring up an investment that's gone badly, and 9 out of 10 investors quickly get very defensive. Same story - criticize the investment, and you're basically criticizing them.
It's a natural reaction. In an old post, I called it a symbolic interactionist approach to investments. Humans act toward things on the basis of the meanings they ascribe to those things. The meaning of such things is derived from the social interaction that one has with others and society. Our investment decisions are tied up with our self-worth as investors, and our wealth is joined at the hip to our perception of social status.
But it's the wrong reaction. Jerry Goodman, aka Adam Smith, wrote about this in The Money Game. "A stock is, for all practical purposes, a piece of paper that sits in a bank vault. Most likely you will never see it. It may or may not have an Intrinsic Value; what it is worth on any given day depends on the confluence of buyers and sellers that day. The most important thing to realize is simplistic: The stock doesn't know you own it. All those marvelous things, or those terrible things, that you feel about a stock, or a list of stocks, or an amount of money represented by a list of stocks, all of these things are unreciprocated by the stock or the group of stocks. You can be in love if you want to, but that piece of paper doesn't love you, and unreciprocated love can turn into masochism, narcissism, or, even worse, market losses and unreciprocated hate."
You are not your investments. Thinking otherwise puts us at risk of committing a mortal sin of investing, if we allow defensiveness to cloud our scrutiny of a prior decision.
And by the way, the same logic should apply when your investments are doing great. Congratulations on the victory - but you're still not your investments.
People are the same about investments. Bring up an investment that's gone badly, and 9 out of 10 investors quickly get very defensive. Same story - criticize the investment, and you're basically criticizing them.
It's a natural reaction. In an old post, I called it a symbolic interactionist approach to investments. Humans act toward things on the basis of the meanings they ascribe to those things. The meaning of such things is derived from the social interaction that one has with others and society. Our investment decisions are tied up with our self-worth as investors, and our wealth is joined at the hip to our perception of social status.
But it's the wrong reaction. Jerry Goodman, aka Adam Smith, wrote about this in The Money Game. "A stock is, for all practical purposes, a piece of paper that sits in a bank vault. Most likely you will never see it. It may or may not have an Intrinsic Value; what it is worth on any given day depends on the confluence of buyers and sellers that day. The most important thing to realize is simplistic: The stock doesn't know you own it. All those marvelous things, or those terrible things, that you feel about a stock, or a list of stocks, or an amount of money represented by a list of stocks, all of these things are unreciprocated by the stock or the group of stocks. You can be in love if you want to, but that piece of paper doesn't love you, and unreciprocated love can turn into masochism, narcissism, or, even worse, market losses and unreciprocated hate."
You are not your investments. Thinking otherwise puts us at risk of committing a mortal sin of investing, if we allow defensiveness to cloud our scrutiny of a prior decision.
And by the way, the same logic should apply when your investments are doing great. Congratulations on the victory - but you're still not your investments.
Saturday, January 16, 2016
Mortal and Venial Sins in Investing
Financial markets have been roiled in 2016 on fears that China's economy continues to slow, and that the Fed will pursue a more hawkish tightening path than anticipated (the two are related, indirectly by the Fed's status as a monetary superpower, and directly by the RMB's link to the dollar). It has once again been a time to reflect on the challenges a fundamental investor faces. Macroeconomic concerns are hard to weigh when you're considering places like the US, and considerably more so when you're trying to assess an opaque economy in transition like China. So should an investor simply throw his hands up in the air?
I see a few potential strategies.
1. Learn all you can about macro. In his outstanding paper "Investing in the Unknown and Unknowable", Richard Zeckhauser notes the outsize returns to investors who can marshal complementary skills. Being a sophisticated macro observer has always seemed to me one such complementary skill. Some of the greatest trades of all time incorporate macro elements, whether intended or not. But I suggest with this a fair amount of trepidation. First, much of macro is unpredictable, and the product of a complex adaptive system, so it seems like a poor use of time trying to analyze it. Second, even where macro knowledge is helpful, there is a trade-off of time spent on macro analysis vs. asset-level analysis (such as knowing more about a company whose stock you own). Third, an excessive focus on macro fluctuations can lead to distraction from long-term trends, and prevent fundamental investors from appreciating the positive outlook for assets. So, perhaps the best idea is to focus on understanding the long-term drivers of economic growth, and to avoid being swept up by emotion during cyclical booms and busts.
