On Having A Variant Perception

What a great term, ‘variant perception’. It sounds both straightforward and intelligent. The meaning is also both simple and profound. How does what I think differ from what everyone else is thinking?

Well, if you take a moment to consider it, you’re really not going to do particularly differently to the average if you lack a variant perception. Equally, it’s worth considering that the ‘crowd’ could very well be correct in their thinking, and by seeking to be contrarian too often, you may end up fighting against the tide.

What this whole Value Investing business boils down to is the attempt to find better-than average businesses at lower-than-average prices. Ideally you’ll find a superstar business at a price usually reserved for basket cases, but that may be a wish too far for most of your lifetime (incidentally these wishes were coming true for brave investors back in March 2009).

Well, having tried both the global macro approach to investing, and the value investing approach, it just seems to me far, far easier to have a useful insight and a ‘variant perception’ in the field of relatively simple-to-understand businesses (micro-economics) than in the field of enormously complex and difficult-to-understand global economies (macro-economics). Not to say that the latter is impossible, I just personally find it much, much harder most of the time.

Being a fairly simple soul, and thinking that results gained from less effort are superior to those gained via more effort, the value approach seems preferable to me over the alternatives. This is especially true with small sums of money to invest, however I can see how things would change as the pool of capital under management gets large enough to limit your investable options in the equity space.

Back to ideas and performance, as it’s the end of the year. Some mixed luck came my way on the 11th of December. HMS, spiked up in price on news of an all-cash bid taking place. The price went from 125p to 215p in the course of the morning, and has been gradually ticking up towards the 233p takeover price ever since. This sort of luck is something that I’m very happy to receive every once in a while, although it is somewhat mixed as the company would be worth far more if it could secure reasonable funding from the banks. In the absence of available credit, it makes sense for them to sell out to a well-financed entity, but the deal was struck at a lower price to the acquirer than I think the enterprise was worth.

Anyway, that provided a nice boost to the portfolio to end the year up 24.1% versus 27.6% for the FTSE 100 index with dividends reinvested. Since inception the portfolio is now up 80.3% versus 31.8% for the FTSE and 1.9% for the S+P. Over the past 3 years the portfolio is now up 52.7% against returns of -1.0% for the FTSE and -16.0% for the S+P, also with dividends reinvested. Long may the outperformance continue!

In terms of current ideas, I’m looking at a US stock that builds GPS units, called Garmin, Interior Services Group and Lo-q in the UK, as well as Velosi and a fair few others. I’ve also been screening for new ideas via the Company REFS service and via the Bloomberg system, which has produced a cacophony of stocks to research in more detail. I’ve been meeting a few hedge fund managers to hear how they invest and talk about my ideas with, as well as some potential investors.

Well, a new decade is here and it’s time to look ahead. Significant uncertainty is all around, but this is always true no matter what the talking heads or wisdom of crowds tells you. I’m very pleased to have kept a record of the past year as it could well prove to be one of the most instructive (and possibly constructive) 12 month periods in my life. Whatever happens next, I’m guessing my role will be far more in-line with my ideals than in the past, which is a pretty nice thing to be able to say about your outlook, even if it’s not a particularly variant perception.

Tomorrow, And Tomorrow, And Tomorrow

One of my favourite stock market quotes comes from the great American Financier (or robber barron, depending on your view) - J.P. Morgan. When asked what the stockmarket will do next, he responded that, "It will fluctuate." And that is about the most prescient answer anyone could ever give on the subject.

Anyway, investing isn't about peering into a crystal ball and seeing what will be. It's a search for opportunities where, on balance, the likely reward of an investment outweighs the potential risks. You can concentrate your risk in a few high-potential investments, or spread it over more ideas that collectively should give you less volatile returns. All this balancing of risks and rewards is a tricky business. This past week or two being a case in point.

One of my favourite stocks at the moment is a little minnow that I now have a reasonable amount of shares in called Lo-Q (ticker LOQ). From looking at the annual report, reading information on the internet, reading the available broker note, talking about the business with friends, thinking about the business lots and finally speaking to the founder on the phone recently, I have formed a strong view on the likely fair value of the business. And my valuation (around £40m) was just a little bit higher than the market cap of the company as quoted on AIM last week. Just a little bit being £30m higher (or a potential 300% rise from the current £10m market cap)!

Back in October I sold out of two business I thought it wasn't worth being in - Umeco and Severfield Rowen. They both seemed undervalued still but my other ideas just seemed better. Plus I was starting to really understand the concept that it's hard to think about more than, say, 6 ideas at once as I was having trouble thinking very deeply about the 11 ideas I had in my portfolio at the time. So I sold out of those two stocks in favour of Lo-Q and Staffline (ticker STAF).

Of course Umeco promptly rallied from 290p to 350p, which just reminds me (again) that my short-term market timing skills are rubbish to say the least. In consolation Staffline managed a 42% rally in November, which was nice.

So this LOQ then. At the end of the analysis I just saw a great, growth business with relatively few issues to derail growth over the next couple of years at least. And at 75% undervalued, a fairly compelling prospect. What to do. Hmm. I thought about selling out of the larger issues I have that are less undervalued (BRK.B at 20% and EMG now at 40%). Probably a good idea, but that's not how a balanced portfolio would look. And there's the rub.

If I'm managing this mini-portfolio with a view to showing others how I would manage their money one day that's one thing (and being somewhat diversified to reduce volatility and avoid potential value traps makes good sense). However, it is a little different to what I should be doing if I were just managing this tiny amount of capital with the very pure goal of maximising post-tax returns in mind.

Recently, it's begun to sink in that I'm going to struggle to get any sort of investment business underway without some fairly huge levels of confidence in me from a set of very well capitalised supporters. And the types of people who would back me would basically ask themselves, "If he's so good, why is he so poor?" Which ends up with the slightly tortuous conclusion that, to be in a position to manage money away from the crowds, I first have to have enough behind me so that I basically don't need to work. Well, if that's what it takes, then so be it.

