On Seeking Out Compounders

One of many useful investment aphorisms is that it is a 'market of stocks',  not a 'stock market'. A rational equity investor's goal may well be to seek total returns in excess of those available from passive index trackers. Unfortunately for that investor, the S&P turned in another extraordinary year in 2021. The index rose by 28.7%, with dividends included, following 31.4% and 18.4% total returns in 2019 and 2020, respectively. Extraordinary, to say the least. Meanwhile, yields on Treasurys, Gilts, JGBs, etc, remain at what could be described as 'confiscatory' levels given that current measures of inflation are running at multiples of such paltry returns.

The two above symptoms (a rising market value of the largest listed public companies, and desultory yields on risk-free assets) are very much linked. There may be some debate as to the underlying cause of such symptoms. In my view, four major forces all play a part, namely: (i) ageing populations in more developed countries; (ii) deflationary forces from a plentiful supply of new labour in emerging markets; (iii) deflationary forces from increasingly efficient supply chains; and (iv) Central Banks largesse in the form of major asset purchase programs providing a consistent source of price-agnostic demand for new government debt issuance.

The issue with trying to forecast what the overall stock market will do next based on changing macroeconomic forces, however, is that you need to be correct on three fronts to profit from any forecasts. First you need to be correct in your forecasts (note that many trained economists have been predicting that interest rates will rise for the past 10 years, and have been wrong for the same length of time as a result). Then you need to select the right instrument to translate your forecasts into an investment decision. Finally you need to be correct in your timing, as being right 'eventually' may lead to large interim losses or, more likely, even larger foregone profits from waiting for the predicted storm to arrive.

And so, whatever the stock market may do next (my prediction, as ever, is that it will fluctuate), the various markets of stocks should still provide decent risk-reward or price-value situations for the savvy investor to take up.

This brings to mind Buffett's excellent advice on seeking out fairly priced compounders, which is as follows: "Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now."

At present such trends as cloud computing and mainstream consumer tech adoption provide tailwinds to businesses that are market leaders in such areas - areas which mark a likely permanent shift in economic activity with related winners and losers. Microsoft and Apple come to mind as winners here. Not coincidentally they are the top two companies in the US by market capitalisation at present, with Apple briefly being valued at over $3tn and Microsoft at $2.6tn within the past week. The questions (for a potential investor to answer) here are twofold. Are their earnings expected to be materially higher five, 10 and 20 years from now and are current valuations what can be regarded as rational prices.

There is no inherent reason that Apple can't keep its earnings rising (from c.$95bn a year at present), but it will have to contend with a shift to the next major computing platform - whatever that may be - constant competition from hardware and software providers and other various business risks that will crop up over time. Microsoft, similarly, could go on compounding earnings (from c.$70bn at present), whilst contending with the deflationary forces that new entrants to cloud computing could bring to pricing models over time. Still, for now, both seem well positioned and arguable cheap (versus Treasuries!). At over 30x current earnings, however, there remains a risk that even if profits increase at a good clip, multiple compression could bring about a lower return than earnings growth over time.

Back to my own little portfolio and returns. 2021 brought a return to form, of sorts, with a 16.8% return following three low return prior years. This was well behind that of the S&P and even behind the FTSE 100's 18.0% total return for the year. I currently hold six stocks and whilst I think all have decent risk-reward or price-value relationships, I feel I can do better by digging a bit harder. I haven't yet succumbed to sitting on obvious compounders and accepting that 10% is a reasonable return (even though I know it is perfectly reasonable), as I still feel 20% is possible with a bit of work.

At the end of the year, the portfolio looked as below, with the following stocks and portfolio positions:

Stock.............Price Paid....Current Price....% Value

Plus500.............£8.10............£13.61................28%

Berkshire...........£160..............£221.................28%

Vistry.................£8.61............£11.84...............15%

Facebook...........£232..............£249.................12%

WPP..................£8.09............£11.20.................8%

Naked Wines.....£6.37.............£6.51..................8%

Here's hoping for a few new ideas to add compounder names that can be purchased at reasonable prices for the year ahead.

