Less is more, more or less

Steady, average, middling – these are dirty words in the investment community. Instead the narrative expounds the wonder of ‘excess returns’, ‘beating the market’ and ‘being the best’. This narrative leaves out much, particularly the elements of time and availability. Actually it doesn’t, it assumes we shall deliver these returns in all accepted time frames (that is to say the time frames arbitrarily delineated as accepted). And that we can choose to be one of the chosen who through skill and hard work can realise these outsize returns.

It seems unbefitting of such noble ideals for reality to intrude. That clumsy interloper flinging off muddy shoes, wafting smelly feet and squishing our carefully arranged cushions as they flop on the sofa. Reality, and I say this with deep sadness, has little respect for our ideals.

In the world of investing, most of us offered an unpalatable truth: that it is insanely difficult to outperform consistently over longer periods and multiples more to do so on multiple time frames. Sorry.

But how about person x or fund y we counter, they do it? If them why not us? And with these exemplars we relegate reality and end up with the following de facto profile: striving for market beating returns with a hope of avoiding the larger losses that are more likely with that territory.

There is a balancing act here which doesn’t work for me.

Base rates (and the zero sum nature of the system) tell us few are good enough to pull this off through skill. This may well be you but if so you are an outlier. If it isn’t then ‘beating the market’ becomes predicated on luck. (think of this as a distribution with widening variance the further from market returns our desired returns).

What then to do? My desired returns (over the long term) may in excess of market returns but my skills, knowledge and tools are middle of the road. If I go with the default structure the only chance I have of achieving excess returns with consistency is if a) I improve a lot or (more likely) b) hit on a rich and long lasting seam of luck.

One is slow, intensive and uncertain and the other is out of my hands.(read the part about Andy Zaky in this post if you want a bit more)

There is an unglamorous alternative. Take a look at the returns of two investors below. Which of the two does better after 5 years?

 

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They both average 12.8% per year but it is investor B who makes the best returns.

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She is the greater success even though it is investor A who would garner all the plaudits. This example is over-the-top as the large losses incurred by investor A would raise eyebrows, but the point is made.

At the end of the five years when investor B shows excellent returns everyone may coo with admiration at their achievement. But over the course of the journey their eyes would have been on the magic dust of investor A.

Such are the differences between arithmetic and geometric means. Arithmetic means are useful for ‘advertising’. Geometric shows us the money.

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This is a handy blueprint for how I structure my investment practice: if I avoid large losing periods then I need not care about ‘beating the market’ in good times. In fact in any time period I need achieve slightly above mediocre returns.

This is rather profound. And less susceptible to arbitrage.

This way of going about the business of investment is not an interesting or exciting profile.Being middle of the pack will not get us noticed. For the most part the industry is structurally incentivised to do better than average (not of just the market but also benchmarks).

This sets up a potential contradiction. In previous posts I have written about the structural value on offer from not being concerned about shorter term volatility (here for starters). In this piece I say I want to limit downside volatility. The answer is in levels – on a trading program level I do what the system demands volatility or not. At an aggregate level the intent is that each program balances the others. Operations are structured to round off the sharp edges and curtail portfolio level losses.

There are numerous methods of smoothing downside volatility – diversification, timing filters, arbitrage, position sizing or other risk mitigation methods for starters. Few of these schemes are poor if used well. Where they fail is when we take 2+2 and get 22. Charlie Munger warns:

It is easier to make a mistake with a good idea because a bad idea is quickly rejected

There is no free lunch. There is a strong incentive to supercharge what works. Wiser heads try and maintain perspective by considering a world including counter-factuals.

That being said the investment game is incredibly forgiving.

We need only be ok at all this to come out well ahead.

The caveat, and isn’t there always a caveat, is that the durability of your methodology is determined by the weakest element. And that weakest element is almost always the same. The one in the mirror, that clump of electrical pulses, chemicals and tissue known as us.

