A Brief Word on the Election

“We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.” –Warren Buffett, 1994 letter to Berkshire shareholders

To say that talk of the election dominated the news over the last 6 months would be an understatement. Despite all the noise and vitriol, from our perspective the election was mostly a non-event. We are business owners focused on the long-term ability of our companies to thrive, not on the price Mr. Market may be willing to pay us for our businesses on any given day, and we were thus well positioned regardless of the election outcome.

As always, we seek to own a collection of businesses that will appreciate over time through whatever bumps in the road may come. We thus sought to ignore the noise and invest without regard to emotion, except to feel slightly positive given the pervasive sense of negativity.

Source: http://latticework.com/a-brief-word-on-the-election/

Fooled by Conviction – Commentary on the original S&P article


  • Diversification is a cornerstone of portfolio construction. It provides investors with the important ability to invest in the face of uncertainty.  Because it can reduce risk without necessarily sacrificing potential reward, it is known as the only free lunch on Wall Street.
  • Yet, we believe that many investors under-utilize a less well-known type of diversification: process diversification.
  • When it comes to asset allocation, we regularly run across a “high conviction” bias whereby investors with their own approach to asset allocation are hesitant to incorporate complementary allocation strategies.
  • The reason for this behavior seems to be a fear that adding managers with different approaches to asset allocation will dilute the investor’s own views.
  • We believe that investors should blend a set of complementary, evidence-based asset allocation approaches (e.g. combining a strategic allocation with a momentum-based approach, a value-based approach, and a risk parity strategy), even if these different approaches regularly hold conflicting views about various asset classes. Doing so can capture the upside of each approach with less extreme allocation swings, better asset class diversification, and lower tracking error (an important consideration in managing client expectations).

Incorporating complementary processes reduces risk in two important ways.

  • First, overall portfolio volatility will be lower.  Why?  Because as we saw previously, using multiple allocation processes reduces the likelihood of large bets on a subset of asset classes.  This allows the overall portfolio to more consistently harvest available diversification opportunities.
  • Second, tracking error will be lower.  While this will indeed lower the chances for large outperformance, it will simultaneously lower the odds of large underperformanceIn our view, managing this downside tracking error is crucial as it helps to control behavioral biases that can interfere with long-term investment success.

he list of evidence-based approaches is usually limited to some combination of the following:

  • Strategic (e.g. balanced portfolios, 1/N, maximum Sharpe, etc.)
  • Momentum
  • Value
  • Defensive
  • Carry

No allocation approach has an equal ex ante probability of success across all market environments.  Evidence-based investment processes that are successful over the long-run can still go in and out of favor over extended periods of time.

Source: https://blog.thinknewfound.com/2017/02/embracing-conflict-asset-allocation/

Fooled by Conviction – Original

In order to improve performance, advocates of active management have begun to argue that managers should focus exclusively on their best ideas, holding more concentrated portfolios of securities in which they have the highest confidence. In contrast, we argue that if it becomes popular, such “high conviction” investing is likely to:

  • Increase risk
  • Make manager skill harder to detect
  • Raise asset owners’ costs, and
  • Reduce the number of outperforming funds

These arguments apply even if we accept that security selection skill is prevalent among active managers. Concentration only makes sense if managers have a particular type of skill, and this skill must be intrinsically rare.

Source: http://us.spindices.com/documents/research/research-fooled-by-conviction.pdf

