I was not able to spend a lot of time this week to take a look at investments.
Much of the time is spent figuring out parts of this bloody internal tech upgrade and this internal crypto training that I was supposed to conduct. Can’t wait for this to be over so that more mental bandwidth can be freed up.
One of the write-ups that caught my attention was this article from Josh Brown, the CEO of Ritholtz Wealth management firm.
The title of his article was quite appropriately named Say Less, and there is a reason for that.
Josh talked about how a concentrated portfolio position taken by a very experienced portfolio manager blew up in his face.
The BlackRock Emerging Frontiers Fund made the biggest long bets at the start of February, putting 9% of its gross assets invested in Russia, after a research trip to the country in January.
We all know why the fund’s position blew up today.
“We travelled to Russia at the end of January to assess the situation on the ground given our large net long position there,” the fund told clients in a letter, sent before the war began. The letter cited Russia’s large current account surplus, attractive bond returns, cheap stock valuations and undervalued currency as reasons for the bullish bets.Bloomberg
When I read Josh’s post, I was in a rather pensive mood. I have a few takeaways from what Josh wrote.
To have a possibility of better than benchmark returns, you have to make unique bets
The BlackRock Emerging Frontier having some sort of disaster. Actually, when I look at the fund’s result, I wouldn’t consider that a disaster.
If you look at Ark Innovation, even Baillie Gifford’s funds the past year, it has been a bigger disaster for the investors who invested recently.
Some of my friends have some stupidly big drawdowns as well.
My experience tells me that to have great performance requires you to allocate your portfolio in a unique manner. It does not have to be riskier. If you have a larger amount of your portfolio in Treasury bill ETF, your short term performance may be better (because almost everything except energy and commodities is going down).
You have to be more concentrated, investing in stocks or in asset classes, or alternative strategies based on your investment philosophy.
Sam Vecht made a larger than index bet on the country of Russia at a point where he thinks has good rewards versus the risk taken. The probability that a war will break out is lower in his mind and it blew up.
Some of us took a larger than a normally concentrated stake in China technology stocks or US technology stocks with no-GAAP earnings. We tried to assess the probability of how long these China crackdowns or USA crackdowns will haunt the stocks we bought. We tried to take in all the financials and qualitative factors and buy at a price we think is fair value for the quality of the business or below net-net cash for some companies.
And they blew up in our face as well.
In another time period, these events will unfold in different ways. Russia would be bluffing and backed off after concessions were given. The China tech firms did as they told, the government relented more and the share price recovers.
We often tell ourselves we are better investors. Our past records speak for that. If not we would have invested in some index funds.
As active managers, what caused our outperformance often is due to our concentrated and unique bets and for them to work out.
There are those who made concentrated and unique bets that didn’t work out. You will seldom hear about those (unless you are in the advisory business and your client is in a reflective and humble mood to share with you.)
If you are investing in a fund and expect that the fund does better than the benchmark, do be aware that the fund manager is doing something unique and possibly more concentrated in something.
Some of those funds you invest in would blow up in your face in a manner that you might not expect.
What is the use of a great 11-year track record?
Why did Josh give Sam’s fund so much air-time?
I think one of the reasons may be how well Sam Vecht ran the Emerging Frontier fund. Here is its record up to last month.
- 2011: 1.6%
- 2012: 0.7%
- 2013: 23.5%
- 2014: 5.4%
- 2015: 7.3%
- 2016: 3.5%
- 2017: 12.6%
- 2018: 8.5%
- 2019: 7.5%
- 2020: 22.1%
- 2021: 3.6%
- 2022 End Feb: -7%
The fund basically did not have a down year for 10 years before that!
For context, here is the calendar year performance for MSCI Emerging Markets Europe Index:
The total compounded return of BlackRock from 2011 to 2021 is 145%. In contrast, the total compounded return of the MSCI Emerging Market Europe in the same period is -4.96%.
The fund is so damn good in my dictionary if you take a look at how volatile the period has been for that index and how poor the return is.
Sam’s team definitely added value there.
I know a lot of investors would choose funds based on the past 3 years, 5 years track record. In this case, its 10-year record is great.
A great past record does not mean that your experience will be great. It does show the investors in the past did well. What you are hoping for is the manager still sticks around, his style of investing still works in the market environment and his team executes well.
This is not always the case:
- Managers leave the fund.