NOTES:

Here is another example for you. Consider carefully the fact that without ever achieving over 15% investor B trumps investor A. Naturally if investor A could curtail those losing years their results would be spectacular BUT as we move up the returns curve we introduce a larger element of noise and luck. There are areas such as HFT and arbitrage where this is less so but their challenge differs in that the predictability of their returns renders them liable to be dissipated as new entrants feed off the carcass.

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Show and Prove

I’ve been a much keener seller than buyer these past few months.  Part of this is reflective of my nervousness at the persistence of markets, their lack of discrimination. They no doubt steer me towards caution despite my efforts to recalibrate my ‘feel’ with more substantive data.

The stronger driver is that I struggle to find value in the general market. In reviewing my holdings I come away with the impression that many are fairly or ever so slightly overvalued:  new buys need more thought, more leeway. Currently there is an element of an expectation of solid growth baked in to valuations. I fear we are at a stage where the bar is raised and disappointment more likely. Whether my fear is warranted is a topic for discussion.

Here is a roundup of my selling activity. The buy side is much quieter.

[All charts from Sharescope, all fundamental data from Stockopedia]

Telecom Plus (TEP)

The first position to face the axe was my largest.

TEP is an exceptional company: well run, nice business and solid prospects. Selling into an uptrend is not something I like to do but once I sold one tranche I kept on selling as the price rose.

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Take a look at some key metrics for TEP (from Stockopedia):

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Despite its quality, TEP is expensive on many measures. This isn’t to say it won’t double or quadruple from this price but this is an odds game and an EV of £1.5bn vs forecast profits of £30-40m offers little to excite.

Hell, even if they double profits in the next 3 years it is tending to the expensive.

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GOAL Soccer (GOAL)

I love this business. They rent out 5-a-side football pitches. An activity simple enough for me to understand.

There is a decent upfront cost to setting up a centre  but once the facility is in place, theoretically, each should be a cash machine. Add in opportunities to cross-sell, build enduring local relationships and  the ever expanding popularity of football and you have a potential win-win situation for all.

There is a large elephant in the room however. Debt. A hobbling debt.

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GOAL were subject to a takeover bid back in 2012. Given their debt, you could take the view a takeover was a good solution; the bid was a tad on the stingy side though. Unusually it was voted down by the shareholders.

I was a bit wary of management; their lack of fight with the bid price didn’t exhibit much confidence in their assessment of the value and quality of the company. When they then decided to issue some shares (around 5% of equity) at a price far below the bid price they got a big red mark. The bid was at 140p and they raised capital at 115p.

If management have such little confidence in their company what signal does that send? . It is great to be realistic but to actively agree to undersell or dilute at low prices is poor.

They next announced a plan to consolidate and pay off debt before continuing their expansion. In the past 18 months they have reduced their debt load by £8m which against an initial debt of around £54m is a bit blah. At this rate it will be a long time before debt reaches easier levels. This is from their recent trading statement:

In order to focus on strong cash generation and enhance return on capital from recently opened centres, the Board decided in 2012 to postpone further new centre openings. This strategic move has enabled the Board to reduce net bank debt from £54m at 30 June 2012 to £46m (December 2012: £50.3m).  (Trading Update Jan 2014)

This cracks part of my investment thesis – that of  each centre being a cash cow, they are more like cash calves perhaps. The change in cashflow (and FCF in particular) over the past two years is again merely ok (detail in the paste below hasn’t come out too clearly here but hopefully you get the gist):

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I sold out before the latest trading statement. The EV at over £150m outweighs the lovely uptrend and business. I was nervous about the results (they were solid in the end and shares have reacted well to them).

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I do love the business but  an investment is built on a thesis, and if the inputs don’t equate to the outputs then care is called for. I am guessing they will have to raise a bunch of cash at some point as the market and opportunity is there. Raising 20-30m will allow them to continue expanding.

In the meantime I’ll keep an eye out for re-entry opportunities.

Pure Wafer (PUR)

Ah PUR, everyone’s favourite silicon wafer reclaim company.

