This week, I read something Nick Maguilli wrote about why own bonds when yields are so low.
He basically came to roughly the same conclusion that I came to, but I think he has a better explanation then me.
Some things just stopped working so well. Not stop working. Stop working so well.
He gave a good example of what Buffett implemented in his earlier years:
For example, in the 1950s Warren Buffett and Benjamin Graham made lots of their money purchasing companies selling below their net current asset value (“net-nets“). This style of investing is the equivalent of paying $50 for a suitcase that has $100 in it. But good luck finding such “net-nets” today.
It is true that you would struggle to find net-nets, but that does not mean you could not make money. I have one or two friends whose portfolio are focus on the Graham style type of investing that is based on identifying mispricing, buying something worth $1 for $0.50.
And they have a few home runs.
In a year where that will lead you to believe that unless you are in tech stocks, you would get no where, they got somewhere.
But in a way, we are seeing enough shit talk about strategies like this that if the trend continues, less and less people will invest in strategies like this.
Maybe This is Better for the Strategy
But perhaps one of the reasons why these strategies could not work so well is because in this computer age, any inefficiency in the markets can be removed.
A lot of what Buffett did was based on what can be found in the financial statements. Computing the intrinsic value by computing what is worth liquidating is very fixed.
This can be done by computers which means that many of us can do it.
So do any of us have an edge over others?
But at least if less people feel that this is a long term investing method that give us an advantage, it is less crowded.
I have always favored the less crowded way. If something is crowded, it makes me wonder if there are alot of sentiments involved.
There are some rules or axioms that stays true throughout time and human behavior is one. So if everyone does something, it makes me wonder if certain strategy is too crowded that we are all paying too much for something that works (which can be rather bad in investing).
How does Investing in Ugly Things Feel Like?
For a large part of my investing journey, I realize what worked better was investing in fundamentally positive things.
When the fundamentals are well and things are healthy, but I feel there are enough people mispricing it.
The mispricing could be
- The quality of the cash flow
- In the duration of how long the quality of the cash flow can be
The turnaround plays do not work so well because I have this psychological issue of not sitting well with ugly things. Ugly things are stocks whose fundamental “seemed intact” but the share price will drift lower.
What is difficult about these stuff is that more often than not, I question if I got the thesis wrong, or that deductive work done lacks the depth required.
So if I know that my behavior is like that, I better shift to a strategy that does not put me in a position where I have to contend with ugly things.
However, in a way, if I were to buy a seemingly quality company, there would be a point where the prices does not “realize” that quality.
The stock price would go sideways or even go unloved. Then how would I feel about that? Would I second guess my decisions?
I admit I don’t like to invest in ugly things or things with ugly moments. The problem is…. quality investments go through ugly moments. So what are we supposed to do about it?
What made us hard to stay with ugly stuff… is often our own psychology. In this time and age where you have a lot of forums, chat groups, it is tough to not be affected.
Perhaps this is why some of the great managers choose to park themselves away from Wallstreet. This is so that they can make independent decisions.
Professional Managers and Advisers Have a Hard Time Sticking With Ugly Things
There are also strategies that would look pretty ugly if you put them against the basic indexing strategies.
For the past few years, trend following, Graham style value strategies, quality strategies based on profitability, multi-factor strategies, risk-parity, you name it have not worked well against indexing.
And it becomes a hard game when your investors chided you for doing worse than an index. Advisers don’t want to recommend your funds or switch away because they are under pressure to deliver returns.
You start shifting your strategy as well.
Shifting your strategy have its good points and bad points. The bad points would be how would you explain to new prospects or existing clients your constant shifting in ideology?
Perhaps you need not explain so much because what you “promise” your clients is that you are able to get them a certain rate of return.
If that is the case, you will live and die by your investment decision. Your clients would likely follow you when you are able to give them returns and leave you when you go into a funk.
You will have to Think About How You Handle Investments That Do not Go Your Way
I think each of us have to think about how do we handle our investments looking ugly.
- There are investments that look ugly and you should not hold on to them, and you should sell them off
- There are investments that looked ugly and there are reasons to hold on. You would just need to learn to compartmentalize and manage them well.
Sooner or later what worked will look ugly.
When Seemingly Good Stocks… Go Nowhere
A good example is when you have a seemingly fundamentally sound stock with a good network effect. Much of the growth is built into the current price.
There will be a point where the growth slows down. And the share price goes nowhere. What is your course of action then?
What if it is more than one stock but a bunch of them? This is very possible since… most folks invest in themes…. a bunch of REITs…. a bunch of tech stocks… in a portfolio of physical properties.
Would it be to stick to your guns, ride through the ugliness or would you shift to other “strategies”?
The earlier you confront this question, and think of how you handle this the better.
I wrote this because… I felt that when times are good people might not have pondered about this. There are enough optimism in the markets to lure folks to believe this optimism would sustain throughout your investment journey.
In investing, you need to put your money into something that have liquidity risk, credit risk, possible insolvency, fraud risk, entreprenueral risk to potentially earn higher expected return.
If there isn’t any volatility, then there should not be outsized returns.
The second reason that I wrote this is because of what I observed at work.
This is a business that cannot tahan uglyiness. When markets go a bit crazy, it is when advisers are suppose to earn their money by getting you to continue to stick with your investments. But it also places a lot of stress on the advisers because re-programming natural human instincts is a tough proposition.
In a way, I think most investors do not know how factors such as value, size, profitability, momentum, credit, term show up.
Hell, I have to dig deep to try and understand to know that these factors show up when they want to show up, and it is not something that we can predict. Sometimes when they show up, one or two occurrences make up for years of underperformance.
Sometimes, it is one thing to say “we do not know when these factors will show up because we cannot predict the markets” and it is another thing to truly understand what that statement means.
Factors can choose to not show up for months or years while in your head, you were hoping these gaps between factors showing up is in weekly intervals.
I came to a conclusion that most people cannot take ugly things. Only the odd weird souls are able to.
And it makes money management challenging if you are basing your investment philosophy on strategies where your client’s investment go through ugly moments.
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