Posts Tagged "finance"
Market Folly posted Baupost’s investor letters from 1995-2001. Seth Klarman is acknowledged as a fantastic and disciplined value investor. My thoughts from the investor letters are:
1) I enjoy reading the views of an intelligent market observer from a time that I experienced but did not have the mental framework to understand.
2) Seth Klarman was very fortunate to have already built up a track record and have investors who trusted him. He underperformed the S&P 500 for five straight years, from 1995-1999. In 1998 Baupost lost 16% when the S&P gained 22%. The relative underperformance for 1995-1999 was 17% per year! By November 1999 Baupost had underperformed the S&P 500 by 5.5% annually over 10 years.
Baupost’s subsequent performance validated the support of his investors and Klarman’s dedication to value investing principles. But that does not matter! Anyone else would have been fired or deserted by their investors, and mocked for trying to describe their mediocre performance as the fault of a “crazy” market. It is very difficult to identify investment skill - I know that Klarman is one of the best investors out there, but his performance statistics from 1995 through 1999 don’t show it.
I’ve read that value investing will result in periods—sometimes long periods—of relative underperformance. But 5 years! That is a long time to wander the wilderness.
I wanted to see what stock prices look like in terms of something other than dollars. So here’s the S&P 500 in ounces of gold, from 1975, the S&P 500 in barrels of crude oil, from 1986, and a long series below - the DJIA in ounces of gold, from 1897.
I don’t know what I was expecting to find, but the minimal growth in the value of equities is surprising. The annual real growth of equities was 1.3% from 1897, and 2.5% from 1975 and 1986. Dividends help, but these are still small numbers.
One year of stocks
I lost my old job one year ago (last day was 2/3), the upshot was that I could start buying stocks instead of just mutual funds. This was great because I like picking stocks and I don’t trust mutual funds. I don’t write about stocks on this blog because I don’t want to bias my thinking and because no one cares, but I want to do a one year public review anyway. Still, I will not identify stocks that are in my portfolio.
Returns:
Simple Return: 28.9% (=Value now/(Initial Value+Contributions during the year)-1)
IRR: 36.9% (XIRR in Excel)
I don’t know how to best express the return since the simple return is what I actually have, but it doesn’t take into account that I added about 50% to the portfolio with new money over the course of the year, which brings down the return because the new money had less time to grow.
I’ve been comparing myself to the S&P 500, and its total return for the past year seems to be 24.4%. If I had just put my money into the S&P 500 on the same days as I added it to my portfolio, my return would be 21.7% (IRR of 24.8%). I guess I can say that I beat the S&P 500 by 7%. That is only one year, so it does not mean much.
Lessons of the past year:
* I do not want to play banker. I bought Two Harbors (TWO) on margin, and made money on it, but I really did not like feeling that I had tied up all of my available capital and would be unable to buy a good cheap company if I came across one. I should not tie up money in clever strategies - I should just focus on finding good cheap stocks.
* I should probably not short stocks. I should especially avoid shorting stocks of companies with good businesses and managements that are good capital allocators just because they are overvalued. Duh! Why couldn’t I learn that from other people’s mistakes!?!. I am not going to make money if the market declines, all I can do is buy when I find something cheap. I should only short a stock if the company is going bankrupt and the price does not remotely reflect that.
* Using margin seems fine when I borrow less than 24% of my equity and have money coming in to pay it down over a short period of time. Still, I don’t think that margin debt helped me very much, as I could have bought everything later, with cash, at a better price. Margin should be something that I keep in reserve and only use if I find something great and don’t have enough cash.
* I like turnarounds and will try to put more time and money into them going forward. The two turnarounds that I own were my best performers, and I bought less than full positions in both. I should not get too excited by two stocks in one year, and must make sure that potential turnarounds really aren’t going bankrupt, and that there’s something healthy once the cancer is removed.
* I make mistakes - I was lucky to sell Ocwen (OCN) at a good price after I lost faith in my ability to value it. This and my short were mistakes.
* The only stock that did not get cheaper after I bought it was J Crew (JCG). Just because I find something does not mean that it will stop being mis-priced. I should double-check my work, trust it, then act and accept that the stock will probably move against me.
I went to the library today, as I’ve been unable to find Keynes’s investment correspondence for sale for the $100 or less that I’d pay (I found out about the book on this blog). I learned some things:
1) my phone’s camera is so good that I don’t need to use a xerox machine
2) bring earplugs to the library - those guys are weird, annoying, and loud
3) Keynes was one of the best economists of the 20th century, extremely plugged in to politics, and still - unable to make money with macro investing.