They nearly went bust during the financial crisis back in 2008 and managed to just about survive. The turnaround omens suggested they were on the crest of a nice cyclical swing. I was optimistic ….  then yesterday they released a trading update yesterday which seemed solid enough on the surface. Until a paragraph near the end (my underline) caught my eye:

Whilst the Board remains confident of meeting market profitability expectations for the full year, revenue is likely to be slightly below expectation due to greater pricing pressure in the global wafer reclaim market. Specifically, our competitors based in Japan are benefitting from changes in the USD/YEN exchange rate, giving them a competitive advantage relative to their home based costs. This has enabled them to offer competitive pricing to worldwide customers.  We estimate group turnover for the current year as a whole is likely to be circa 5% below market expectations. (Trading Update Jan 2014)

I sold most of my holding before finishing that paragraph, and the rest 20 minutes later.

Three reasons:

  1. They are a business heavily dependent on outside value drivers. If they are facing pressures so early in the cycle my investment thesis is in even unknown territory.
  2. Currency movements can persist for a long time and as long as it does so will the pricing pressure.
  3. This is another management team who don’t fill me with confidence; reading their reports up to 2008 they were quite confident as they headed into the abyss. They are still prone to hyperbole, the facts not matching the rhetoric. I am perhaps being harsh but that is my impression.

The sell decision is made on a balance of probabilities, these are subjective probabilities with large scope for error due to my calculations and variance in the inputs  and outputs. I am likely to get it wrong quite often but I can only trust in my judgment and my skills. Screwing up on my own terms is more skillful in the medium term.

Overall the outcome with PUR is frustrating as I held these for 3 years and felt there was good upside. I’ll keep an eye on their next update.

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Volex (VLX)

Finally Volex. I sat on this one for a while after their extremely poor update back in November and even bought some more at 90p.

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I was lucky with the rebound and was undecided on what to do. In the end I sold.

I feel I am unable to assess the business going forward.  This makes it more of a coin toss and if I am to invest sensibly I’ll put coin toss money into a nice loaded coin:

Upside = large, downside = minimal, coin = reasonably predictable.

Management and analysts did a good job of talking up the opportunity on offer but in the light of the poor handling of the results why should I give them the benefit of the doubt?

Management Speak

The consistent strand in most of the above is  that of management and their role in these decisions.

It is not even about the quality of the managers – running a business is a tough gig so some leeway is warranted.

Nonetheless I see and invest in so many companies who are poor and confused communicators.

That is not excusable as it is fully within their control. Be clear and make sure your words match the facts. Talking up the wonderful state of the business while the evidence is otherwise is tantamount to admitting you are either:

a) not careful b) not competent c) don’t think much of your shareholders or d) a combination of the three

Let me reiterate running a business well is tough. I have  worked for many years as a strategy consultant and helped run a start up for a little time. I see first-hand how complex, chaotic and messy even the best companies are while in action.

Nonetheless we all have control of our words*. This is why I try and improve my communication skills through activities like this writing. In my sloppiness of hand I see my sloppiness of thought, of assumption and action.

There is a rare power that comes when word matches deed, it results in trust and credibility.

In raising the bar on management quality, I fear I have shrunk my investable universe somewhat. That is ok. Whether we like or not good management matters. Credibility matters.

* excepting some clinical condition of course

Amendments

02/02/14 made some amendments for grammar and clarity

15/12/14 some rewrites

Happy Endings: Into 2014

A great rotation? Maybe . . . or maybe not. Nowadays pundits and the media are quick to come up with cute labels – usually just the right size for a headline or sound bite – to describe things that are taking place or that “everyone knows” are just around the corner. I don’t know whether it’s going to be great. Heck, I don’t even know if it’ll happen. But I like to enumerate the pros and cons and try to put them in perspective, as much as I like skewering excessive generalizations and pat pronouncement – Howard Marks, Oaktree Capital

Before a science can develop principles, it must possess concepts. Before a law of gravitation could be formulated, it was necessary to have the notions of “acceleration” and “weight.”- Herb Simon, Administrative Behavior

Last week to avoid an inactivity fee on a spread bet account I punched out a few index bets. Despite the tiny stakes it was surprisingly stressful. The flashing of price quotes felt so ominous and suggestive of impending drama.