There's some freedom in the above, though. I was fixated on making my portfolio work in a way that would be operationally viable with a much larger sum than I am currently managing. And the case in point, LOQ, is not something that anyone with decent sums of money could invest much in. If you're managing £100m or so and want to get a decent return, you've got to start looking at companies with market caps broadly in excess of £100m to avoid owning more of the company than you can get in and out of easily. Any smaller and you're going to end up owning such a large chunk that you'll move the price significantly on your way in and out, thus eliminating the potential profits that a smaller fund could benefit from.

Happily, mini-investors with the time and skills can look in this sub-£100m market cap universe and find a wealth (literally) of undervalued gems to put their money to work in. Frankly, it seems like a decent investor with small sums of money should be able to totally destroy the market averages by investing a concentrated portfolio in this universe of stocks, so that's where their attention (and mine while not working for anyone else and managing miniscule sums) should be focussed.

It's been a year since I started this blog now, so I may post less frequently from now on. Here's the current portfolio and performance since inception, as at 30 November 2009. Hopefully I'll be able to update the portfolio and performance and check back on how the likes of LOQ are progressing in the future. It's good to get ideas down before the event, and check back later to see how things are panning out. As Buffett says, "In the business world, the rearview mirror is always clearer than the windshield."

Portfolio

BRK.B - 19%

HMS - 18%

MTEC - 18%

LOQ - 12%

EMG - 11%

ISG - 9%

WMH - 6%

STAF - 6%

GMG - 5%

Returns

(Compound)

Since Inception 3 years 1 year

Portfolio 59.2% 38.4% 7.1%

FTSE 100 26.0% -2.4% 26.8%

S&P500 -0.3% -16.4% 26.7%

(Annualised)

Since Inception 3 years 1 year

Portfolio 10.3% 11.2% 7.1%

FTSE 100 5.0% -0.8% 26.8%

S&P500 -0.1% -5.8% 26.7%

Inception was on 10 March 2005. Portfolio returns are calculated after all costs (paying the spread, stamp duty and dealing costs) but uses the mid-price for current valuation purposes. Index returns assume dividends are reinvested and do not take any costs into account (meaning the actual returns from investing in such indexes would be lower).

A Bright Future

As the investor awoke from his deep slumber, the masks he had been trying on for size during his European sojourn fell away to reveal his true self. The sun was rising in the sky as he stretched his arms high above his head and his now expansive vision of what was to come filled his mind with wonder, excitement and no small degree of trepidation.

There is now a fairly unshakeable belief in me that I can outperform markets in general by a wide margin over time. That belief (and the expected outperformance) is large with small amounts of capital and shrinks with larger amounts. I think that most professional investors would say the same thing, but few probably have personal investment accounts that show they have been able to actually do this. Sadly, only a minority will have professional performances that beat the market averages over time - especially once fees are taken into account.

It may sound egotistical to say you are better than the professionals at an activity, especially one regarded as being so difficult to master, however, for the enlightened at least, the investment game is surprisingly simple and easy to outperform in. That is, before you take behavioural biases into account.

Plato once said, "For a man to conquer himself is the first and noblest of all victories." This couldn't be more prescient in the field of investment management. The only way I know to overcome the inevitable biases is to stick with one strategy and not be swayed by the emotions of the market. Whether or not this will be possible is entirely dependent on temperament. By understanding exactly why you should have an edge in investing, and checking each time you make an investment decision against a list of credentials for making investments, you can alleviate many of the biases that lead to poor performance.

The simple process of finding undervalued stocks may involve a vast amount of hard work, but happily this will neither feel hard or like work if you love what you are doing. You only need to sit and think carefully for half an hour or so on a given company to have an edge on many of the people who will end up buying or selling shares in that company's stock over the next few years. Some will be depressed at it's prospects and offer you very favourable terms to sell you shares in the enterprise at a low price, and some will be highly enthusiastic about the future for the company and willing to pay you a compellingly high price for a share in its expected future profits. It is the induced hope and fear of others that creates such rich opportunities for those with the right temperament, who are also willing to do a bit of work, to profit from their folly.

Sadly, many investors decide to invest for reasons other than a perceived gap between price and value. Exploiting the difference between the two is the lynchpin of the value investing process and has worked over and over again through a variety of markets and with clearly understandable and repeatable results (perhaps more in direction than in magnitude). That few appear drawn to the process seems odd, but when you factor in career risk for professionals and the extreme short-termism of many investors, it is more understandable.

So, opportunities abound for those able to be reasonable at assessing the fair value of businesses, and then exploiting the difference between price and value by buying where a sufficient margin of safety exists.

I look forward to a future where I will be able to help people invest more wisely. I look forward to a future where I can help people by compounding their capital at rates of return that will warm their hearts by helping them to meet their goals and fulfill their dreams. I look forward to a future where I will be able to think about investments all day long and teach others of the plentiful opportunities available in markets; to help them understand the mechanics of valuing businesses and profiting from the market's inevitable bouts of greed, fear and folly.

The road to this point has been rocky at times, and I've had to learn from mistakes that thankfully were never so large as to divert me from the path which I am still on. I will definitely seek out people who I feel I can learn from, but in the final analysis the real rewards of fulfillment and satisfaction will arrive as long as I can immerse myself in an activity I take real pleasure from, and by performing well in an activity that I, personally, attribute value to.

A New Dawn

The sun gradually pushed out a soft light across the dewy hills. As the shadows appeared, our protagonist stirred and shifted, awaking from a deep and restful slumber. To the east a ball of light hinted at its imminent arrival, haloed over the jagged peaks, spreading it's rays over the upper sky. Slowly, but steadily, the ball arose and the rays fell, in perfect harmony. Light shone on the investor who had been roused by the appearance of daybreak. A new day had arrived, and he intended to live it to the full.

Whatever has happened is in the past, and all you can do is look to making your future as bright as possible. I've always known that my future is as an investor and not a trader, so it's with some disappointment that I reflect on the past few years of excessive trading activity, where capital has been created and destroyed. But underneath the gross volatility of my trading activities I have been developing a knowledge and skill base that I am increasingly certain is one that will significantly outperform over time.