- Fund did well because a certain factor style, sector, region the manager tilts towards is working well. The manager failed to recognize that and when the environment change, he did not realize this and could not adapt.
- Manager made a unqiue and concentrated bet that impaired the fund and tarnish the reputation
This can be used to describe us as active investors as well.
We get lured by a good so-called long term track record without going back to first principles and asking what is the “investment base rate”.
The investment base rate is that regions take turns being better and becoming worse, some factor styles such as momentum do well during certain periods and then another factor style do better in other periods. Things do not stay the same.
We may have placed too much emphasis that what happened in the last 3 years, 5 years or 10 years will work in the next 10 years.
Does Being Sophisticated Enough Mean You Won’t Fxxk Up?
There would be a lot of arm-chair retail investors reading this saying “It is so obvious war is going to break out. Serve him right to be so stupid. These fund managers are useless!”
If you say something like that then I expect your personal fund to have a better performance than this BlackRock fund.
You don’t get a decade of positive absolute performance (when the index has 5 calendar years with negative double-digit returns) by not knowing there is every chance some things may blow up.
Sam Vecht studied international relations and history prior to his multi-decade experience allocating capital in the region. Based on all of his wisdom, experience, research, connections, contacts, reading, listening, studying, his conclusion was that the risk was overblown and Putin was bluffing.
Putin was not bluffing this time.
Josh wonders: If Sam wasn’t in a position to have gotten this right, what on earth could make you believe anyone else could?
Josh left two quotes from Socrates in around 400 BC and Albert Einstein:
- Socrates: “The only true wisdom is in knowing you know nothing.”
- Einstein: “The more I learn, the more I realize I don’t know.”
Another guy with a lot of sophistication that blew up was Bill Miller of the old Legg Mason fund. He beat the S&P 500 for 15-years in a row (no easy feat) and then decide to double down on the financial institutions in the Great Financial Crisis.
You can listen to a few of those interviews where he explains the rationale why his fund took those positions.
Bill Miller got through that difficult period (you can go look up how many assets the fund was haemorrhaging), reflected on how he did things and came strongly today.
These days, I really wonder how much of what I know about business prospecting and individual investing actually matter. There were a lot of stocks that didn’t get into that I thought were great investments at reasonable prices. There were also stocks that I get into that I thought the same.
And in the past year since Bill Hwang’s episode that made me ponder about this question a lot.
I would like to think I know more than the general when it comes to how to assess the financial statements, look at things from various qualitative angles. My experiences with Singapore small-cap have probably honed my risk management abilities.
The picks that I came close to making, that I made and got out of, made me wonder if I do not have the temperament or that I coasted along in a favourable market.
They say that proper investing is not speculation and is a sensible way to build wealth. That is probably true on a portfolio level.
But on an individual stock level, you are making a bet that your thesis is correct. This could be 50/50 or 70/30. Some crazy shit believes it’s 100/0 that their picks will definitely work out. I think these crazy shit have never been humbled before.
The right approach may be to accept that some of your picks are going to blow up and you should structure your portfolio to be able to stay solvent in that scenario. Accept greater than normal drawdown is a feature of that portfolio.
If you are not able to accept the feature, you got to tweak the strategy, be less concentrated both in companies and regions.
Some Investors have Unreal Expectations of Fund Managers
A lot of investors have this idea that fund managers are the super investors but they failed to see that there is a limitation to what investment sophistication can get you.
The manager cannot just sell all the stocks if they see a potential downturn coming. They have a mandate to give you exposure to a certain region or sector. Imagine that you buy into a fund hoping for exposure to Emerging Markets Europe and then you realize the fund is in 100% cash and you don’t get the exposure.
The second reason is… it’s just difficult to time an unfolding event. A drawdown may turn into a correction which may turn into a bear market, and even that, there are different magnitudes. A drawdown most often just end up turning up.
The fund manager probably knows that the odds of the market going higher is larger than it turned to a bear.
The investors tried that on their own, didn’t get good results, and then have this expectation that the managers could do it.
The base rate, in this case, maybe that the investors failed to realize that while there are managers like Sam Vecht that can add a lot of value, the majority of the managers struggle to even keep up with the indexes and are limited by circumstances compared to what an individual could do.
Managers like Sam Vecht, Bill Miller, Bill Ackman are the rare ones. They still blow up once in a while. For the rest, they struggle to keep up with the indexes. A lot of us aspire to be like them but its good to recognize not all of us could.
It is good to recognize this fact.
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