Having expended my £2 and with a sigh of relief I shut the software and returned to my world well removed from the flashing lights. A place with space.

It got me thinking on perspective. One catchphrase I carry with me is ‘to see differently, look differently’.*

This skill is an amalgamation of  multiple skills. This is what makes it so difficult. And rewarding. Often if we try and see or understand differently, an obvious or congruent outcome comes to mind. So we stop looking. Using heuristics, limiting search and options are fabulous tools but they have their time and place.

At this time of year we see many end of year reviews. Reviews are great. Outside the demands of the present, we can take stock and look to improve. A review however should be determined by business requirements not what feels tidy.

Investing, like life, just rolls on – there is a beginning and there will be an end. In between the definitions are only those we create. We should review where we can be aligned with action and improvement cycles. If we review too often we capture noise and it can become an exercise in box ticking. If it is too infrequent we miss large chunks of relevant activity and end up trying to either play catch up or attempting too many changes in one go.

The Story of A Year: This Went Up, That Went Down Because ..

Let us look at the actual review. Usually they are based on narrative – what happened, and why and what will happen because of what happened. Story is usually built on assumptions of cause and effect melded into a coherent strand. In this form it feels authoritative and complete. This makes enjoyable  and often powerful reading but In our spirit of peeking behind the curtain we can bring awareness of the numerous flaws in this type of review. Looking back we are prone to justifications, rationalisations and other biases that mask the road to learning and development.

We can play with this – invert by looking to discern baseless assumptions, beliefs masquerading as fact  and sloppy narrative strands in our narrative.  This is good practice as it is directly applicable to the work. It helps us to develop the skill of maintaining a position and exploring variant viewpoints without the need to follow through or recoil. This is inordinately difficult but a beautiful practice.

Don’t Hate the Player, Hate the Game

One strand where looking differently can be useful is in the ‘paradox of skill’. This is a situation where the  bad hunters have all starved. Now surviving hunters are almost  equally skilled but the supply of prey is unchanged. In the paradox of skill catching dinner  becomes primarily the result not of superior hunting skill but of luck.

Our choice is to compete on these terms which at least for me isn’t a good strategy – my competitors are better equipped than me, they are more skilled (so I’m falling down even on the basic tenet of this paradox) and they are certainly more determined.

Perhaps we can try and invert this  and play a different game. While they hunt we farm. When the hunters decide to be farmers, we hunt.  Warren Buffett, in a letter to Katherine Graham, explains this concept:

Your win-loss percentage in tennis will not be determined by the absolute level of ability that you possess. Rather, it will be determined by your ability to select inferior opponents. If you select with care it will be quite easy to attain a winning percentage higher than, say, Cliff Richey while he is playing on the tour. Application of this principle is the key element in bridge, poker, or investments. (Harder to apply in the latter, however — it is easier to identify a couple of palookas at the bridge table)

It is not just playing the game, but idea of the game itself – in the investment game some rules are set but this isn’t tennis. Maybe the rules are true but perhaps they are just accepted. Let us not assume, let us cross the line and see. We  may stumble onto a different game.

The touch of the royal hand

Focusing on only one level encourages a mindset that is closed – however clever we may be on that level overall we will be fundamentally dumb. I am reading an entertaining book called ‘Shaman’ by Noah Gordon. He tells an illustrative story about a tubercular disease of the lymphatic glands called scrofula. In the middle ages it was believed that the touch of a royal hand would cure it. One point was missed, before the royal hand was laid on the patient the wounds would be cleaned. Miraculously people tended to recover after being touched.

We may scoff but how many of these misguided beliefs do we bring to our actions? We can be stuck at the wrong level or with the wrong model. Investing is an untidy business, prone to misplaced beliefs. Nonetheless an inquisitive mind is rarely wasted.

On a personal level  this is certainly a work in process,  a developing way of seeing (see this piece) which I hope never stops developing. Each step nonetheless leaves me prone to myriad other insight failures revealing themselves (and distracting me) as the road unfolds. So it is and so it always shall be.