It's all about Value, it always has been and it always will be. But my investing hasn't always been intelligent. To have almost proved the maxim that with a bit of capital and a high IQ you can lose a great deal very fast isn't perhaps an achievement I need to reflect on too deeply (or indeed share too often), but I have to admit to my mistakes and learn from them. Perhaps slowly, but I have to learn.

So, out with the currency trading, out with bond futures, out with options, commodities trades and the like and out with equity index punts. In with VALUE INVESTING. The way it should be and the way it needs to be.

It will be a gradual shift, but the portfolio is formed now and I've finally made the analysis of my performance that I had meant to do for a long while. In short I've made 55.4% since March 2005 versus the FTSE being flat and the S+P down 12%. Not too shabby. The annualised return is 10.0% since March 2005, which I can live with. And here are the current stars of the portfolio...

1) Berkshire Hathaway (BRK.B) - 20%

The one and only. After the analysis is done I have this as a 25% discount to fair value, so a potential 33% upside if it achieves that fair value in the near future. But the return on equity from this fantastically well capitalised business is a not stellar 6.6%, although probably over 10% on a normalised basis (excluding 2008 losses on stocks and derivatives). 10% on $109bn - not bad, sir! Once the only stock in here, now maybe on its way out, think it will have to go if the discount narrows to 10% or so.

Everything from Insurance to t-shirts and prefabricated houses. A holding company for a fantastic collection of 100% owned businesses and shares in fantastic publicly traded companies, bought either at fair prices or a discount to fair prices. Over time this business will grow and grow and continue to produce prodigious amounts of cash. Succession risk prevents the stock from shooting upwards, but it has an excellent returns to sleep ratio to it!

2) Hallin Marine Subsea International (HMS) - 14%

My best idea currently. According to my estimates, this company is trading at a 51% discount to its fair value. It returned 65% on equity last year and is on a P/E of 2.65x last year's earnings despite a 30% run up in the stock prior to tomorrow's earnings announcements.

The more I think about the business, the more I like it. A great management team providing excellent service to a sector with lots of cash available doing things that are difficult to do and winning new business at a steady pace.

HMS provides subsea intervention equipment and teams to the oil and gas and telecommunications industries. A lot of their revenue is earned out of their Singaporean hub, where the economy is on a much sounder footing than here in Europe. Growth at the profits line has been 120% annualised over the past 4 years... yes, annualised! They have managed this by starting out small, but they are still pretty miniscule at a market cap of £56m - although I expect that will change markedly over the next few months.

3) Man Group (EMG) - 12%

An association with the Head of Research of AHL (the futures trading arm of the hedge fund group) first introduced me to this company. In an industry in turmoil and in need of consolidation, I believe these guys have what it takes to come out not only in one piece, but shining.

I have them at a not-quite-enough-to-be-buying-here 22% discount to fair value. But they are yielding 9% on a well covered dividend. That's 9% from what I regard as a solid business when I can get around 1% in a bank. Returns on Equity are over 10% still based on last year's earnings, which look unlikely to be repeated for a good while yet, but even with normalised earnings of a little under $1bn per year the stock's market cap of $8.4bn isn't what I would regard as expensive for what I do regard as a business with a good future.

When to sell will be a dilemma, but I think with such tiny sums of capital to invest at the moment it will be a case of finding new ideas to invest in before selling ideas that still show up as value investments in my mind.

For completeness, here are the other protagonists in my motley crew of investments. In order of the value within the portfolio...

4) Interior Services Group (ISG) - 12%

5) Matchtech (MTEC) - 12%

6) William Hill (WMH) - 7%

7) Game Group (GMG) - 7%

8) Lo-Q (LOQ) - 6%

9) Umeco (UMC) - 5%

10) Severfield Rowen (SFR) - 4%

11) Staffline (STAF) - 2%

The one idea that I am least happy with is Umeco, and may sell out of this stock soon enough. They provide supply chain outsourcing to the aerospace and defense markets (unexciting) and also manufacture composite materials for airlines, wind turbine blades and Formula 1 teams (exciting). But margins aren't all that wonderful and the return on equity is around 8.5% versus 20%+ in most of my other holdings with the exception of Man Group and Berkshire Hathaway.

At least it is up 20% on where I bought it less than a month ago (the market has been strong this Autumn), so the discount has narrowed and the reasons for buying the stock have diminished somewhat. That leaves a question of what to do with the funds once the stock has been sold. There's not much bad news knocking about in my favourite stocks, so I'll probably add to the holdings in Lo-Q, which could be a fantastic investment, but it's hard to see if the business model is truly sustainable.

So, a new dawn has arisen in this investors outlook. I'm going back to London for work, but my heart will stay in the mountains. And my dreams of running a fund are still in tact, as you can probably see from the above. The counter on this blog has been ticking upwards recently, and I'm not sure exactly who is reading this, so if you have anything to add, please comment below and be as open as possible. Feel free to spread the word if you find anything useful here also - anyone buying my investments will only push the prices up and I'm pretty much fully invested now, so that's ok with me!

The true test starts now though, as my portfolio did not fully exemplify my value philosophy before the recent additions in August. I'm very pleased to have made such good returns in the past, but really it's 20% a year in good years and to not lose too much in bad years that I'm shooting for. Then again, with 2008 such a disaster for most investors, I think I have the right to feel pretty good about a 50% plus gain over a period when the FTSE has ended up where it started.

Mr Bear Goes Into Hibernation

Finally the bear in me has been re-educated. It wasn't enough to endure multiple months of rising markets and declining net worth, my mental tenacity saw to it that my views were sufficiently entrenched to remain inflexible in the face of bullish market signals. Nor was it enough to know all that I'd written on since December last year. Not even the extensive knowledge of Value Investing principles from Ben Graham, Warren Buffett and Charlie Munger's writing would see to it that my investment decisions would be wise and profitable in what may amount to the best year in my working lifetime for investors to clean up without so much as breaking a research-based sweat.

How close was I, intellectually speaking, to becoming the man that I know I have the potential to be? How could I write in January that, "I have stocks picked out to research further, and ideas to progress. The speculation continues, but it helps with my markets education. I still think the best risk-reward lies in Value Investing. To time it right, I want to be bottom fishing with the tide firmly out."