4) Keynes eventually became a successful value investor, proving the power of Charlie Munger’s quip: “I’m right, and you’re smart, and sooner or later you’ll see I’m right.”
I might post a link to my google doc pdf of 20+ good pages from the book.
John Maynard Keynes, Value Investor
Memorandum for the Estates Committee, Kings College, Cambridge, 8 May 1938
…In fact the chief lesson I draw from the above results is the opposite of what I set out to show when, what is now nearly 20 years ago, I first persuaded the College to invest in ordinary shares. At that time I believed that profit could be made by what was called a credit cycle policy, namely by holding such shares in slumps and disposing of them in booms; and we purchased an industrial index including a small holding in an outstanding share in each leading industry. Since that time there may have been more numerous and more violent general fluctuations than at any previous period. We have indeed done well by purchasing particular shares at times when their prices were greatly depressed; but we have not proved able to take much advantage of a general systematic movement out of and into ordinary shares as a whole at different phases of the trade cycle. In the past nine years, for example, there have been two occasions when the whole body of our holding of such investments have depreciated by 20 to 25 per cent within a few months and we have not been able to escape the movement. Yet on both occasions I foresaw correctly to a certain extent what was ahead. Nevertheless these temporary severe losses and the inability to take substantial advantage of these fluctuations have not interfered with successful results.
As the results of these experiences I am clear that the idea of wholesale shifts is for various reasons impracticable and indeed undesirable. Most of those who attempt it sell too late and buy too late, and do both too often, incurring heavy expenses and developing too unsettled and speculative a state of mind, which, if it is widespread, has besides the grave social disadvantage of aggravating the scale of the fluctuations. I belive now that successful investment depends on three principles:
(1) a careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probably actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time;
(2) a steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it is evident that they were purchased on a mistake;
(3) a balanced investment position, i.e. a variety of risks in spite of individual holdings being large, and if possible opposed risks (e.g. a holding of gold shares amongst other equities, since they are likely to move in opposite directions when there are general fluctuations).
On the other hand, it is a mistake to sell a £1 note for 15s. [CR: 75 pence in modern terms] in the hope of buying it back for 12s. 6d. [CR: 62.5 pence in modern terms], and a mistake to refuse to buy a £1 note for 15s. on the ground that it cannot really be a £1 note (for there is abundant experience that £1 notes can be bought for 15s. at a time when they are expected by many people to fall to 12s.6d.).
Another important rule is the avoidance of second-class safe investments, none of which can go up and a few of which are sure to go down. This is the main cause of the defeat of the average investor. The ideal investment portfolio is divided between the purchase of really secure future income (where future appreciation or depreciation will depend on the rate of interest) and equities which one believes to be capable of a large improvement to offset the fairly numerous cases which, with the best skill in the world, will go wrong.
I decided to update my rent vs buy post from October ‘09. Buying a one bedroom apartment in Manhattan has gotten a little cheaper—relative to renting—in the past year. But it’s still far from where I would want to buy. I will wait until monthly house payments are half of monthly rent.
Bailouts
A friend and I met up tonight, and over some drinks we were in heated agreement over how governments have not been dealing with failed institutions properly, be they automobile manufacturers, insurance companies, or banks.
My solution is for the government to be a DIP (debtor in possession) lender only. No ownership of equity, no protection for equityholders or bondholders, just protection of the operating business. So the government cash infusion would be enough to guarantee banks’ deposits, swaps and other contracts (except executive compensation, I’d probably reject those because you shouldn’t get paid for driving a company into the ground), but not any subordinated debt, and certainly not equity. Then the business would work its way through reorganization, and have an initial public offering. The new cash would first pay the government its principal and interest, as it’s the most senior lender, then the secured lenders, and anything left over would pay subordinated debt—and if by some miracle money was left beyond that—and prior equity holders. This is how restructuring works when the government isn’t injecting money, and it should be how it works when it does.
These bailouts of bond and equity holders (see Ireland, this week) are such a misuse of money. For example, why do the shares of the Bank of Ireland have any value? Restructure it and wipe them out!
The institutions would be stronger, and more useful to society, if they were restructured properly. If other companies face a crisis of confidence and go under, let them, the government can step in as many times as necessary - because it will always be repaid in full. The only people who get hurt are investors, and that’s all in the game.
"In essence, the Fed now will print money to buy as much as $900 billion in U.S. government bonds through June—an amount roughly equal to the government’s total projected borrowing needs over that period."
—The WSJ wrote it better than I did (but I wrote it first).
The FT added a bit more:
“With the US Treasury expected to issue $1,200bn in debt over the next year, the Fed’s purchases under QE2 are expected to absorb much of the new supply and keep yields low.”