The message however remains the same (lesson 2 here) – the market is not the end, it is just a point to focus.  The game is a gift and should be enjoyed, but success or failure are neither here nor there.

In the intensity of the moment it is easier to forget this than remember.

All the best for 2014 and beyond.

 

*This is borrowed from the following poem:

Stop and look around you.
Look out from the frameless window
Of a long pause.
Let the images come to you
Rather than chasing outward after them.
Allow yourself to reorient so that
You’re no longer pulled along
By the stream of events.
If you want to see differently,
You’ll have to look differently.
– Journeys on Mind Mountain

AMENDMENTS

15/12/14 – Heavy rewrite

Greece: From Pessimism to Scepticism

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Everything flows, nothing stands still – Heraclitus

The twin attractions of investing in Greece have not been lost on some of the savvier sections of the investment community. With a drachma reunion now a receding fear, Greece offers the rare opportunity of offering a turnaround opportunity without the currency risk baked into the usual ‘emerging market’ boom-bust play.

Nonetheless the tone of novelty expressed by a recent article in the FT titled ‘Paulson leads charge into Greek banks’, suggests the thought of Greece as an acceptable choice for the world’s investment dollars is still … a little radical. A fall greater than that of the US market in the Great Crash of 1929 tends to bake in views. That being said  the solid performance of the Athens Stock Exchange over the past 18 provides food for thought.

The 6yr and 2yr charts below for the Athens Stock Exchange General Index show us where we are (from Trading Economics):

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In 2012 Third Point, a hedge fund run by Dan Loeb, was one of a number of hedge funds to turn a notable profit on their Greek bond positions. Many have stayed on. In Third Point’s Q4 2012 letter Loeb writes:

More than ever, we are convinced that Greece will rebound strongly and we expect to participate in the Hellenic recovery both as holders of sovereign debt and through opportunistic equity investments. The Greek equity market is relatively small, but the nation is starved for capital, and we have an appetite to invest in strong businesses run by talented management teams.

This begs the question, is Greece a good destination for our hard earned investment dollar?  This is a question that should be answered either very generally or extremely specifically. I shall discuss in general terms.  Sir John Templeton provided a guide for measuring stock market seasons:

“Bull markets are born on pessimism, grown on scepticism, mature on optimism, and die on euphoria.”

Given this framework we could say we are at the earlier stages of the bull run. It is worth keeping an eye on the unfolding narrative on not just Greece but Southern Europe as a whole. The trajectory of asset pricing is often helped along by the evolving narrative around the ‘facts’ translated to expanding multiples.

From the vantage point of an outsider, the Greek story is still couched in nervousness. When I talk to my friends in Greece they are still (understandably) rather down on future prospects. Similarly money managers are a cautious bunch, and tend to tread the path less risky (to their careers). If the narrative continues the shift from ‘unemployment still over x%’ to ‘unemployment falls for the xth month’  their stance may soften.

At some point the story will be strong enough for a money manager to invest without fear of opprobrium. When that channel opens we have the chance to shift this, so far quiet, bull market to the next stage.

Please note I do not mention any move to buy in. I’ve kept a close eye on Greece for the past couple of years and in an article a year ago I liked the prospects but wasn’t sure on the timing or the best way of participating (see below for link). Right now I still like the story, I like the prospects, but I am still concerned on the downside. I’m not sure of the hook and without a hook I find it hard to manage a position.

When I solve that conundrum I’ll happily join the Southern Europe party.

Full Disclosure: I hold shares in TPOG a UK quoted vehicle wholly invested in the Third Point Master Fund.