Then to see the tide fall further from the shore in March than it has been since the mid-1970's - before I was even in existence - and not be focussed on the knowable and predictable rather than the unknowable and unpredictable.

The answer lies in human fallibility and the difficulty of being a contrarian when it really matters. An education can sometimes be expensive, but experience can be one of the best educators out there. It's massively frustrating to have had the time, energy, capacity, tools and capital to have profited immensely in a low-risk manner from the market's disconnection from reality earlier in 2009, but the outcome I've ensured by remaining a bearish speculator in a surging equity market is to have depleted the capital (and confidence) that could have been compounded by now into something reasonably impressive and transformed my hopes and dreams one large step closer to reality.

Here is what I wrote whilst at Octopus Investments in August...

"I'm more in the mini-bull market camp now, having arrived here still quite bearish at the start of last week. The whole scenario just feels extremely similar to 2003 - the lows in March, and the 'climbing a wall of worry'. Huge monetary stimulus finding goods and services to buy and pushing profits up. Sadly at the cost of future tax burdens and the deferral of necessary pain.

Also, whilst it feels like the Great Crash scenario was a possibility, this has now been averted (or postponed?). There's a necessary downward revision of profits as a proportion of GDP to come and that will be brought about by the rising costs of inputs to the economy in the form of imported commodities and finished goods from countries with rising currency levels. Inflation figures reported by governments don't represent real inflationary costs to consumers, so inflation may appear more subdued than it actually is.

At some point, I think that the Russel Napier scenario of rising markets being pin-pricked by the collapse in government debt values and the staving off of inflation by central banks as a highly likely scenario. But it is not imminent.

Overall, it seems eminently possible that profits could rise for a year or two only to fall back to 2008/9 levels (or worse) as the cost of risk free debt causes leveraged companies and consumers to retrench more fully or pushes them through their breaking points. I can see multiples remaining at current levels (15x or so) and profits rising by 25% or so ($60 to $75 per share on S+P), similarly to 2003 (but not to the same extent). Hence a 25% rise in the index as an upside risk.

As the bear market got going in 2008, I felt quite certain that we were looking at a repeat of 1929, with a 50% rally expected, to be followed by further, more aggressive falls. Now, I'm feeling quite certain that the worst was averted and a mini-bull market is going on. The major risks to this scenario are unexpected inflationary/deflationary pressures that suppresses earnings multiples and corporate profits. Over time I would expect these problems to be close to inevitable, with the S+P Index breaching it's 2009 lows. However my view that this would happen in mid-2010 is now revised to around mid-2012."

Whilst the above shows that market directional agnosticism has not yet been achieved, it also shows a view that is less ardently bearish than in times gone by. Fortunately, coupled with the above notions were some actual analysis of potential investments as part of the work supporting the fund manager at Octopus. And from these ideas a portfolio was born. All the investments I've made will be published here with prices at inception as a means to review the decisions at a later date, and hopefully as a record as to the methods and execution that will pave the way to future success for me as an investor, leaving behind a few years of volatile speculative activities and changes in fortunes that do not a potential Managing Partner in an Investment Partnership make.

Live your life like a thrown knife

The title comes from a Todd Skinner quote, a hugely successful and motivated climber who sadly died a few years ago. The very concept appeals to me greatly, but the truth is that I've not exemplified the concept since my last posting.

In the markets it's been a fairly poor month for me, coupled with an odd sense of further positive reinforcement for both the value ethos and my potential skill as a stockpicker. The tragedy still remains that I have revisited the bearishness that I need to extricate myself from, and have done so not just with the purchase of put options, but with the sale of call options. Expiry is in September, so could all pan out in a positive way, but really I should be focussed on the search for value and the exploitation thereof. Not the search for direction, and the speculation thereon.

The most interesting move in the stocks I've been following would have to be that of HMS. From highs of around 145p (as mentioned below), the stock positively tumbled following an announcement from management that margins would contract in 2009 - something that had been clearly noted in the 2008 annual report. So not very big news, in my mind, but Mr Market voted the stock down to 110p, then 105p, swiftly followed by a low of 95p a week or so later. Supply outstripped demand., you could say. But in a small corner of France, close to the Swiss border, a rump of demand was buying as much as he could.

That particular story is still in progress. The stock got as low as 2x last year's earnings. Margins were noted as falling, but not collapsing, and revenues were reported to be up on last year. The product is strong and services a niche of the oil industry which is cash rich. All quite bizarre, and one to watch. It really looks like a $150m company to me and trades for around $60m. If it continues to grow as it has been the $150m valuation will look conservative. Definitely a value play, or I've just not uncovered why the market sees it as such an inexpensive company. One to watch for sure.

On the stockpicking front, another stock I was following last year has been having a good run of late. Michael Page, a recruitment agency, doesn't exactly sit in the recessionary sweet spot. Particularly in the UK where it services a large proportion of financial sector clients. However, my basic thesis was that demand for their services in emerging economies is set to grow as service sectors emerge to satisfy the needs of a growing middle class and increasingly complex 21st century societies. Happily they don't hedge their foreign earnings, so a falling pound is good for profits (aside from the causal or secondary effects).

Anyway, apart from the above, it just looked way too cheap for the potential growth possibilities and extremely strong management team. Essentially a value play with a potentially long-term investment horizon. So I bought. So far so good. Then, during the March rally (which continued into May!) I sold for a tidy 20% profit. This is, in hindsight, another in a string of disastrous moves during 2009 so far. Not so tragic in taking the profits, but buying at £2, with a future view of a value at around £10/12 (discounted to today to give £5/6) and then selling when the stock got to £2.40 was not exactly in-line with the philosophy of a value investor. The bearish sentiment ravaged my holdings and with the stock now over £3, the decision to sell isn't looking too wise.

Well, those are two stories of a few stocks I've been following recently. Equities are up, whilst the economy remains in the pits. There is work to be done on Nexen Inc, a Canadian energy provider with interests in the North Sea, as well as William Hill (back below where I sold my holdings in March) and Man Group (still hovering around 285p, pricing in a halving in AUM). But more interesting stocks may be uncovered during a two week stint with one of London's better investors, as I have an internship with a man at the top of the small-cap league tables planned for the middle two weeks of August. Hopefully I'll learn lots and be of some use to him. Time, as ever, will tell.