On Market Dislocations

The past calendar year was, to put it mildly, an interesting one for investors. The S&P started the year at 3,230 and ended it at 3,756, paying a dividend of around 59 points along the way. You would think that a return of something close to the indexes total return of 18% would have been easy to generate as a result. Yet the market low of 2,237 on 23 March 2020, reflecting the liquidation of risk assets in the face of the first global pandemic seen in 100 years, tested investor's nerves.

As pointed out previously, those who focus on time in the market vs timing the market can ride out such dislocations with relative ease. The dream scenario of selling before the market tanked in mid-February, to then buy back after the significant decline could have easily resulted in a 50%, or greater, gain from market timing alone. Anyone latching on to the relative strength of businesses in commercial cloud, online retail, or other lockdown beneficiaries may have been able to do significantly better.

However, the reality of the situation was that those invested in less attractive businesses probably saw their portfolios decline by of the order of 50% over that turbulent month. Many of these stocks, at the market's lows, presented excellent buying opportunities for those with the fortitude and short-term mindset to benefit from the ensuing 'value rally'. A portfolio of relatively low quality businesses could easily have returned as much as 100% from the market lows to the end of the year.

So much for hindsight. In the midst of the turmoil I managed one intelligent purchase and some very unintelligent sales. The sales mostly came in May, after the worst of the stock market's losses were over, but before there were clear signs (to me at least) that risks of any significant recession (or, indeed, depression) had been avoided.

Whatever the excuses may be, by trying to protect against market declines in late 2020, I held excess cash as markets rallied hard on vaccine approvals announced in November. At the time there were plenty of businesses with good prospects and pessimism baked into valuations to have been able to construct a well positioned portfolio. Knowing that market timing is futile is one thing - staying fully invested through thick and thin is another.

At least holding excess cash can have the benefit of avoiding stupid purchases. By consistently trying to not be stupid, and occasionally having a useful insight into a perceived price-value gap, returns should at least be adequate over time. If those insights are of a high quality and there are sufficiently many of them to create a portfolio of ideas with a margin of safety, then those returns should be more than adequate.

Many years now of observing the results of holding excellent businesses purchased at fair prices has embedded the belief that this really is a better way of consistently trying to not be stupid, and therefore generating adequate returns over time. The better the business and the lower the entry level, the more likely it is that the returns can be better than adequate.

A friend with a low turnover strategy (as trading is a hassle in his job) owns the likes of Facebook, Apple, Amazon, Google and Disney. All excellent businesses and all easily observable at times over the past few years as being available at sensible prices. This does beg the question over whether the time and energy of seeking out brilliant risk-reward situations that need to be replaced with new brilliant risk-reward situations every year or two is worth the time, energy and stress given the alternative of holding excellent businesses for the long-term.

The portfolio generated a return of 0.7% against a decline of 10.6% in the FTSE 100 and a gain of 18.4% in the S&P 500 during the course of 2020. It remains a concentrated set of interesting risk-reward ideas and the goal remains a 20% rate of compounding over time. It is, however, tempting to accept a more subdued (but still excellent) 10% rate of compounding with both less effort and with a lower risk of seeing returns fall far short of the targeted growth rate both in any given year, and also over longer periods of time.

On Speculation vs Investment

The past year, moreover the past decade, has been a wonderful period for investors. It has been less kind to those of a speculative nature (as is, perhaps, the case for all decades!). The total return of the S&P 500 in 2019 was a whopping 31.5%; even the lower quality FTSE 100 achieved a total return of 17.2% for the year. Over the past 10 years the annualised figures are 13.5% and 7.4% for the S&P 500 and the FTSE 100, respectively (measured in local currencies).

And what of the portfolio. Well, 2019 was a year to forget… to put it mildly. Essentially the question of whether putting capital into what I can now admit were highly speculative enterprises was an investment or a speculation has been rather abruptly answered. They were a speculation. Unfortunately, the early gains had the perhaps predictable effect of making them appear lower risk than any rational person could easily have appraised them to be. The opportunity to exit them with significant gains locked in was taken to an almost complete extent during 2018 then, sadly, undone during 2019. Very sadly, the significant gains within the largest holding were all but reversed in 2019 to leave nothing but coal in the place of the 2017 carbuncle stones.