Further reading:

My earlier foray into looking at Greece last Dec (2012):  http://mundanefinance.com/investment-ideas/meanreversal/

Greek Recovery Makes Stocks World’s Best as Paulson Buy:  http://www.bloomberg.com/news/2013-10-31/greek-recovery-makes-stocks-world-s-best-as-paulson-buys.html

Now Is the Time to Buy Greece:  http://www.fool.com/investing/general/2013/10/30/now-is-the-time-to-buy-greece.aspx

mundane finance--7

The Pain of Pleasuring Wall Street

mundane finance--7

Last week I discussed the opportunities that emanate from the foibles of human nature. This week I’ll go a step further and look at a specific aspect. It is one that is personally pertinent as it is a constant challenge not to slip back into the ‘unhelpful’ type of thinking.

As is normally the case most ideas and thoughts have been expressed better by my cluster of learned persons. In this case the Berkshire Hathaway duo of Charlie Munger and Warren Buffett. In this quote Charlie Munger is discussing writing insurance but it is just as relevant to buying stocks:

“Lumpy results and being willing to write less insurance business if market conditions are unfavourable… that is one of our advantages as an insurer – we don’t give a damn about lumpy results. Everyone else is trying to pleasure Wall Street. This is not a small advantage” [1]

“This is not a small advantage” – it is a sentence tacked on as an aside but he might as well be screaming in our ear. Munger is telling us that the route to success is in making the correct decision in the big picture, not what seems or feels correct in the moment. Such a path may be decidedly uncomfortable, mocked or frowned upon. But in doing so we tap into a huge advantage over time.  Let us dig a little deeper.

Risk Is Volatility. Except when it isn’t

Markets do not exist tangibly. They are an idea, so they must be explained through a framework of concepts and ideas. Over time these ideas (quite naturally) become entrenched and shape the default narrative and framework of the investing majority.

One such concept is that of risk. Psychologist and Nobel prize winner Daniel Kahneman reminds us of the conceptual nature of risk:

““Risk” does not exist “out there,” independent of our minds and culture, waiting to be measured. Human beings have invented the concept of “risk” to help them understand and cope with the dangers and uncertainties of life. Although these dangers are real, there is no such thing as “real risk” or “objective risk.” [2]

In finance this risk has been cemented as the volatility of the asset (the variance of price movements).There is a great attraction to recognising risk as volatility. Volatility is both easy to explain and measure. It is also a central tenet of the elegant and much-implemented modern portfolio theory [3].

This doesn’t make it any more real even if many participants have forgotten the fact it is a construct.

James Montier in his book Value Investing writes:

“Risk shouldn’t be defined as standard deviation (or volatility). I have never met a long-only investor who gives a damn about upside volatility. Risk is an altogether more complex topic – I have argued that a trinity of risk sums up the aspects that investors should be looking at. Valuation risk, business or earnings risk, and balance sheet risk” [4]

This leads to some strange incentive structures for those. We see a reappraisal of aims to ensure performance that does not lag or show excess short term volatility, even if at the expense of longer term performance. While discussing the problem with targeting relative rather absolute returns Montier (with barely restrained disgust) explains:

“The obsession with benchmarking also gives rise to one of the biggest sources of bias in our industry – career risk. For a benchmarked investor, risk is measured as tracking error. This gives rise to Homo Ovinus … – a species who is concerned purely with where he stands relative to the rest of the crowd.” [5]

You can read this thinking in many places if you keep an eye open. Keynes mirrors a similar imperative to conformity in his classic General Theory:

“Worldly wisdom teaches that it is better for reputations to fail conventionally than succeed unconventionally.” [6]

Many a money manager will ignore or abandon high payoff opportunities that smell funny. It is a sensible logic; why take steps with limited personal upside but massive downside? Incentives structure behaviour. Long term thinking need never stretch beyond bonus season.

Choose chaotic order, not ordered chaos

This is fertile ground for are free from treating volatility as risk. Without a requirement to achieve or show good short term returns a sizeable advantage is available. It is an offer that should be accepted with doffed cap as it is a pretty straightforward source of outsize returns. Straightforward but not easy.

In acting with no care for shorter term fluctuations we battle an innate desire for order and certainty. Our brain will be so much happier and sleep better seeing everything as steady, managed and known. Put another way, just as turbulence feels far more dangerous than it is, choppy price movements feel risky and cause us stress.