On seeking to change oneself

Following my last post, and a good night's sleep, I awoke and as soon as was possible commenced in deleveraging my own portfolio. Gone were the Apple shorts, gone the FTSE shorts. Back to simply holding positions in a few stocks where I felt I had an edge, which is to say a few stocks that I believed to be undervalued. But such transformations of temperament do not take place immediately.

According to the research I've been conducting, habits are the key to all outcomes. A more advanced argument from the realms of NLP is that values drive beliefs, which in turn drives your thoughts and from there you get your habits, which leads to your actions and thence your outcomes. But, crucially, those habits can be manipulated away from their basic tendencies with sufficient work. In some forms this is done by revisiting values that may inhibit outcomes at the other end of the relationship. I haven't been too successful with this approach though. In other cases, a simple application of a new habit (generally where it doesn't conflict with deeply held beliefs) will be sufficient to bring about new outcomes.

So, how do habits form? Well, simply from repetitive actions. By repeating an action every day for a month, it has been shown, a new habit can be formed. This seems to be a great path for creating outcomes in the future that I would dearly like, and I'm happy to say that some progress has been made in this area.

So, following the closing out of the more speculative positions, I adopted a new approach, although I did retain some of the old habits, which have caused some pain to my P+L. The new approach is the one I seek to maintain forever more. That of the Value Investor. Do enough work in valuing a stock to be comfortable with your own view on where it should be fairly priced. Check the market price and buy if significantly undervalued. Simple.

As a case in point, there was some volatility in the price of shares in Man Group following an earnings announcement on 28th May. First the shares fell by 10% on the earnings news. This was surprising to me as I thought the news was fairly positive. They had written down a retained stake in the trading arm that was (wisely) sold off recently, and underlying profits apart from that were strong, given the climate. So the immediate sell off was a bit odd in my view. And, what does one do when he finds an undervalued stock trading at a discount to intrinsic value - he buys. Unfortunately I bought when the stock was down 5%, so didn't get the best prices of the day but did well enough paying an average of 245p/share. They stock is back up at 285p today (16% above where I was buying) against a fall of around 5% in the FTSE 100 index over the same period.

But hang on. A one month period does not a long term investor make. At least the market voted my way after the first day of decline. Similarly my other favourite, Hallin Marine Subsea International, posted healthy gains over the past month and stands at 146p/share today. My view is that both these stocks are significantly undervalued and I continue to own them.

In my more speculative trades, I am now short US treasuries to benefit from a perceived rise in fears over inflation to come. I would like to short oil at what was recently over $70/barrel, but think I have no edge here. Incidentally, I have no real edge in treasuries, but was annoyed not to have done something about my views when 10 year yields hit 2%, so have done something about it at 3.54% (now 3.7%) and have a stop limit order in place in case I am wrong. For the general indicies, I have (speculatively) bought put options that expire in September on the S+P at a strike of 850. This is my psychological hedge, to offset the annoyance if markets tank and I'm not involved in the fall.

And so, it appears, the new thought habits haven't set in quite yet. I've not been glued to  a screen as I have my CFA exam on 6th June and have been busy ever since. Off to Italy this evening, so more busy-ness for a couple of days. On changing habits, Antony Robins notes that it is the pain and pleasure associated with outcomes that leads people to really seek change in their lives. Well, enough pain has been endured watching red numbers grow larger as my bearishness has been met with rising markets this year. And the last month has seen some pleasure from the shoort-term gains on Man Group stock and rising treasury yields. Perhaps more research, when there is time, and more competent investing with positive outcomes is the key to long-term success.

Of course that's why investors want to see track records in the first place, as they may be repeatable in the future.

So here's to creating the habits of success. Think long-term. Perform robust analysis. Always, ALWAYS preserve capital. And try to be macro-agnostic, or at least not incredibly biased in one (negative) direction all the time!!!

On Human Fallibility

Though time moves relentlessly forwards, the progress of this secular bear market moves in waves. Whatever the presumptions I had, or expectations of outcomes related to the current recession, it is clear that an excessively strong bias can have negative repercussions. This relates closely to Soros' statement that the secret of his success is knowing that he is fallible. 

The market is, in many ways, a mechanism that transfers wealth from those with a short-term bias to those with a long-term bias (Buffett). Based on the truth therein, it would appear wise to adopt a long-term bias. So what prevents rational people from doing so? One thing, human fallibility. Hence the successful speculator's answer, of knowing he is fallible. Soros' ability to turn from long to short on such information as a back ache is the stuff of legend. My ability to turn from bearish to bullish is disastrously lacking.

There is really only one way to react to the knowledge that adopting a long-term bias is the way to have an enduring competitive advantage in the investment game, and that is to adopt such a bias. And to do so wholeheartedly and without regret or remorse. And yet, I have found myself continuing to pursue trading opportunities that can only be described as short-term speculative activities. I have managed to create a rationale that supports this activity, but the rationale probably belongs somewhere between spurious and hopeful. However, for the sake of argument it is included below.

Back in the recent years of 2006 and 2007, when the economy was ticking along nicely with 10 years of positive growth behind the UK, it seemed unlikely to me that the housing market would hold on to it's 100% gains of the prior decade, and that the consumer, having reached indebtedness to the tune of £1trn, would continue to spend more than he was earning each year. Thus spending was to decline eventually, and the very full prices for equities were likely to decline also.

Armed with this knowledge and a speculative bent, I set out to capitalise on my beliefs in the form of profits from shorting the equity indicies - a rather blunt effort in what could have been an incredibly profitable targeting of  the housing and financial sectors, given the benefit of hindsight. As the markets fell, I would open new short positions, and generally lose a little as the declines were met with bids to keep levels held up well... until the crash that is.

Beginning largely in May 2008, a year ago almost to the day as I write, equity markets (and many others in sync) began an incipient slide that wiped 50% off their values over the space of the following summer months. A fine speculator should have absolutely cleaned up, with the insight as to the depth of problems to come, the slow response to these problems, and the massive reactions once the realisation hit market participants that the great debt party was over. Many fine speculators did, and yet I did not.