Whilst this speculative episode can have nothing but deleterious effects on any hopes of creating a strong investment track record, in terms of attracting institutional funds, the entire track record was – to some extent – spoiled by the initial foray away from solid investment assets and into the realms of the highly speculative early-stage biotechnology nano-cap universe. With the benefit of hindsight, any straying from sound investment principles was an invitation to the risk of a permanent loss of capital. But the allure of easy gains proved a temptation hard to resist at the time. Perhaps the reasons were partly related to working in a somewhat speculative environment. Perhaps with external capital and the promise of sticking to sound investment principles the initial investments would never have happened. But they did, and the results show the dangers of straying from a sound investment approach.

So, 2019 in portfolio-land was a poor -6.5% return. By way of mitigation, this was after larger losses part-way through the year with August YTD losses of -17% followed by a gain of +12% since the end of August (when the strategy was finally return to one of high-FCF yield investments in unloved enterprises with a long history and some degree of predictability to future cashflows). In a slightly stronger form of mitigation, results for the decade were an annualised gain of 23.6% and a total return of 732%.

Clearly 2019 would have been a lot more profitable and a lot less stressful had I simply followed the sound advice to hold index trackers. The noted cash holdings were a drag on returns (vs the broad indices) at first, and then far worse when transferred into speculative holdings. But what of the decade ahead?

The S&P 500 began the 2010s at a price of 1115 and ended it at 3231; the FTSE 100 began the decade at a price of 5412 and ended it at 7542. Whilst it is impossible to say what the next decade will hold, a repeat of the multiple expansion seen over the past 10 years in the world’s most followed (and possibly most important) index is highly improbable. In the absence of multiple expansion, with a dividend yield of 1.8%, to match the past decade’s returns the index would require earnings growth of over 11% and an absence of multiple contraction to counter-act these positive sources of returns.

11% annualised earnings growth may be possible, but this is partly due to the fact that some potential future market participants such as Uber ($60bn market cap; $6bn in losses over the last 12 months) and Tesla ($87bn market cap; $800m in losses over the last 12 months) will either grow earnings significantly over the next decade or not join the index. Large market constituents such as Apple and Microsoft (with a combined $2.6tn price tag, or 9% of the index’s $30tn total capitalisation) appear to be growing per-share earnings at double-digit rates, but the outlook for these behemoths will need to be at least as good by the end of 2029 as it is today for their earnings multiples (22x and 28x, respectively) to remain in tact.

Perhaps passive index tracking is, indeed, the best solution; it certainly appears to be for the vast bulk of investors. Much of the portfolio’s returns during the 2010s was from a sweet spot in the first half of the decade where earnings grew strongly, and multiples expanded markedly – especially for smaller companies. With multiples now at elevated levels for quality businesses and with the economy towards the tail-end of an expansionary phase, growth in asset prices will be harder to come by. But the fun of trying, and the challenge of doing so, means it is likely I’ll keep plugging away. Compounding capital at over 20% annually for a decade may be a tough challenge, but challenges are there to be met and it is heartening to know that the portfolio managing this elusive goal over the past decade, albeit with some significant fluctuations along the way!

On Market Timing

Whilst I mused on the difference between investment and speculation in January of last year, the reality of what constitutes market risk hit many full in the face from October to December of 2018. Fears of ‘trade wars’ hitting economic growth, combined with other reasons provided by the commentariat led to sell orders, fund redemptions (requiring more sell orders to meet year end redemption notices) and broadly a preference for cash over shares as the calendar year rolled over.

For those who held their nerve (or more accurately their stocks) through this period, I suspect many will be nursing significant losses where their holdings were either unconventional (or simply bad) investment ideas. As for differentiating between the two, I am increasingly of a mind that for something to work truly spectacularly, it is likely to be seen by the majority as unconventional (or simply bad), as investment ideas go.

In the world of the fully invested quality investor, however, it does not seem to me that much has really changed through what is being termed by many as recent market turbulence. The broad indices are close to (around 10% off) their all time highs. Interest rates are still low, which should keep risk assets priced at high levels vs their expected future cashflows.

It is a near certainty that a significant rise in interest rates would mean lower share prices in a general sense. With government bonds yielding historic lows, the temptation is to assume mean-reversion and expect a poor stock market performance. But over what time-frame is the question. And, more importantly, what else is there to do with your capital over that period?