The skill is to modify this brain narrative. In my languid journey from control freak to happy surfer this has been an unfolding and rather slow work-in-progress.

At stages I think I have transcended the need for nice tidy lines. I then find new manners in which I, unknowingly, amend my behaviour to avoid enduring excessive turbulence. It is as if my brain, as a kindness and without disturbing my awareness, nudges my behaviour to stay within certain bounds of volatility.

Physicist Richard Feynman, in explaining the workings of a rubber band, reminds us of an essential wisdom. Everything is something quite different when we amend the level of analysis. The quite static rubber band we see holding together a sheath of paper is, as he explains in his inimitable manner, also “… a dynamic mess of jiggling things”.

My practice then is to see through the visceral force of volatility, to remember it is also as a mess of jiggling things and that jiggling is often the bind that holds together robust long term returns.

Notes and Sources:

[1] believe the source for this is the Wesco Annual Meeting in 2000, unfortunately Munger’s speeches are less reported than Buffett’s so they can be harder to pin down: http://mungerisms.blogspot.com/2009/08/wesco-2000-annual-meeting.html UPDATE 07/02/14: Ha I found the source in Poor Charlie’s Almanac (a fabulous read well recommended: find it here)

[2] Kahneman, Daniel (2011). Thinking, Fast and Slow, Penguin. Kindle Edition, p. 141

[3] For a refresher there are many good explanations of MPT, here is one http://www.investopedia.com/articles/06/mpt.asp.

[4] Montier, James (2009), Value Investing: Tool and Techniques for Intelligent Investment,, Wiley,, p. 9. You can read and download (not sure how kosher it is but .. you can find it here: http://www.valuewalk.com/2013/05/james-montier-value-investing/

[5] Montier, James (2009), Value Investing: Tool and Techniques for Intelligent Investment,, Wiley,, p. 3

[6] Keynes, J. M. (1973). The general theory of employment, interest and money. London: Macmillan, Chapter 12. Read it here: http://ambidextrouscivicdiscourse.com/wp-content/uploads/2010/10/The-General-Theory-of-Employment-Interest-and-Money.pdf

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Structure: A Proper Investment ‘Secret’

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I don’t know too much about Bill Gross; but I do know that in writing ‘Consistent Alpha Generation through Structure’ he radically shifted the manner I approach the investment process. Radically and I feel for the better.

It all came down to explicitly bringing out the concept of structure. Here is his definition:

“After more than 30 years of managing institutional and individual bond monies, I have gradually come to the understanding that successful money management over long periods of time rests on two, somewhat disparate, foundations. The first is “a secular outlook” …. The second foundation is what might be called the “structural” composition of portfolio management, and whether the reader agrees or disagrees with the secular thesis, I would argue that those who fail to recognize the structural elements of the investment equation will leave far more chips on the table for other, more astute investors to scoop up than they could ever imagine. A portfolio’s structure is akin to its genetic makeup. It is how it is constructed without regard to short-term strategic decisions. Structure incorporates principles that are longer than secular, principles that are nearly paramount and should be able to deliver alpha during years when the manager’s magic touch-to use a basketball metaphor-seems to have disappeared or when there’s simply a time-out on the court, with secular investment opportunities few and far between…..

Some examples of successful investment structures will give the reader a clearer idea of the concept. Banks have a formidable investment structure: Borrow short near the risk-free rate; lend longer and riskier. If a bank does not overdo the structural model (and they can and have), profits are almost guaranteed on a long-term basis as long as capitalism as we know it survives.”

 

Gross, William H., Consistent Alpha Generation through Structure. Financial Analysts Journal, Vol. 61, No. 5, pp. 40-43, September/October 2005. Available at SSRN: http://ssrn.com/abstract=827404

Read: http://www.cfainstitute.org/learning/products/publications/faj/Pages/faj.v61.n5.2754.aspx

Or

http://www.jstor.org/discover/10.2307/4480698?uid=3739832&uid=2&uid=4&uid=3739256&sid=21102886186697