Excessive short-term trading during the period, including a week of madness around the Lehman's bankruptcy in September (precipitated in part by the relative shock as to the level of profits achieved by that date), took at least 1/3rd of the profits I should have made, given my leverage and positioning, out of my hands. Still, the year's overall profits were fantastic and enough to fund 18 months here in The Alps, so you can't complain too much about that sort of outcome, can you, unless it's not the final outcome of course...

As we reach a point a year from where the depths of problems inherent in many western democracies was finally appreciated by the masses, many of the factors that were closely scrutinised, acted upon, and reacted to, appear to have been conveniently forgotten once again. Consumer indebtedness is still excessively high, corporate leverage remains problematic for many firms and the banking sector remains in a state of de-leveraging, thus reducing the availability of credit to those institutions and individuals who simply cannot maintain old levels of spending without such leverage.

An investigation of the Crisis of 1929-32 shows many bear market rallies, of up to 52%, lasting for periods of an average of 50 days (http://www.zealllc.com/2002/rallies2.htm), so the thesis that the current crisis is not yet over is far from written off by the current 40% rally over the past 60 days.

Anyway, my rationale for remaining short-termist is one of a practical nature. If markets are to continue to decline, the pain associated with my being right and losing money from adopting a long-term bias will be high. In this scenario, however, my prospects for employment will be significantly better than I currently envisage them to be, as the 'old order' of affairs will be restored and people will be looking to expand once again. I cannot for the life of me, however, escape the notion that the probability of this being the low point in our current economic cycle as hopeful at best, and plain nonsensical at worst.

So, as I find myself at a junction with the potential for further losses if I remain stalwartly short and markets continue to forge ahead, I have decided to continue in the vein that I started with back in 2006. It is my strongly held belief that markets have a strong tendency to overshoot, and that this is a behavioural phenomenon in mankind, so will repeat ad nauseam so long as people remain determinants of market prices.

Furthermore, the currently held beliefs that we are in the midst of an economic recovery create an opportunity for fine speculators to profit from the likely coming realisation that the old order of affairs simply cannot be repeated.

Finally, that the deleveraging process that began in 2007, has barely started, let alone run it's course, and it is the lack of understanding prevalent in the majority of commentary that leads me to conclude that markets have yet to fully appreciate the incipient problems that have to be worked through the economy in order for it to be righted once again on a surer footing.

And so, back to the fallibility issue. If I am to realise my fallibility, it makes sense only to focus on the knowable, those long-term micro-economic issues that have created wealth in all those who follow the facts to their relevant conclusions and are not swayed by the emotions of the markets. But to avoid the realisation of my own fallibility, to cling to the notion of my undefined and unlikely superior ability to make sense of short-term swings in markets, would appear to be the position that I am currently adopting by having short positions out there in the market.

So, to end, the ultimate realisation that one is fallible, is the major step REQUIRED to become a significantly good speculator, or indeed investor. My own, overriding, fallibilty (on a general level) is to not react accordingly to other areas of my own fallibility (on a short-term predictive level). Or will it be my saving grace that I have finally reached such a state of self-awareness as to be able to truly adopt the mental position of the rational, long-term biased investor that I so dearly want to enter into.

Old father time, as ever, is watching and marching ever forwards. My aspiration is that my knowledge and self-awareness will lead to appropriate actions tomorrow and forever more.

A winter of discontent

How is it already April? My current malaise is due to a few factors, all related, and all a bit sad to reflect upon.

In short, my capital has been depleted by some poor capital allocation decisions. The question of whether I am to become one of the better capital allocators about, is still a significant one for me. However, there is an unequivocal answer as to the question of whether or not I have recently been a significantly better capital allocator than average, using speculation/trading as my means to monetise market insights. And that answer is no.

As is often the case, an inverse of my actions would have brought about some excellent trading results this year. I have been short the Great British Pound, as well as short the Equity Indicies. But my true failing has been to be short shares in Apple Inc.. In this final regard, the tragedy is in the lack of work performed prior to making the decision. It was based on almost no research, and an underlying belief that the company was sound and had good long-term prospects.

Some quick calculations this afternoon led me to conclude that the company would be cheap at around $60bn ($67/share), reasonably priced at around $100bn ($111/share) and expensive at $140bn ($155/share). So, as a value investor, I can only ask myself what was I doing going short at $90/share? And as an aspiring trader, what was I doing doubling up at $100/share?

Well, the losses have run as the stock has risen to around $125 today. Not good.

But, to invert. Had I done the work and seen the shares at around $80, I wonder if I'd have realised that the share price being offered was a bargain, especially given my views about the long-term prospects for the company. And what do INVESTORS do when offered a bargain price for a great company. They buy shares, of course.

All this logic of markets overshooting and trends persisting, I have learned, is nothing when compared to the true test of whether or not someone is a good, or great, trader. It is essentially all about making sure that you loose very little when you are wrong and make a great deal when you are right. In both of these regards, I can now regard myself as having failed over the period in which I've been trading/speculating.

And yet, I feel no sadness or remorse. Indeed, I may find, once the analysis is done, that the lessons have come relatively cheaply to me. And if the lessons have been finally internalised and if I am to go onwards with a renewed focus on my true style and niche area for outperforming in the financial markets, then indeed it will be a valuable lesson. It's just a shame to have not learnt from other people's mistakes.

So, the answer as to whether Mr Buffett or Mr Soros is the one to follow has been answered. And Mr Buffett's lessons hold the key to my future.

His key thoughts on investing, as I understand them, are as follows:

 - It's not what you know and what you don't know that matters, but rather how well you define your circle of competence

 - The key to investing is to close the doors and be greedy when others are fearful and fearful when others are greedy

 - Rule number one - don't lose money. Rule number two - see rule number one

 - A great company at a fair price is better than a fair company at a great price

Will this translate into the seeds of an Investment Partnership by May 2010? Well, interestingly it's now just 8 days until May 2009. Buffett clearly stated that he could make 50% with a million dollars of capital. So constraints on performance with 1/10th of that would seem limited. The key is simply to read hundreds of annual reports, to think of the value of these businesses and then compare them to the prices being offered by the market. Where a large discount is offered, or a small discount for a great business, there is an opportunity to invest.