The Art of Looking Stupid

  • The investment management industry is filled with thousands of extremely smart people …  One thing I’ve learned over the years is smart investors – understandably – don’t like to look stupid.
  • That’s a shame as looking stupid is often necessary when practicing absolute return investing … As long as performance deviations aren’t due to valuation errors and permanent losses to capital, investing differently during periods of inflated valuations may not be stupid at all, but a sign of discipline, perseverance, and even intelligence. In other words, looking stupid is not the same as being stupid.
  • Instead of being ashamed or embarrassed, I view my ability and willingness to look stupid as a competitive advantage … Patient positioning almost always looks questionable or unintelligent during periods of sharply rising asset prices and inflated valuations.
  • The secret of looking stupid, is not caring what other people think. Perception risk is a very real and underappreciated risk in the investment management industry. In my opinion, it’s one of the leading threats to investment discipline and one of the reasons so many active funds look the same as their peers and benchmarks. If you’re constantly concerned about what your boss, peers, and clients think about you and your positioning, you’ll never master the art of looking stupid.
  • To be clear, looking stupid indefinitely is not a smart long-term strategy … The goal of positioning differently, or remaining patient during market extremes, is to ultimately take advantage of the inefficiencies and distortions created by conformity and group-think. Eventually cycles end and the mispricing and extrapolation of market extremes unwind. This unwind can create tremendous opportunity, which should allow flexible absolute return investors to shift from patient to aggressive positioning. In effect, there should a period each market cycle when opportunistic and aggressive positioning is necessary and ultimately beneficial.
  • The purpose of looking stupid is to look smart over a complete cycle. While I’ve had some of the worst in-between cycle performance, I’ve also had some of the best complete cycle returns. To successfully look stupid and generate attractive full-cycle absolute returns, investors might consider setting their egos aside, think independently, and eliminate the importance placed on perception.

Source: http://ericcinnamond.com/the-art-of-looking-stupid/

Should you buy real estate?

Once you make up your mind, you see only data confirming that view. This is called confirmatory bias. So here is a confirmatory bias article that I found on Huffingtonpost.

Normally I do not like stuff on H’post…but this is a good article meant for RE lovers I guess. I fully agree with the author on:

  1. Indian RE is terribly over priced
  2. Our salaries have not kept pace with the RE prices, or RE prices have run far ahead
  3. RE prices have to correct 50% or rents have to double soon
  4. If you own RE, you should not be proud, you should be worried about marketability
  5. The cap of Rs. 200,000 on interest on rental property will lead to correction in the RE prices for now

Source: http://www.subramoney.com/2017/02/should-you-buy-real-estate/

Looking for Alpha

Be off the radar.

Find micro caps.

Turn more stones than others.

You need an edge to make supernormal returns in the markets. You generally cannot exploit a) information asymmetry but b) processing/analytical or c) behavioural with mid or large caps. The last i.e. c) being the most sustainable edge with longest durability. Eventually the game runs out with information asymmetry.

So, my goal has always been to exploit a) as much as possible. In fact I went to far off places to seek alpha with a) including Middle east, Fiji, Kenya, Nigeria, Nepal, ended up investing in a couple of these markets. It continues to work.

With lots of connecting dots over time and experience one can exploit b) intuitively like pattern matching. But c) can take you to play the game in billions not just millions. Which is when others are losing their head you keep yours.

Source: https://lifeandequities.wordpress.com/2017/02/02/go-micro/

The other side of uncorrelated

In the end, nearly all of these investors in so-called “alternatives” are doomed to fail because of unrealistic expectations and unreasonably short holding periods. They don’t know what they own and they are unwilling to take the time to understand the why, relying solely on past returns (damned lies and statistics).

The WisdomTree Managed Futures product was in fact uncorrelated to stocks (-.04) and bonds (.01). But it was the other side of uncorrelated that transpired, the side no one wants to talk about or accept: the times when the “alternative” is down when the other things in your portfolio are up. If something is truly “alternative” and uncorrelated, these times will inevitably happen.

That’s not a defense of WDTI but a reality of diversification: if everything in your portfolio is “working” at the same time, you’re probably not as diversified as you think. I have no idea if WDTI is a good or bad investment. That may seem silly to some because its returns have been subpar.

How could something that has lost money for six years possibly be anything but bad?

