investment performance

Stocks Have No Memory

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Clients sometimes bring up their own history with a particular investment in
trying to assess it. We sometimes hear things like this:

• “It’s done nothing but go down since we bought it.”
• “This is the most boring stock ever! It just lays there.”
• “At what point do you give up on waiting for it to turn around?”

As investors, our challenge is to form an opinion about the future value of prospective investments. Broad economic trends, industry developments, and company evolution may go into the mix. Reading annual and quarterly reports, checking our research sources, and looking at pertinent news are part of our routine. We frequently have to do some arithmetic, too.

Notice something missing from our recipe? Investment price performance does not go into the stew. Track record is not a factor for us personally. If you believe in buying low, you sometimes buy things with terrible recent performance. Conversely, some of the best track records in history belong to bubbles at their peak.

We aren’t saying our approach is the right approach. There is a whole school of thought that says you should only invest in things that are already going up—trend followers. But our approach is our approach, and we are unlikely to change.

Market values depend on the consensus opinion of the rest of the world. As contrarians, we look for potential gaps between the consensus and how we believe the future may unfold. No guarantees, of course—but we aren’t going to base investment decisions on a consensus that may be flawed.

Your stocks do not know how much you paid for them, or when you purchased them. We look at companies, not stocks—and make decisions in line with what we see. Opinions change, the consensus shifts, and we wait. Sometimes we look out of step for a time, perhaps years. That’s part of being contrarian.

Clients, if you would like to talk about this or anything else, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

Stock investing involves risk including loss of principal.

The Three Kinds of Performance

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In our recent reading, we came across another useful concept from Morgan Housel. He talks about the three kinds of investment performance:

1. Bad.

2. Overall good, but occasionally bad.

3. Always good but fraudulent.
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Many have had experience with the first one. The last one is obviously not a place to be. The key to the second one, according to Housel, is communication. Communication builds the trust required to get through the rough patches and down times.

Every day we are grateful for you, whom we believe to be the best clients in the world. You talk to us, you listen to us, we usually understand each other. We work to communicate in various ways, but it is a two-way street!

You know we won’t get mad if you ask a pointed question—if it is in your head, we want to hear it. You trust us enough to start a dialogue when you think we may not be on the same page. When there is something you think we should know, a development in your life or an investment idea, you tell us.

And we do you the honor of believing you can handle the truth. If we need to acquaint you with some aspect of changing reality as we see it, we do so.

Our mutual trust and straightforward communications seem very valuable. It is indeed the key to living with ups and downs. Our best guess is that things will turn out well, on balance, over the long haul. Of course, we can offer no guarantees.

Clients, if you would like to discuss this or anything else in more detail, please email us, call, or set an appointment.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Average Is Not Good Enough

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There is a split in the investment world. One camp believes people should just buy passive products that seek to mimic the investment universe at low cost. They think it is not possible to gain any advantage by actively managing portfolios. The other camp believes there IS a benefit to actively managing portfolios and choosing particular investments.

You know where we fit: investment research, the selection of securities, and managing portfolios is about all we do—except talk to you. We are in the “active” camp, not the “passive” one. The debate rages on.

One thing is certain. The passive camp enjoys lower expenses, because they ordinarily only do a fraction of the work that we do: we research about individual companies, read annual reports, sell this and buy that to try to gain an advantage.

When you think about it, the whole universe of active investors cannot all deliver above-market returns—with their higher expenses. So the idea is the whole universe of passive investors must therefore do better than the whole universe of active investors, due to lower costs.

Our view is that the average performance of active investors is determined by some investors who are above average and others who are below average. So it is imperative for us to be above average—to be worth more than our freight—to have a sustainable business.

Once upon a time an active manager purchased a bond that had declined after it was issued, for 50 cents on the dollar. It was purchased from another active investor, who took a 50 cent loss. The bond later matured for a dollar, so the bargain-buyer had a 50 cent gain. On average, active investors broke even. But one active manager did better than average, and one did worse than average.