Today I downloaded the past 5 years of annual reports for Apple, Berkshire Hathaway, Man Group, Hallin Marine, Michael Page and William Hill. So there's a fair amount of reading already. I'm currently listening in to the Apple 2nd quarter results conference call. If I was long, especially at $80 or so, I'd be very happy right now(!) But I'm not sad, or angry, or worried. I'm excited.

Here I am in Chamonix, with a depleted capital base from highs less than 4 months ago, and yet with enough to live off for a few years. I have a few months to get some exams over with (and hopefully enjoy a few days out in the mountains). Then I am looking at either working for a major Investment Bank, or setting up Sherman Asset Management. Whatever I've been through in the past is gone now. All that remains is what's ahead. 30 is approaching, and the greatest thing that I have in my favour is that I know where I want to get to. Some days clarity is obscured, and details are unclear, other days the bigger picture returns. But, broadly, managing capital away from the crowds is a huge and inspiring goal. How I will get there is uncertain, but the journey is enjoyable, and that's what counts.

Planning to climb for two days up high now - a last jaunt before hitting the books hard for the CFA in June. To date I've managed 4 routes in 4 months, which is nothing really to write home about (or blog about). But I've met potential climbing partners and have sorted out what life here is like, so if I make a long-term life out here, then the 4 months that have passed so far will not have been in vain. And even if that is not the case, I'm sure that living out here for a winter will be a very special experience that will leave me feeling more whole as a person forever.

Expectations may have not met reality, but the past is always something that should teach you how to live your life better. Dwelling on mistakes, or wishing for a different history is not going to change it. All you have is your future. One life. Live it well.

3 months in

What to make of the picture three months on? Perspectives have been altered and the reality has not quite met with expectations. Emotions have waxed and waned with the markets and days out in the hills. A trip back to life as I knew it, perhaps 'reality' as I will come to know it again soon enough, gave the perspectives that I sorely needed on how different life out here is, and how different life back in London would be too.

And the confusing part is that neither is necessarily an obvious choice as being better or worse than the other.

In simple terms it is very easy to see that a life involving many days in the mountains would be far more easily served with a relocation to somewhere an hour or so from the great peaks and vistas that surround me daily here in Chamonix. But equally what has been left behind isn't all bad. The relationships built over 6 years in London have become important to me. The lives of people I've come to know well are ones in which I wish to share time with in the future. This does not obviate an extended trip away from London life, or even a move completely away from it, but it does mean that something has been left behind that would not be so bad to return to - the proximity of people that I care about.

And then there's the question of how I am to earn a crust in the future.

Ay, there's the rub, for in that sleep what dreams may come. And in Chamonix, dreams of a life with more varied stimulation than mountains and mountain people is permeating my thoughts. What of all the other great things that life has to offer? The people and places that add spice and richness to life's possibilities. And the personal growth that comes from seeking to become something that you are not currently ready for. Whilst this feeling can be nourished in mountain life, the unfortunate reality is that a price often paid for excellence in the mountains is a relative poverty outside of them.

When speaking of poverty, I do not mean to imply that people who dedicate their lives to mountains are impoverished. I would rather indulge in a love of mountains than fill out my days in a grey office repeating essentially the same actions day in and day out. The poverty lies, as will all focussed pursuits, in that all other aspects that life has to offer are necessarily subjugated to the over-riding aim. For the pluralist, this is a sacrifice too far. And the personal growth that can come from work is sorely lacking in my life out here. Sadly, it will remain so if I do not add direction and resolve to my daily activities.

Another unfortunate reality that is setting in is that it is going to be rather difficult to convince potential investors to entrust their savings to a man with a track record that does not exactly scream of 'high probability' investments made for the long term. And why should they? I do not believe in myself enough to commit 100% of my capital to my long-term ideas, partly as the timing of my next form of income is highly uncertain and my outlook generally still bearish. This love of mountains is not taking me where I want to get to in terms of my future as a great investor and therein lies the rub.

A few years ago, aged 22, I commented that I would like to make half a million pounds and start a hedge fund by 26. Later this was revised to 36 (as events collided with reality)! The path set out on once I'd revised the timings was to work in a bank as a research analyst, make a name for myself, work as a junior in a hedge fund, get a track record and then set up on my own. The first step, to work in a bank, wasn't too appealing as I knew that time in the mountains would be massively curtailed, so instead I worked as an auditor. This nulled any sense of wanting to work ever again in a similar corporation, but bought me time to get over health problems and create a foundation for future success.

The last 3 months has opened my eyes to how life is out here in Chamonix, and how it could be living nearby in Gevena, or Lausanne. My climbing dreams are still with me, but the balance of life has perhaps swung too far over to the mountain side, and away from the longer term investment management dreams. For sure I'm still passionate about spending time in the mountains, and will continue to aim to do so whenever possible, but the sad reality is that I need to subjugate this to time spent building a reputation, a track record and an array of investing skills and contacts in order to become the investor that I know I have the potential to be.

All of life's choices negate the options and paths not travelled. Each journey takes us to crossroads and turning back is never an option. All you can do is make a decision and enjoy the journey as well as possible. There is no right and wrong when complex decisions arise, but there is often a sense of compromise. And where long-term goals are firmly embedded, it currently seems that taking the high-probability trade to get to where you're going, not necessarily as fast as possible, makes the most sense. But, sad to say, a life less ordinary it is not.

On Trading Financial Markets

Well, it should probably be noted that not only is trading financial instruments not for everyone, but it's almost certainly going to end in disaster (in the form of financial ruin) for the vast majority. It's an odd phenomenon that exists to create a world that sucks people in and spits them out in such an astonishingly repetitive and predictable manner. I've discussed with friends in the past a trading algorithm that does exactly the opposite of what a new market participant chooses. We concluded that such an algorithm would be a phenomenal money-spinner!

