We will only invest in a security that we can buy for significantly less than our estimate of its intrinsic value. This sounds simple, but it is not. And surprisingly few professional investors truly adhere to it. Industry jargon separates “value” from “growth”, basing the distinction on accounting and valuation ratios. We believe value can encompass growth (appropriately discounted for uncertainty), so long as one is disciplined enough not to overpay.
Everyone wants to get rich quick – we believe most of the market is too short-term, for a number of well-documented reasons. Keynes said “it is better for reputation to fail conventionally than to succeed unconventionally”. Couple this with the less conscious behavioural biases of greed, herding, etc, and the scale of the issue becomes clear. One of the value investor’s strongest weapons is his ability to exploit these short-term biases by simply riding out the panic that often grips markets. We believe over time, market prices for our discounted securities will converge to fair value, although often patience is required. We strongly believe in behavioural biases and try to mitigate this risk through staying conscientious of our short-comings, in-depth research and a focus on the mid to long-term.
Many professional investors seem to do minimal research, simply following hunches, sell-side reports, or other investors’ opinions without verifying the facts for themselves. We ensure we know a business before we invest in it, taking time to talk to those who know it best – for example its customers, suppliers, competitors, former employees and other industry experts.
RELATIVELY CONCENTRATED PORTFOLIO
Most of the market believes you need hundreds of stocks to be well-diversified – this is not true – even eight stocks provide you 96% of the benefits of diversification.* The more stocks you hold, the more you risk simply mimicking a market index, diluting your best ideas with mediocre ones.
A proven way to save money is to lower transaction costs (commission/spreads/taxes). The average fund manager turns over his entire portfolio more than once a year – a bonanza for his brokers but often not so much for his investors.
Most funds have many self-imposed mandates based on an index, geography, market capitalization, cash holdings, investment rating or other arbitrary restrictions. We believe a flexible mandate allows us to take advantage of funds with these mandates and have a larger pond in which to fish for superior investments. For example, when a stock leaves the S&P 500 or an investment rated bond is downgraded to junk, thousands of passive and active funds are forced sellers, which may lead to the price decline far exceeding the fundamentals of the security.
These constraints open many opportunities up to investors (see search our strategy – spin-offs, merger securities, bankruptcy/distressed all exploit these constraints).
The ability to hold cash is also positive as you can only put your cash to work on ideas that meet your criteria and not simply add to positions that may not be attractive – because EMH was so prevalent a theory – the asset allocation element was taken away from portfolio managers and given to consultants. Managers no longer looked across the capital structure and were required to be fully invested at all times because they were there to provide “equity exposure” or “fixed income exposure” and not to make sound investments only when they appeared.
There are dis-economies of scale in investing – the larger you are the smaller the universe of investments with corresponding fewer bargains and more competition.
Our search strategy enables us to locate bargains more quickly so that we can spend more time on in-depth research.
In-depth research allows us to make better, more informed buying and selling decisions and raises our comfort level and conviction.
We utilize a checklist and track quantitative elements in order to minimize some of our behavioural biases.
Well thought out portfolio construction and monitoring coupled with our knowledge/research allows for superior long-term decision making compared to others who trade in and out on short-term or macro fear and greed.
INCENTIVES ALIGNED WITH INVESTORS
We care about making you money as much as ourselves. We are co-invested along with you and share your pain and gains. Large asset management companies have an enormous sales force to investment professional ratio. They care more about sales and raising AUM to gain fees than they do about performance. So long as they do not screw up they are happy to have mediocre results and collect fat fees. We believe performance is our best marketing strategy.
PRESERVATION OF CAPITAL
We focus on downside risk and probabilities. Most funds focus on the greed aspect of how much money they could make and not on how bad things could get. Money only compounds over time if draw-downs are limited in scope. We pay little attention to short-term market moves but we do care about the probability of a permanent impairment of loss.
ABSOLUTE RETURN FOCUS
You cannot pay for your children’s schooling, your retirement or a new car with relative performance. We focus not on what a particular benchmark or “the market” is doing but rather if the investment makes sense in an absolute return focus (considering inflation and purchasing power). Most market participants only care about how they do compared to peers or a benchmark. This leads some to simply closet indexing or a need to chase the newest fads or glamour stocks so that they are not left behind. This can be disastrous and lead to poor decisions or attempts at window dressing.