One remedy for the dilemma of trying to time markets, as I have previously noted, is simply not to do it. Just hold good businesses and when bargains are few and far between, accept that the quoted value of your portfolio may ‘suffer’ from higher discount rates or lower expected future cashflows. Over time, however, the benefits of being a holder of equities should fully compensate the mental anguish that may (or may not) be caused by swings in quoted values.

Another path, and the one that I chose to select in late 2018 as my more speculative holdings were hit harder than the broad market, is to move to cash. And cash, whilst yielding next to nothing at present, at least has the advantage of not going down in a market decline. It offers optionality to the holder over possibly lower future share prices. And yet... it could simply be a form of market timing to say that cash is more attractive than holding shares at any given time.

The dilemma is solved, to some extent, by revisiting what exactly are your investment goals. If you are in the protection-of-capital-with-slightly-better-than-the-broad-market-growth-camp game, then being underinvested for even short periods can harm performance over a long period (witness the January 2019 market bounce). If you are in the significant-outperformance-and-high-compound-rate-of-growth game, then avoiding drawdowns and protecting capital by seeking out favourable risk-reward situations with limited expected downside and good upside potential may require periods of holding cash. Is this market timing? Possibly. Is it speculative? Probably. But at least by returning to the core of what it is that you are trying to achieve with your portfolio - and thinking through the strategies with which you wish to achieve your goals - can lead to periods of holding cash in some instances.

As for the portfolio’s performance itself, 2018 brought huge growth on top of the 2018 high performance... until the summer came... and then it all went into reverse. The total return for 2018 was positive in cash terms, but brought my first negative return (-1%) in money-weighted terms. I held cash into the end of the year as I cared (somewhat ridiculously) about the -1% figure and didn’t want it to get worse. To then view various businesses I had recently owned (and liked at current levels) bounce by 10-20% in January, was a lesson in the ill potential of trying to time markets vs just sitting through the potential turbulence in quoted prices.

In any case, if the goal is a 20% compound rate of returns over a long period of time, a few months of performance is unlikely to affect the broad outcome. But taking that goal, and trying to achieve it with cash for any extended period is unlikely to work particularly well. Owning solid, sensible, large-cap businesses is also unlikely to meet the above goal (unless the starting point is a more subdued price environment than exists in early 2019). And so, it’s a case of keeping the gun loaded, looking for targets, and waiting to pull the trigger when prices are at attractive levels. A more speculative approach than the conservative investor would hope to employ, but one which can at least benefit from market dislocations should they come about again... and they do have a tendency to come around from time to time.

On Investment vs Speculation

I have mused in the past on the differences between investment and speculation. Some refer to the contrast as follows: an investment has the overriding attribute that growth in the underlying cashflows will generate a return for the investor; whilst a speculation has the overriding attribute that a change in asset price, mostly from other people’s appraisals of the value of the asset, will generate a return for the speculator. This is a nice summary, but there are grey areas in between, and it may over-simplify the (never entirely clear) differences.

In this post, Jason Zweig cites the following excellent quote from Fred Schwed to illustrate his view of the difference, “Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investing is an effort, which should be successful, to prevent a lot of money from becoming a little.” He goes on to make very valid points that the same asset can be an investment for one person and a speculation for another; the reasoning behind an investment decision is what differentiates an investment from a speculation.

I have been pondering the above as this year has been a very good one indeed. The portfolio grew by 89.3% over the year - from a still concentrated portfolio of 6-8 stocks. The nature of the investments could be accurately termed ‘unconservative’, but I do not believe that they were entirely ‘speculative’, even though the underlying future cashflows are subject to a high degree of uncertainty.

The reason that I do not deem either the individual investments to be entirely speculative, and more particularly the portfolio as a whole, is that - in my mind at least – for a reasonable range of future scenarios, the weighted expectations of fair values were all far above the share prices when the shares were acquired. Some factors left investors focused more on the downside risks, than the upside potential, to the point where, in my estimations, the probability-weighted fair values made the investments compelling.

And the next part is where I wonder if I may have an edge over the majority of other investors. It barely occurred to me, as far as I can recall, that concentrating my bets in investments with uncertain future cashflows and therefore uncertain future share prices was a particularly risky strategy. Quite the opposite, in fact. By owning shares in businesses that I deemed to be worth a lot more than I was paying, I felt that I was reducing the risks of losing money in the event that my analysis would be proved wrong; the essence of Graham’s ‘Margin of Safety’.

