Dear Investment Portfolio

Dear Investment Portfolio

Dear Investment Portfolio, we’ve been together awhile now, almost 10 years. A lot of stocks have come and gone during that time leaving their inevitable impressions. Some I should have never sold while others should not have been bought in the first place. But that is how you and the market have taught me. I had to go through those hard lessons in order to grow and develop into the investor I am today. That’s not say I have reached the summit of market knowledge. I’m sure there they will be further lessons to absorb in the future. The investing experience is really a work in progress.

I have seen you bob up and down on the surface of the market as I recorded your weekly values over time. And with those ups and downs I have learned how to compose myself during the storms that can come and go in the marketplace.

You have taught me that you are really just an extension of myself…no its more than that, you are a projection of what is going on inside of me and a way of keeping score so that I can keep track of what I have learned so far.

You are unique because there is no one else quite like you out there. Maybe more than anything else you have taught me the value of extending my time frames and spreading my risk.

You are something I have created, and over time I have seen you develop a faith in myself and the universe that in the long run everything will be okay.

The World of Large Mutual Funds

The World of Large Mutual Funds            

We can all go down together, but I can’t let them go up without me.

Justin Mamis

The manager of a large mutual fund had to report to his boss about his fund’s performance over the last quarter. His fund was down 3 percent over that time frame while the SP500 was up 10 percent. The fund’s mandate was mid to large cap growth with value. They both worked for a large institutional bank (so you know where this is going). The fund manager’s boss asked him what the hell he was doing. Both of their bonuses were hanging in jeopardy. The manager explained he was trying to position the fund into a lot of under followed names that had a good chance to increase in value over the next 2 to 3 years. “Christ”, his boss said, just put the money where everybody else is putting their money. That way we will stay near the index and won’t be noticed. The fund manager said he was trying to make money for the unit holders over the long term. The boss told him “we’re not here to make money for other people we’re here to increase our assets under management so we can make more money for ourselves. It’s important we make our quarterly numbers.” He went on. “We do this by blending into the crowd so we can keep our jobs and collect our bonuses.”

“But I just read this blog on the internet about something called Wager Value”. The boss blew his top. “Wager Value, what the hell is that?”  Maybe I should send you down to inhuman resources for a re-orientation. The fund manager finally agreed to do what the boss wanted. As he left he noticed several other mutual fund managers hiding behind the drapes in his bosses’ office, trying not to be noticed, meanwhile his boss was thumbing through a dictionary trying to look up Wager Value.

Okay, maybe I’m being unfair here. I didn’t mention any of the various investment committees that the fund manager would have to pass his stock ideas through. But it all leads back to the same thing, closet index hugging. Something to keep in mind next time you have to pay your management fees for a fund that is just trying to match the market over the longer term, minus fees of course. Small wonder the herd effect is alive and well in the stock market.

Separating your Ego from the Investment Process

Separating your Ego from the Investment Process


The best way to learn something is to teach it

somebody

Avoid forecasting and making predictions. When you make a prediction about the future, part of your Ego is attached to it. You want to keep your Ego out of the investing process. You really do. The Ego will get in the way of what you trying to accomplish because it will have its own agenda which involves thumbing its nose to the rest of the world when its right and making you feel frustrated and angry when it’s wrong. It has no redeeming qualities; that’s what makes it the Ego. Ever have an argument with someone who proved you wrong but you couldn’t admit it, welcome to the Ego. The Ego is all emotion with little logic and very insecure. It has to feel it is in control so it can exist. It’s really a pain in the ass but despite everything I have said about it, it is allowing me to type these words on my keyboard. So as much as I hate to admit it, I need it or I wouldn’t be able to exist as a free and separate entity. So no matter what I can do I will never really be free from the Ego. It’s like a wild horse who will never be saddled but you have to make peace with it and be aware of its impact on your investing portfolio.

Imagine watching yourself from a third person point of view, like watching a movie of yourself while you go about your business. Learn to observe your own behavior and try to stand apart from yourself and whatever you are doing. You may not be able to totally tame and control the Ego but maybe you can put a lot of furniture in his way so he doesn’t break anything or do too much damage. Making predictions about anything removes that furniture.

Time Arbitrage

Time Arbitrage

Investment is a process in time

Hyman Minsky

There is a short term bias that exists in the world of the stock market. Over time the fast pace of modern society has overtaken everything in our culture including the way we view investing in the financial markets. Everybody wants to make money faster especially when the market is going up and it goes up most of the time. 

The investment industry has morphed over the years into more of a marketing business that is based on satisfying the short term gratification of it's participants. Mutual funds are set up to satisfy what the investing public wants and what they want is short term performance. How the fund performed over the last quarter. There is a recency bias that exists in investing where people are overly affected by what happened last month, last week and even yesterday. In response to this mutual fund managers are constantly judged by their recent performance. Fund inflows and outflows are driven by how they rank against their peers in the last quarter. Faulty incentives are perpetuated rewarding the fund manager for maximizing fund inflows and negating fund outflows. Fund managers end up making decisions based on short term performance while sacrificing long term strategy. It's even worse in the hedge fund world where they are expected to show positive results every month.

And of course the media play their part hyping last years top mutual fund performers with fancy charts and splashy advertising. But in the end the media are only fulfilling the the public's need for instant gratification.

The result of all this is the funneling of money into stocks that are doing well right now. This can affect the way the management of these companies run their businesses with an emphasis on pumping up earnings so they can make their numbers when the next quarter is reported. 