We do a whole lot more than manage investments, of course. Planning to help you work towards your goals, putting market action in context, answering your money questions, coordinating with your legal and tax advisors… these things are also part of our work. But striving to grow your bucket is why we get up in the morning.

Average (ordinary, middling, mediocre, unexceptional) is not good enough. Active investors need to be above the line over the long term. We have no guarantees to offer. But our goal is to be exceptional.

Clients, if you would like to discuss this or anything else, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All indices are unmanaged and may not be invested into directly.

All investing, including stocks involves risk including loss of principal. No strategy assures success or protects against loss.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

 

Did Your Bucket Grow? The Measurement that Counts

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We have an issue with investment theories that look great on paper but may not help people build wealth. The vagaries of human nature mean that investments which are appealing and popular and those which make money tend to be two different things.

In our opinion, Modern Portfolio Theory or MPT is in the category of ‘looks great on paper.’ MPT attempts to mitigate risk by diversifying a portfolio across different asset classes with different risk profiles. But it can not predict the future–this risk analysis is based on historical performance trends. Backwards looking, it tends to work until it doesn’t. It does, however, generate nice pie charts and beautiful rationalizations.

The apparent precision of MPT, based on measuring things that have little bearing or relevance to long term investors, may be a key factor in its appeal. We concluded that a lot of effort goes into measuring things that can be measured, whether or not the exercise is useful.

Recently we measured something in your accounts. We think it is telling evidence of our work together, your effective investing behavior and our research and portfolio management.

You can see in LPL AccountView or in reports we can run for you where your account balance stands relative to your cumulative net investment over time. In other words, your deposits and withdrawals since the beginning add and subtract to determine your net investment. By looking at your balance, we can tell the cumulative net gain or loss you have made over the years.

Many advisors could tell you the expected standard deviation of your portfolio, or the proportions of each asset class you should own, down to the hundredths of one percent, based on past performance. Some offer reports that compare monthly, quarterly, and annual account performance against a series of benchmarks.

If we had to guess we would say our simple measurement is the one you care about—did your bucket grow? And by how much? Clients, if you would like to tell us differently, or have a longer discussion on this or any other topic, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Security Selection Doesn’t Matter—or Does It?

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One of the staples of conventional investing wisdom is asset allocation—the choosing of broad market sectors, determines investment outcomes. Supposedly, the selection of individual securities within each sector barely matters.

We will explain where the flaw is after a little history. The theory dates back to 1986 when the Financial Analysts Journal published a paper, ‘Determinants of Portfolio Performance.’ The authors concluded that asset allocation explained 93.6% of the variation in portfolio quarterly returns.

Since then, others have concluded that as much as 100% of returns are explained by asset allocation, that security selection doesn’t matter at all.

This version of reality is convenient for some financial planners, who are thereby relieved of the work of actually researching securities and managing portfolios based on that research. If it doesn’t matter what you own, only the category, you simply need to choose your pie chart of sectors and buy stuff to fill it up!

Here is the flaw: all securities are owned all the time, by someone. If you look at the aggregate of all investors (or many investors), security selection appears not to matter. But the individual does not own all securities – and the specific selection of what he or she does own has a huge impact on outcomes.

Investor A buys a security for $100, sells it later for $25 to Investor B. Investor B holds it while it recovers to $100. One has a 75% loss, the other a 300% gain. Security selection matters. In the aggregate, the security started at $100 and ended at $100. But that leaves out the loss for one and the gain for another.

One of Warren Buffett’s earliest investors put $15,000 in, back in the 1950s. Today his name is on the home of the symphony orchestra in Omaha, a beautiful performing arts facility he donated to the community. Security selection matters.

We offer no guarantees about the outcome of our work. But we believe the selection of individual securities is the biggest factor in those outcomes. If you would like to discuss this topic or anything else at greater length, email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

Asset allocation does not ensure a profit or protect against a loss.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.