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March 14, 2015

Investment Quotes from Legends

It is important to periodically revisit the  lessons of investing from the great investors – past as well as present. Warren Buffet recently wrote a letter to shareholders celebrating the 50th anniversary of Berkshire Hathaway, which has some real gems when it comes to investing principles. Tren Griffin, a technology, policy  and strategy partner at  Microsoft, writes a very interesting blog ( 25iq.com ) where he covers a dozen things he has learned from a  broad variety of  greater investors (including Warren Buffet, Charlie Munger, Howard Marks, Seth Klarman and  Ray Dalio), business leaders, entrepreneurs and venture capitalists which usually contain some very valuable insights. To summarise the dozen things he has learnt from Warren Buffet’s letter:

1. “We are limited, of course, to businesses whose economic prospects we can evaluate. And that’s a serious limitation: Charlie and I have no idea what a great many companies will look like ten years from now.” “My experience in business helps me as an investor and that my investment experience has made me a better businessman. Each pursuit teaches lessons that are applicable to the other. And some truths can only be fully learned through experience.”

-Treat an investment security as a proportional ownership of a business.  A security is not just a piece of paper. Not all businesses can be reasonably valued. That’s OK. Put them in the “too hard pile” and move on.

2. “Periodically, financial markets will become divorced from reality.”
“For those investors who plan to sell within a year or two after their purchase, I can offer no assurances, whatever the entry price. Movements of the general stock market during such abbreviated periods will likely be far more important in determining your results than the concomitant change in the intrinsic value of your Berkshire shares. As Ben Graham said many decades ago: ‘In the short-term the market is a voting machine; in the long-run it acts as a weighing machine.’ Occasionally, the voting decisions of investors – amateurs and professionals alike – border on lunacy.”

-Make bi-polar Mr. Market your servant rather than your master by  trading with him only when it serves your interests!The best advice is simple: “be greedy when others are fearful and be fearful when others are greedy.”

3. “A business with terrific economics can be a bad investment if it is bought for too high a price. In other words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire is not exempt from this.”

-Buy at a bargain price which provides a margin of safety- i.e.  when securities are purchased at prices sufficiently below underlying value to cushion against mistakes, stupidity or just bad luck.

4. “As Tom Watson, Sr. of IBM said, ‘I’m no genius, but I’m smart in spots and I stay around those spots.'”

-Know your circle of competence and stay within it-  risk comes from not knowing what you are doing. There are a number of behavioural biases that contribution to this problem including overconfidence bias, over optimism bias, hindsight bias and the illusion of control.

 5. “Decades ago, Ben Graham pinpointed the blame for investment failure, using a quote from Shakespeare: ‘The fault, dear Brutus, is not in our stars, but in ourselves.'”

-Most investing mistakes are psychological.  Investing is simple, but not easy. Buffett has a great system, but his emotional and psychological temperament is especially suitable for investing. Like Charlie Munger, he is highly rational as human beings go. Everyone, including Buffett, makes mistakes. You can do very well in investing by just avoiding stupid mistakes.

6. “It is entirely predictable that people will occasionally panic, but not at all predictable when this will happen. Though practically all days are relatively uneventful, tomorrow is always uncertain. And if you can’t predict what tomorrow will bring, you must be prepared for whatever it does. Investors, of course, can, by their own behaviour, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.”

-Buy at a bargain, avoid forecasting  and wait!  You can determine that buying an investment now is a bargain that creates a margin of safety based on a valuation process, but you cannot predict when the price will rise.  So you wait.

7. “Gains won’t come in a smooth or uninterrupted manner; they never have.”

-Investing results will always be lumpy.

8.”Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.”

“It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.”

-Risk is not the same as volatility. It is “volatility” after all which enables an investor to benefit from Mr. Market’s bi-polar behaviour (i.e., volatility is actually the source of a value investor’s opportunity). For the best essay on the proper definition of risk read Warren Buffett’s 1993 Berkshire Shareholder’s letter.

9. “For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky….”.

-Most investors should buy a diversified portfolio of low fee index funds/ETFs.  As Yale’s David Swensen says: “Asset allocation is the tool that you use to determine the risk and return characteristics of your portfolio. It’s overwhelmingly important in terms of the results you achieve. In fact, studies show that asset allocation is responsible for more than 100 percent of the positive returns generated by investors.”

10. “Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game.”

-Follow the “cost matters hypothesis” as described by John Bogle: “In many areas of the market, there will be a loser for every winner so, on average, investors will get the return of that market less fees.”  Mr. Market is both a benchmark and your competition. You need to beat him after fees and costs. Few can beat him and so most should be him.

 11. “Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.” “When bills come due, only cash is legal tender. Don’t leave home without it.”

-The only unforgivable sin in business is to run out of cash. The need for some cash as dry powder applies to everyone, the only question is how much cash to have on hand.

12. “We will never play financial Russian roulette with the funds you’ve entrusted to us, even if the metaphorical gun has 100 chambers and only one bullet. In our view, it is madness to risk losing what you need in pursuing what you simply desire.”

-Black Swans can appear any time. People will try to get you to buy things by hiding this risk.

-Brilliant insights into the investment process from one of the all-time  investment greats and should be the basis  of  one’s toolkit for investing. My personal four key principles form a subset of the above:

-Diversify. You do not know what tomorrow may bring so diversify to mitigate risk.
-Be a Contrarian. By investing when other are fearful and being fearful when others are being greedy allows one to build a margin of safety and take advantage of the bi-polar Mr. Market.
-Be Patient. Allow time to work to your advantage. As Jason Zweig notes: “Regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.” 
-Do not  Leverage: As noted by Jeremy Grantham - It can remove the one advantage the individual investor has over the professionals – patience!  As Howard Marks also notes: “Leverage magnifies outcomes, but doesn’t add value.” 

-As Gavyn Davies  observes in his FT blog:  after a  negative January, February was another very strong month for global equities, with the US market posting its best monthly return since October 2011. Global equities are now up by 5.1 per cent this year, exceeding the  pace of the ‘12-14 advance.  However, there was a significant rotation in terms of performance, with  Europe (+ 14.7%) outperforming the US (+2.2%) – see chart below.  This has been in the aftermath of  the U.S. stock market tripling since 2009, driven by a moderate but continuous recovery in GDP and corporate earnings and (most importantly)  the QE policy by the Fed. However, earnings are now being negatively impacted (with downward revisions exceeding upwards revisions by 33%) by a strong dollar and the collapse in oil prices, and with the Fed likely to raise interest rates this year, the U.S. will probably  underperform Europe and Japan which  have supportive central bank policies in the form of QE.

As the second chart below illustrates, the recovery of global markets from the March 9, 2009 low (for the U.S) continues with India, U.S.,  Japan and Germany (in that order) posting the most spectacular gains. The Shanghai index, with its 52% rally last year, seems to have finally broken out of its trading range over the last 3 years. The buy on sharp market corrections and  reduce on significant rallies approach still holds.


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