There is a beauty in simplicity and for those with the temperament, just staying fully invested through thick and thin, i.e. not trying to time markets, seems to be the best option. Those who felt great by avoiding the enormous downdraft of the declines of 2008-9 often found themselves holding cash or hedges and avoided some or all of the massive upswing back to record stock market levels. Those who stalwartly held good businesses from 2007 to 2016 may have seen the quoted prices of these businesses halve (or worse), but the intrinsic values have steadily risen and in many cases risen quite markedly in this 9 year period.
Since March 2015 (the last blog post), I had the concept to hold cash in anticipation of better prices to come. However temptation took a hold and I bought shares in two businesses that were, in short, mistakes. The early signs were reasonably positive on these investments, and the portfolio's value reached new highs with returns of over 1,000% since inception. As has happened before (more than once!), the feeling that I was smart was quickly treated to a good slap around the face by Mr Market's gyrations.
Somewhere around May 2015, it almost felt like a switch was flicked and the broad stock markets started to inflict their first real bout of pain for the decade. By the end of the year, despite broad indices being down slightly (up slightly with dividends reinvested), many value investors had horrific results for the year. Some prominent investors had the worst results they had ever experienced. Whatever the reasons, I found myself thinking how sensible I had been to think that cash was a good investment in March, and yet how dumb I had been to then buy shares in two seeming bargains soon afterwards.
My unfortunate capital allocations decisions for the year were Ferrexpo and Delta Lloyd. The former, being a Ukrainian Iron Ore mine, had plenty that could go wrong with it, and although I was looking at 40% paper profits in May, by August I had lost my appetite for the risks associated with the business and I sold out for a small gain. As it turns out this was enormously lucky as the firm announced in mid-September that its cash balances were in an insolvent bank owned by the CEO. Any calculations made for testing the solvency of the business - already a marginal affair - were suddenly in jeopardy and the stock quickly halved in price. This somewhat heart-stopping behaviour was a reasonably good lesson in reaching for yield/gains. I knew there were risks, but having cash reserves effectively vaporised was not something I saw coming. A part of me knew that commodity producers (for a start) are poor places to see capital treated well. Another part of me knew that leverage in a capital structure can lead to problems (great businesses have no need to juice returns with debt in the first place, so its existence - if material - on a balance sheet is often a poor sign). But the allure of keeping up my 40%+ returns led me to take on excessive risk. I was lucky to escape without any losses on this one.
Delta Lloyd was a mistake in listening to (and believing) management. I had followed the firm for a while, and been to see them present at their Investor Day in Amsterdam twice, meeting the CEO, CFO and so on. Management were quite insistent that the business was producing around €450m of cash a year, which was remarkably high vs a €3.5bn market cap at the time. As the quarters rolled by their story became less coherent with various odd reasons provided for why book value fluctuated wildly with slight variations in interest rates. By August, investors had had enough when the firm posted a €1bn move in book value in a single quarter on a book of just €4bn (the goal of any bank or insurer should be to protect book value as one would an investment portfolio). Their reasoning was mostly centred around how they mark their liabilities to market, but effectively investors lost confidence in management's ability to manage. It was only after this that I purchased shares (having sold my holdings prior to the August shock). My reasoning was that the price had fallen so far that the market cap was implying a €1bn capital raise. Reasoning that no rational management team with any interest in preserving shareholder value would look to raise capital after the price had fallen so far, and also looking at their capital base and seeing it was still a solvent entity - with adequate capital for all regulatory requirements - I was busy buying the shares. As events transpired, the new CEO showed he had no interest in preserving shareholder value, only in over-capitalising the business and diluting the interests of shareholders who had been aboard for a very unhappy ride in the past. In the end I suffered a 25% loss in this position, or about 5% of the portfolio's value - a wound, but not as bad as it could have been.
So the bear market was wiping out years of capital growth from various stocks, and it has continued to do so in 2016. Three seemingly good businesses that I follow in retail have fallen quite a way since last summer. Hugo Boss is down nearly 50% in the past year after attempts to address the brand's drift downmarket have come unstuck (the CEO having fallen on his sword may have marked a turning point for the strategy). Next has fallen 30% this year after saying sales in their online channels are under increasing pressure from new market entrants. And Sports Direct shares are almost 50% lower than their 2015 highs after a series of what could politely be termed poor public relations events transformed the business from a solid growth story to an embattled corporate governance debacle. In all three businesses the outlook for profits growth has certainly slowed, perhaps turning negative for a period, but the businesses have hardly changed in the past year, and it seems to me that their intrinsic values are not 30-50% lower than they were a year ago, but the market's perception has shifted, and with it the quoted price for each share in the equity of the business.
In portfolio-land 2015 ended with a lucky escape as GVC (then my largest holding) rose 23% in the month (I no longer hold shares in the enterprise as I can no longer see a bargain valuation and I can still see a variety of risks). The overall return for the year was a rather meak 0.2% - at least a positive result in a year that saw a variety of proverbial bombs exploding across equity markets. 2016 to date is showing a return of a healthier 7.2% and the portfolio currently consists of 49% cash. The high proportion of cash has looked like a missed opportunity as markets have rallied since February lows when fears (again) of a serious credit contraction in China or due to oil and gas related loan losses in the banking system took hold. The adage to invest when others are fearful should have flagged putting money to work in those areas given I did not share the view that either risk was as prominent as commentators seemed to think, but a lack of focus (for positive reasons such as focusing on my day job) held me back from taking advantage of this mood swing.
The above inaction at an opportune moment (in the short-term at least) is a good example of the difficulties created by not being willing or able to adopt a long-term investment horizon (an affliction that prevents many professional fund managers from making the most of their opportunity set). In addition, it takes a good deal of time and energy to grow a pool of assets in a concentrated portfolio. Finding bargains takes time. Understanding potential risks if searching for bargains in lower quality assets takes time. But most of all, being able to take a long-term view and being prepared to stomach volatility in the interim depends very much on your own character, as well as the support of your client base. The 'excess' returns earned from 2011-14 in the below chart were very much linked to not having any clients to worry about and also having the energy to stay focused on what was important and knowable, rather than be distracted by the unimportant and unknowable noise bounded around in market-chat all day long. For now a lack of time and an inability to write on stocks as bound by the rules of a new employer will likely cause this to be the last of these blog posts. The record is pretty good at 22% over 11 years, or 814% overall. Perhaps there will be a chance to reproduce at least some decent returns on a larger pool of money one day in the future.
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