So, in relation to the above, I have had to concern myself recently with a point posited by my old housemate. In relation to quitting my job and moving to Chamonix, he said, "Is Oli Sherman brave or stupid, that's the question."! Well, I can add to that the possibility that my trading history over the last few years is more likely to fall into one (or both) of the above categories than any other.

My favourite quote on leverage comes from Joel Greenblatt. He likened the use of leverage to running through a dynamite factory with a lit match. You may get away with it, but you're still an idiot. Well, I almost didn't get away with it over the last couple of weeks, which I guess puts me in the category of idiot, which is a shame as I thought I was some sort of financial genius!

However, all this trading is for the purpose of learning about market dynamics, as well as to understand better my own mind in relation to trading decisions. The last 2/3 months is a good case in point.

So, my view since mid-2008 has been that the Great British Pound will fall. Badly. I was calling for it to fall to around 1.60 versus the US dollar. I also thought that the dollar would fall against the likes of the Yen and Swiss Franc. So I decided to try and monetise these views via bets in the spread betting market. The results were favourable. For a period.

The last month of 2008 was a pretty disastrous one for holders of pounds with any international debts and/or future liabilities. But it suited me rather well as I made enough on my currency positions alone to fund a winter in The Alps. As 2009 started, the pound fought back, and I missed it as I wasn't checking prices at all for the first week. My £5k loss for the first week of 2009, it was kindly pointed out to me, translated to a quarter of a million loss for the whole year, which is significantly more than my net worth! Anyway, the loss didn't phase me too much as I understand how markets can undergo consolidation periods during trends, i.e. a rising pound didn't meant that I was wrong about the pound being in a strong downward trend.

As if to validate my position, the pound promptly continued it's slide through the next two weeks, and my loss for the year was rescinded. That felt good. Then something odd happened. The pound had found some friends, and it rose back to regain the pre-New Year levels.

OK, so markets fluctuate, what are you going to do. Well, my view hadn't altered on the pound, or on the dollar. I felt strongly that the fundamentals were in line with my view and that the trend (of both currencies declining in value) was still in the process of adjusting the exchange rates. So I increased my position size to profit from the consolidation.

And the pound continued to rise... And rise... And rise.

Whilst the movements weren't particularly large, my positions were. I was effectively short £200k of GBP, mostly against the Swiss Franc. This was starting to hurt.

Anyway, as the losses mounted, I continued to check the logic of my position, and I hung on. Then, over the weekend, with time to reflect, I decided to cut my positions in half as any further losses would wipe out more than next season's skiing (which I'd already lost over the past 2 weeks). As I was implementing the reduction in risk, I got carried away and decided I didn't know anything useful about trading currencies, so I should get out of it all together. So I did. I cut almost all my currency exposure.

Of course, what happened next, but the Great British Pound lost it's friends and fell. A lot. So I reinstated the shorts in half the original size. Then it fell some more, and here we are today.

Now, for future reference we're at 1.6825 for GBP/CHF and 1.4544 for GBP/USD. And that's not going to stay the same for too long. Markets move further than most people expect, and once a trend is in place, it tends to persist for longer than most people expect. So, I should be true to myself and stick with it all. Not value investing, sure, but a fine way to make a living if you can control your risk and your emotions. Interesting to see how this all pans out!!!

On Creating An Investment Partnership

Aspects of mountaineering have commonality with those of investment. But where is the artificial adversity in a sound investment practice: answer - nowhere. Artificial adversity exists for the speculators of this world. Is that my future?

Intellectually there is only one path that makes sense to me for a sound future as an investor. The lessons from Graham, Buffett and Munger are timeless. Their principles sound, relevant and, possibly, implacable.

Somewhere in the human spirit is the strength to fight adversity, indeed the desire to fight adversity. This emotion drives men to distraction, it can be seen throughout love, life and the joy expressed in exploring this emotion is what draws men to mountains.

But the goal of sound investment is to find the path of least resistance. To take knowledge from the tree and pluck the lowest hanging fruits. Why seek adversity when it may lead to ruin?

Thus far I have made little inroads into my investment research. Stocks have risen and fallen, pages have been turned and potential investors have been met. But crystallised investment decisions have not been reached and enacted upon.

The track record is ticking away. I am still speculating for profit. Perhaps this is where my future lies. But speculation is no basis for taking on other's capital. Why is my story not that I have made investment gains in the past and will likely do so again in the future using the same strategy? Perhaps the strategy can be logically linked. No. Gains must come from principles that will be applied again in future.

The wall of doubt is there, but what is it made of? Not brick and, yet, not sugar. I have my doubters, my detractors, and perhaps I can thank them for making me stronger.

I asked a friend if he thought I had more chance of climbing the 6 classic North Faces of The Alps, or of becoming a successful investor with £20m under management. His response was that I was asking him to compare two very small probabilities!

But all human potential resides within each and every one of us, surely? If it's not impossible, then why not make it happen? There are hurdles to overcome, of course, but adversity just gives you a way to rise above and grow to meet the next challenge.

Creating goals, growing to meet these goals, helping others with their challenges, these are all things that inspire me.

The investment dream is taking shape. Slowly morphing out of the plasma of an unknown and uncertain future is a great and worthy reality. It seems wrong to have things just work. Perhaps low self-esteem keeps people from moving towards their true potentials. It's as if by telling yourself that the future is as malleable as you choose, that you can build it in your mind and shape it in your actions.

May 2010. Sherman Asset Management. The beginning.

To thine own self be true. Seek and ye shall find. The future is not written.

There are so many thoughts I have on the subject, so much going on in my head. Of quotations, past experiences and the experiences of others. I could probably write pages on just how I view the markets. Chapters on the movement of the tides, the pull of the moon, the way to catch the wave and then ride it in to shore.

Anyway, for now I've made my first pitch to a previously unknown potential investor. I've started reading Securities Analysis. I have stocks picked out to research further, and ideas to progress. The speculation continues, but it helps with my markets education. I still think the best risk-reward lies in Value Investing. To time it right, I want to be bottom fishing with the tide firmly out. After all, the best waves come with the moon full, an offshore morning breeze and the tide passing through the midway point.