“Never discourage anyone who continually makes progress, no matter how slow.” – Aristotle
What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he or she avoids big mistakes.- Warren Buffett
I’ve been at this game for a little while but as the road unfolds I am continually reminded how incomplete and patchy is my understanding of the game. It is both disconcerting or invigorating depending on my mood .On the other hand over the past 15 years I’ve hit more high note than duds and done so without too many tears. I’ve somehow or the other avoided big mistakes. Maybe I am some kind of master of the universe :p
Two opposing narratives perfectly showcased by the divergent paths of my value programs this year – the Large Caps are up 20% (and only 60% invested) while the Small Caps are down 12% and sinking. Master of the universe or dolt?
One year is neither here nor there. 3 yrs + is more aligned to my average intended holding cycle (see below t0 = 1):
Nearly good. My Small Cap Value program (SCVp) has a 3yr CAGR of 9% (vs.15% if it had been a breakeven year) while the Large Cap Value program (LCVp) 3yr CAGR is 20%. Long term expectations are 15% for the SCVp and 12% for the LCVp.
It is review time. What to do with this information?
I can give you story: that for the SCVp the music stopped while the rest of the market hummed – just in the past few weeks we’ve had a profit warning from LRM (Lombard Risk Management) and meh finals from FCCN (French Connection) rocked the boat. While writing this last week SAL (SpaceandPeople) fell 15-20% on inline results and prospects. I have other stories as required but what is it worth?
I’ve written on the pitfalls of reviews here and it is all still applicable. In sitting to write my year end review I’ll keep the following in mind:
1. My intended holding period is 3 years even though the discussion is this past year.
Without care I look at the one year chart above and derive inferences of what went wrong or right based on that frame. Rather I must look at last year through the 3 year picture that I have decided is more relevant. Myopia is a favourite subject of this blog and operating on inconsistent time frames can lead to significant long term damage (unintended consequences et al). This is where it is useful to have our framework and intentions of the programs clear.
2. These are concentrated portfolios with high idiosyncratic risk
Each position is a probability-payoff bet, there is no certainty although I hope there is mispricing. I’ll let you into a secret, things will vary and shit will happen. To structure as I have and then bemoan the fact that results weren’t to my liking is churlish. Doubly so when it is over a time period which I claim is not material.
3. Good performance does not automatically mean good process or decisions and vice versa.
We tend to be driven to action against what we consider to be ‘bad’. On the flip side we give little thought to areas that are ‘good’. This seems arbitrary. Review should encompass all programs of a similar nature equally.
4. Review should concentrate on elements where I have control
Not war stories or ex post dissection of decisions involving coulda, woulda, shoulda’isms.
Where do I have control:
1. Design and structure of the program
2. Planning and execution
3. Analysis (Trade Selection)
I’ll ignore one as it is too important for 100 words. This leads us to:
PLANNING AND EXECUTION
There are two questions:
1) did I have a clear plan for each position?
2) did I follow it impeccably?
I feel my facial muscles tighten as I consider this as I’ve been extremely poor on these grounds over the past year. My levels of distraction and sloppiness have been higher than usual. Usually I get away with it. Sometimes I don’t.
Trade Plan –every important element of the investment should be specified before the action happens. Sizing, investment thesis and ‘hooks’, entry and selling criteria, targets and what to do when the unexpected hits. It isn’t set in stone but changes must happen outside the action.
Execution – If my planning phase has been incomplete when it is time to act I am stuck trying to decide what to do. I end up chasing and reacting. This has been too common the past year.
Impeccable isn’t an ideal for me, it is critical.
I am a believer in a forecast-lite heuristic analytical framework over detailed valuation (more here).
Was my analysis flawed in the SCVp (and therefore good in the LCVp)? It is tricky to know this – how to disentangle the random coin flip elements from the quality of analysis?
Intead let us sidestep this question, there are easier ways to answer this. The SCVp portfolio does what it says on the tin (value, small cap based on broad strokes and behavioural edge). If I think that is wrong then I should look at that.
My inclination was to lay the blame with the quality of my investment selection, undoubtedly there are elements that can be tightened. But otherwise this is mostly unfair – the quality of analysis has never been strong; the design of these programs are predicated on never needing to be strong.
Analysis is not the problem. The problem is the planning and execution missteps.The programs requires that element to be watertight.
They aren’t. And that dear friends won’t cut it!