2. Invest in assets that are relatively insensitive to economic fluctuations. There are two variants of this strategy. The first is to invest in assets whose prices are relatively stable. This will likely lead an investor into low return strategies like investing in government bonds. For obvious reasons, I don't recommend this, even if it will help you sleep better at night! The second variant is to look for assets whose prospects are relatively bounded in a variety of economic scenarios (note there is often a great deal of overlap between these two variants: it is precisely their occasional divergence that is worth exploiting). The traditional version of this is to invest in various types of utilities. But there are obviously many high quality businesses out there who are resilient to most economic downturns, through a combination of competitive positioning and financial strength. These businesses generally trade at premium valuations (i.e. with low implied returns) for that reason, so when they go on sale, it's best to be prepared to act swiftly.
3. Be realistic. Understand that there will be ups and downs in any portfolio. Just as important, one has to differentiate between forgivable and unforgivable mistakes. Or, to draw a parallel to Roman Catholicism, we should differentiate between venial and mortal sins in investing. Charlie Munger has a great quote: "I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn." But there's a limit to how harsh we should be with ourselves. I'm constantly wary of being a pattern-seeking, story-telling animal. It's okay not to know whether Chinese growth will be 3% or 6%. It is much less okay to lose money on a company that is modestly cheap if Chinese growth is 6% and in dire straits if growth is 3%.
If I had to highlight one unforgivable sin in investing, it is getting swept up by emotion at market tops or bottoms (only identifiable in retrospect, unfortunately). But what's worse is that we have a tendency to compound these errors. It is really, really not okay to lose sight of the long-term prospects of a wonderful business, sell one's stake in that business, and compound that error by refusing to buy at a higher price. So, if you make a mistake, so be it - wipe the slate clean, lest a venial sin turn into a mortal one.
I wish all readers a happy, productive and - just maybe - sin-free 2016.
P.S. John Huber has an excellent post touching on some similar themes.
I see a few potential strategies.
1. Learn all you can about macro. In his outstanding paper "Investing in the Unknown and Unknowable", Richard Zeckhauser notes the outsize returns to investors who can marshal complementary skills. Being a sophisticated macro observer has always seemed to me one such complementary skill. Some of the greatest trades of all time incorporate macro elements, whether intended or not. But I suggest with this a fair amount of trepidation. First, much of macro is unpredictable, and the product of a complex adaptive system, so it seems like a poor use of time trying to analyze it. Second, even where macro knowledge is helpful, there is a trade-off of time spent on macro analysis vs. asset-level analysis (such as knowing more about a company whose stock you own). Third, an excessive focus on macro fluctuations can lead to distraction from long-term trends, and prevent fundamental investors from appreciating the positive outlook for assets. So, perhaps the best idea is to focus on understanding the long-term drivers of economic growth, and to avoid being swept up by emotion during cyclical booms and busts.
2. Invest in assets that are relatively insensitive to economic fluctuations. There are two variants of this strategy. The first is to invest in assets whose prices are relatively stable. This will likely lead an investor into low return strategies like investing in government bonds. For obvious reasons, I don't recommend this, even if it will help you sleep better at night! The second variant is to look for assets whose prospects are relatively bounded in a variety of economic scenarios (note there is often a great deal of overlap between these two variants: it is precisely their occasional divergence that is worth exploiting). The traditional version of this is to invest in various types of utilities. But there are obviously many high quality businesses out there who are resilient to most economic downturns, through a combination of competitive positioning and financial strength. These businesses generally trade at premium valuations (i.e. with low implied returns) for that reason, so when they go on sale, it's best to be prepared to act swiftly.
3. Be realistic. Understand that there will be ups and downs in any portfolio. Just as important, one has to differentiate between forgivable and unforgivable mistakes. Or, to draw a parallel to Roman Catholicism, we should differentiate between venial and mortal sins in investing. Charlie Munger has a great quote: "I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn." But there's a limit to how harsh we should be with ourselves. I'm constantly wary of being a pattern-seeking, story-telling animal. It's okay not to know whether Chinese growth will be 3% or 6%. It is much less okay to lose money on a company that is modestly cheap if Chinese growth is 6% and in dire straits if growth is 3%.
If I had to highlight one unforgivable sin in investing, it is getting swept up by emotion at market tops or bottoms (only identifiable in retrospect, unfortunately). But what's worse is that we have a tendency to compound these errors. It is really, really not okay to lose sight of the long-term prospects of a wonderful business, sell one's stake in that business, and compound that error by refusing to buy at a higher price. So, if you make a mistake, so be it - wipe the slate clean, lest a venial sin turn into a mortal one.
I wish all readers a happy, productive and - just maybe - sin-free 2016.
P.S. John Huber has an excellent post touching on some similar themes.
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