  • Well, while six years seems like an eternity, we know some of the best strategies in history have had negative 6-year returns. How can we be sure that WDTI is not one them and just happened to start out with a bad string of luck? We can’t.
  • We also know that past performance tells you nothing about the future. If investing was as simple as picking the best performing strategies and asset classes ex-post (after-the-fact), we would all be infinitely wealthy. But the market doesn’t work like that, does it? In fact, the opposite is more likely to be true (see “The Harm in Selecting Funds that Have Recently Outperformed.“)

I have come to understand that this thinking, while unfortunate, is inevitable. Investors love the idea of non-correlation and diversification so long as everything is going up and to the right – and at the same time.

That’s true of stocks, bonds, gold, hedge funds, value, momentum, and any other asset class or strategy you can think of. So long as it’s going up, it is “working” and there is no risk. But the minute it starts going down, that’s a problem that requires immediate action, for the other side of uncorrelated is simply intolerable.

Source: https://pensionpartners.com/the-other-side-of-uncorrelated/

6 smart tips for micro-cap investors

1) When it comes to investing, don’t be a chicken, be a hawk : Don’t be afraid to say no to 99.9% of investment opportunities. You only need to find one great company, before others, to change your life. Extraordinary returns follow extraordinary discipline. An investor’s goal should always be to make as few investment decisions as possible. Keep your hurdle rate high and embrace inaction.

As you fly above the investment world looking for opportunities, develop tools, strategies, even statements, that you can apply quickly to evaluate opportunities. Know what you are looking for so you can develop the vision to recognize an opportunity quicker.

2) Don’t bother finding the next multi-bagger if you are not going to develop the conviction to hold it: Stocks rarely perform in the time frames we predict, and it’s why the market only works for investors that have a long-term portfolio focus. Performance is never linear, up and to the right, year after year. You sometimes have to hold onto a position for a few years before it goes up 100% in 3 months.

If you’re invested in great businesses that continue to grow and earn more money, don’t let lulls in stock price and boredom scare you out of them.

Investors tend to over-analyze when stocks are going down (fear) and under-analyze when stocks are going up (greed). ‪The hardest part of investing is holding through these times, embracing boredom and inactivity, and distancing human nature-emotion from investment decisions.

3) Learn to differentiate between business performance and stock performance: Sustainable multi-baggers have certain characteristics: Long-term revenue and earnings growth with little to no dilution. When you are holding onto a position ask yourself – Is this business growing and making more money per share than it did a year ago, two years ago?

Successful investors can differentiate business performance from stock performance and can take advantage of those investors who can’t.

4) Avoid piling into a position at one go: All my winners had one thing in common, I was always averaging up. Most of my losers had one thing in common, I was always averaging down.

My personal investment philosophy is to buy microcaps that I think can be 5-10x in a few years. It might sound insane, but I don’t buy stocks where the peak potential return is less than 100%. I’m look for and buy undervalued companies that have the potential to get very overvalued.

5) Successful investing isn’t about being right all the time; it’s more about the ability to identify when you are wrong quicker: When you find yourself constantly averaging down it’s normally a sign that your ego has taken over. You’ve convinced yourself you have to be right, but you forget that being broke and right is the same thing as being wrong. Your ego clouds your judgment and slows your thinking. Many investors have gone broke trying to prove the market wrong, and you certainly aren’t going to prove yourself right by throwing good money after bad.

6) The management makes the difference: The smaller the company, the more should be the focus on management and qualitative analysis. CEOs of small microcap companies tend to wear a bunch of hats, so their influence is much greater than larger companies. Founders are the difference makers.

Invest in management teams that focus on the long-term and let their execution do the talking: 90% of microcap management teams say too much and do too little. This rare breed is called “intelligent fanatics”. I want to invest in owner-operators that have an intense focus, integrity, energy, and intelligence.