All of this creates a situation that you can refer to as time arbitrage but its really about Wager Value again. If an investor can focus on the longer time term and ignore short term performance in his stock holdings he can fade what the majority of the investing world is doing and make more money in the long run by exploiting these inherent market inefficiencies.

A good example of time arbitrage is when a good company (high returns on invested capital over the years) misses their quarterly earnings number. The market will clobber the stock presenting the astute investor with an opportunity to get into a good investment at a discount. In other words the stock will go on sale for awhile. But the investing public caught up in short term performance will dump the stock instead of buying it. It's the emotion of the market place again and it happens every quarter, all you have to do is wait for it.

In other words, be contrary during market extremes. I know I've repeated that line again and again but its one of the great truths in investing.

Portfolio Management

Portfolio Management

Rule Number One. Keep your investing money separate from the money you need to live on. There is an old racetrack saying, ‘Scared money never wins’ and it is the truth. In other words don’t bet the rent money on the horses or the stocks.

There is a lot of talk about asset allocation in the financial world. I largely ignore it. If you are a passive index investor it does have some merit but if you are a stock picker like me you don’t need it. This world is filled with two types of people, 95 percent of them want take your power away from you (the church, the medical world, the financial world, the media, and probably the government as well) and there is maybe 5 percent who want to empower you. Generally they will not sound like everybody else and tend to go their own way. I say this to warn you about the financial industry. There is just so much bad advice going on out there. Look at it this way, you go to a party and say pleased to meet you while at the same time you’re thinking what an asshole. You say one thing outwardly but are thinking something different inwardly. This applies to all of us as individuals but more importantly it applies to all the so called organizations of the world (governments, financial institutions, medical establishment, the church). They all say one thing but are thinking something else. Think about how the big Banks all talk about the great service they provide you with while they hit you with hidden service charges. So take what the financial world tells you with a grain of salt. End of paragraph.

Take your investing money and separate it into two piles. One pile will be to buy stocks with while they other will be in cash. If you’re a conservative careful investor you might want to have 50 percent in cash and 50 percent in stocks. If you are more aggressive it might be 10 percent in cash and 90 percent in stocks. The Current Market Environment discussed a few posts ago will guide you in this area. And forget Bonds. They are not setup for the small retail investor. Just my opinion of course, if the markets are looking rocky you may want to hide out in a bond ETF for awhile, it’s up to you. Let experience be your guide as it has been for me.

Another thing is to spread your risk. You do not want to put all your money into three stocks. You need to diversify your holdings but you don’t want to over diversify either. I would say you should own at least 10 stocks preferably more to be properly diversified. And you would want them in different industry groups as well. I personally hold 22 stocks in the financial services, industrial, tech, energy, commercial real estate, infrastructure, healthcare, manufacturing and food exporters areas etc…and each industry group will have sub groups within them. I also own several Master Limited Partnerships. It all comes back to spreading your risk because random events can occur disrupting your portfolio so you have to have it structured so you won’t be shaken out of your holdings.

I have most of my money in what I feel are my best ideas so my portfolio does not have an equal amount invested in each position. When you start off you probably don’t want to do this but as I have said before let experience be your guide. As you gain more experience you may want to weight some of your holdings heavier than others.

And lastly all of my investments are in Canada as I find Canada to be a fairly inefficient market. Some will tell you, you have to be invested globally but as many of my companies do much of their business abroad I already have global exposure. I guess that’s it. If I’ve forgotten anything I will talk about it in future posts. The first 5 posts I’ve done pretty much encapsulate my approach to the markets so far but I am still learning.

This is my 5^th post in two days after starting this blog yesterday. I have looked upon what I have done and it is not bad but I am tired and will rest even though this isn’t the seventh day. 

Psychology

Psychology

I have seen the enemy and it is us.

Pogo

Your own internal thought processes and feelings are probably more important than everything else put together. If you do not have your head squared away the way it should be everything else you know about the market will not help you. Therefore it pays to examine your own behavior and feelings both about yourself and the outside world in general. We are a product of our early childhood conditioning which provides us the foundation in which we judge all the experiences we have gone through since. Examine your reactions to various life situations and you will find out a lot about yourself that you might not have thought about before. Think about when someone says your wrong about something, or when the stock you just bought drops 20 percent in one day. That last one happened to me except that it happened in 20 minutes. You get the idea. The way we react to what we face in life and in the market will go along way in determining your success or failure in whatever you decide to do.

Here’s one suggestion. Try not to get too excited when things are going well and avoid getting too depressed when things turn against you. Try to keep things in balance and keep a level head. Imagine yourself on the outside of your life, looking in. Be objective and pause. Take a deep breath and breathe out. Do it again. Gain some perspective on things. Review what you have done in the market and be objective with yourself. Have you made any mistakes? If so don’t beat yourself up about it, try to correct them. Try to learn from them. It’s only a game. If on the other hand you’re doing quite well, stay humble and be thankful. The Gods of Investing and Trading must be soothed and appeased. The market is a mirror to your own internal life processes and will reflect back to you what you are telling yourself.

I’m not trying to sound like the book of knowledge here. Remember this is a diary to myself you are looking into. I’m talking to myself as much as anyone else. One other thing, sometimes there is nothing to learn. Sometimes something bad happens due to bad luck, just a random event. That’s the nature of the markets. Remember in the long run the random events both good and bad will even themselves out. It really is just a game.