May 27, 2018

An underappreciated edge

I wrote the following note recently to our subscribers. Hope you find it useful too.
I wrote extensively on risk in the last year’s annual update (read here) and highlighted the fact that cash levels in the model portfolio were at an all-time high. (around 30%).

The reason for pulling back in, the latter part of 2017, was due to the frenzy and crazy valuations in the market. I was no longer comfortable with the risk reward situation and decided to stick to our process even if it meant that we had to forego easy returns.
I think we delivered fairly good results for CY 2017, even though we lagged the market in the second half of the year. More importantly, we dialed down the risk as much as we could.

Not easy to be disciplined
It was not an easy decision. It is painful to watch companies you are researching go up by 50% in a span of few weeks, even before you get a chance to finish your analysis. However, I have felt that a key edge for individual investors is their ability to be patient.

I can assure that it is not easy to sit and do nothing. I am an Engineer and MBA by education and have worked in a corporate job for a long time. As you all know, being patient and doing nothing is not acceptable in these roles. The more you do, the more you are rewarded.

Investing is not the same. More action in terms of buying or selling, especially for our style of investing does not improve returns. On the contrary, as I have often found out, may even result in worse outcomes. The work on research and analysis of current and new position continues behind the scene, but the act of pulling the trigger must be done thoughtfully.

Ignoring noise
We don’t have to react to every bit of news which gets published – oil prices up, interest rates up, some news about the manager’s nephew’s aunt etc. The point extends to the quarterly results too. I have been analyzing the results which have been good for a few of our positions. Overall, if the long-term trajectory of a company is intact, I do not want to read too much into it and take a short-sighted decision.

Most of you are aware of the above attitude and it is not new to you. However, it makes sense for me to emphasize this repeatedly to all of you. In this age of instantaneous news and social media, everyone thinks that reacting to news all the time is the key to making above average returns.

I am increasingly of the view, that in the current environment of hyper speed and automated systems, investors like us will do better by taking an opposite view – slow down, think deeply about a few companies and focus on the long-term trends. We will win as we simply have much lesser competition in this space.

Several of our current positions exemplify this mindset. We have held them for years and will continue to do so as long as they continue to perform and are not overly expensive.

Not blind to risk
The above does not mean that I am blind to risk and will be patient for the sake of it. If something goes wrong at a company level, I want to take time and think deeply about it and then take a decisive action.

However, my bias is usually do nothing as I have learnt from experience that most activity in the portfolio does not add much to the returns, only makes us feel that we are doing ‘something’. Although some of you may not share this sentiment and have numbers to back up a more active form of investing, I can only say that one has to invest based on their own temperament.

You will have to be comfortable with our slow and plodding style of investing.

A structural advantage
Mutual fund managers and other professional investors cannot  afford to lag the market for long due to career risk. If you think otherwise, then you under-appreciate the pressure on someone who may not be able to provide for his or her family if they lose their job due to under-performance. A rare few can manage that pressure, but don’t count it.

There is a structural advantage if the Investment advisor (we should mention Investment Adviser) does not have a career risk when he or she makes good long-term decisions, even if that causes the portfolio to lag in the short term. This advantage (for the clients) is further enhanced when the manager invests a majority of his net worth in the same manner as the client.

Me and Kedar have setup the partnership in such a way that we do not face any such career risk. This edge has allowed us to be patient and not worry about the optics of our actions. I have often ignored emails from some of you, wanting to do ‘something’, if I don’t think it makes sense in the long run.

In addition to that a large part of our networth is invested in the same fashion as the model portfolio. This does not guarantee that each of our decision will be right, but our incentives are aligned with yours. We eat our own cooking.

We have also made it a point to ensure that subscribers who join us, are aware of our approach and buy into it. We will not deviate from it even if some of you write to me and start getting impatient (wanting to pull the trigger).

In the pipeline
Our cash levels are around 30% of the portfolio and I continue to look at new ideas. I don’t want to rush into it. We will add to the existing positions or to new ones if the price is right and I feel comfortable with the company’s prospects.

If all of us plan to invest for next 10-20 years, a few months will not make all that difference. We are in this for the long haul.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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