In conclusion, keep this in mind:

  • I like companies with no debt, or at least low debt. Small companies and debt just don’t go well together. Travel light, travel far.
  • Cash flow, not reported earnings, is what determines long-term value. Undiscovered companies that can sustain 30-40+% growth rates from internally generated cash flows are hard to find.
  • Look for owner-operators with intense Focus, Integrity, Energy, and Intelligence.
  • For a small microcap company to be a market leader, it must dominate a small market. I want to own businesses that dominate a small market that is expanding. This normally pushes quality attributes down to the financials.
  • Look for a clean capital structure. I look for low outstanding shares, all common shares, and low amount of warrants/options as a percentage of outstanding shares. You want to invest in a management that treats its shares like gold.
  • I prefer no institutional ownership. When you find and invest in great businesses that bigger money doesn’t own, the stock has nowhere to go but up.
  • Find repeatable, sustainable, profitable growth. My biggest risk as a microcap investor is dilution. I want to find companies that are self-funding their growth.
  • Buy when the business is fundamentally undervalued to limit risk and to fully leverage multiple expansion. Your margin of safety is buying an undervalued business that can get overvalued.
  • What counts in the long run is the increase in per share value, not overall growth or size.

Source: http://www.morningstar.in/posts/39305/6-smart-tips-for-micro-cap-investors-2.aspx

Buffett’s genius

In fact, his [Buffett] true genius isn’t just his ability to identify undervalued companies; it’s his ability to buy and hold onto those companies through the inevitable fluctuations that all markets experience. That’s not just about insight. It’s also about an ability to divorce yourself from emotion, to be rational at a time when other people are acting irrationally, and to be calm when others are fearful.

On the walls of the Berskhire offices, framed front pages from days of market panic, like the 1929 financial crash, serve as a reminder not to succumb to the passions of the moment. That’s something that all investors know they’re supposed to do. But actually being able to do it, being able to buy when everyone else is screaming, “Sell,” and not to buy when everyone is telling you to do so, is a very hard thing for most of us. For Buffett, it seems to have been as natural as breathing. But it’s not difficult to see how that hyperrationality, that ability to divorce yourself from what’s going on around you, might also make it difficult truly to connect with the events of everyday life, which happen, after all, in the moment. Buffett was born to be great at investing. He had to work really hard to be good at living.

Source: http://www.newyorker.com/business/currency/becoming-warren-buffett-the-man-not-the-investor

The three basic metrics for evaluate gold mining stocks

 [00:28] The first one is market cap per oz of production. Market capitalization is simply the number of shares the company has times the price. So you multiply the two together that’s the total value of the company is valued by investors. If we divide that by the number of ounces of company produces in a year we get the market capital per oz of production and right now those numbers average around four thousand dollars an ounce.

[00:54] Market cap per ounce of reserves of PnP reserves. Proven and probable reserves are the highest definition reserves can have. That’s what you build mines on, proven and probable reserves. So market cap per oz of proven and probably reserves is the same thing, in a sense of a mine typically has 10 times the number of reserve balances it produces in a year then this number usually is that going to end up around three or four hundred dollars an ounce were as productions around four thousand dollars an ounce.

[01:24] Operating cash flow to market cap. Operating cash flow this is the key because it tells us how profitable of mine is. Operating cash flow is simply you take the gold price and you subtract from what are called the cash cost of producing an ounce of gold. That’s the labor, the power, the steel, everything that goes into getting an ounce of gold out of the mine on an ongoing basis. It’s not the cost of building the mine, it’s the ongoing cost of operating the mine. So if we divide the market cap by the operating cash flows that the mine generates every year, that’s subtract the cost of production from the gold price multiplied by the number ounces a year that gives us the OCF. If we divide the operating cash flow into the market cap we get an OCF multiple and over time that number [MC/OCF] runs around 6 to 7 times average in the industry.

[02:16] So we’re looking for companies that are below the average of production and reserves and operating cash flow multiple. That means that the company is being undervalued by the market. Those are the companies we want to look at. We’re not so interested in companies that are overvalued because they don’t have so much left in the upside.

Source: https://www.youtube.com/watch?v=RGFhRw1ZLjI