The other dilemma that this poses, is that having generated a return in a single year of close to 100%, it seems that I have truly entered the realm that Keynes termed ‘unconventional’, as part of the phrase that, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

In any case, and for whatever reasons, 2017 worked well. The risky stock mentioned in my last post tripled over the year. A reasonably large spread-betting business with a 24% FCF yield growing at over 20% a year almost tripled, including dividends (a bit less after withholding taxes) and other investments added to the overall return also.

And as to whether this may constitute the last year of writing on the topic of investment gains, the jury is out as ever. It would certainly be no bad thing to apply skills learned from my personal account investing to much larger pools of capital, helping institutions to achieve returns that compensate them for equity market risks. In fact it would be doing more for society than simply compounding the assets of my own family. However, it is hard to escape the idea that making outsized gains (20%+) over a long period of time would generate gains (even after appropriate fees) that should be highly attractive to those able to tolerate the vicissitudes of Mr Market’s fluctuations.

Using the Buffett fee model (no fees on the first 6% gain, 25% of gains above this paid as performance fees), a 20% underlying asset growth would translate to 16.5% gains after fees. Over 20 years of compounding this would generate profits on a £1m investment of £20m; an enormous sum vs expected returns on most equity funds. Perhaps this could be the plan, with 20% gross gains targeted over 20 years, starting in 2020. As at 28 January 2018, the portfolio has grown at an annualised rate of 29% over three years and 33% over five years, so even with less concentration, the idea of a 20% annualised gains doesn’t seem so far fetched.

On When To Sell

[Note to Readers: no companies mentioned by name in the below blog post are current holdings and there is no intention of advocating any purchases or sales based on the below commentary.]

In my last blog post, on 30 April 2016, I mused over how to tread in the event of a bear market in stocks, noting a 49% cash holding in portfolio-land. This was rather handy in a sense as certain domestic UK stocks fell markedly eight weeks later following the UK electorate’s vote to leave the EU. The currency markets voted that this would hurt the island nation’s future growth prospects, and sterling fell by over 15% from the end of April to the end of the year.

Mr Market’s reaction to the referendum result was one of those rare events where certain stocks trade briefly at very silly prices; this time at bargain valuations rather than what seems a more common silly-on-the-expensive-side prices that have been more prevalent since the Financial Crisis. The constraints of my workplace and a broker whose website was failing and call-centre flooded with incoming orders, meant the first few hours of trading were blocked for me, but decent valuations persisted for a number of weeks, leaving time to pick up bargains.

Thus it should have been a return-to-form year for yours truly, but a few errors were made afterwards (namely selling too soon), and what now seems like a stroke of bad luck hit the portfolio’s returns in December to produce another flat year – the second in a row. This time the result felt extremely poor, with the S+P up 11% for the year (close to 30% in sterling) and the FTSE 100 up by 18%, the portfolio’s meagre 1% gains looked feeble in the extreme and ended a run of six calendar years of market-beating performance.

The bad luck in December was that three of a total of seven holdings racked up double-digit losses in the same month. Fortunately all three have since rebounded; less fortunately one was sold before the return to form; more fortunately one was added to before an over 50% rebound; and happily the largest holding is now up by almost 100% for 2017 so far. The effect of all this is that, somewhat related to the calendar year coinciding with temporary dips in Mr Market’s appraisals for portfolio holdings, the YTD return for 2017 is a rather pleasing +44%.

Now I have been here before, halfway through the year, in a self-congratulatory mood with over 40% gains, and yet I am still to complete a calendar year with over 50% gains, which is the benchmark Buffett has pointed to being a return he ‘knows’ he could generate with $1m or so.  So what will come of the full 2017 is a rather interesting question.

One choice is to lock in gains, riding out the year to meet that arbitrary hurdle for the first time. Given one of the stocks is what may politely be termed ‘speculative’ this is of course the prudent course to take. However, Munger’s concept to constantly search for ‘lollapalooza effects’ and then maximize the gains after loading up on opportunities exposed to them is front and centre of why this may be, in fact, a decision that could lead to regret. On the other hand, the words of Joseph de La Vega that, “Profits on the exchange are the treasures of goblins. At one time they are carbuncle stones, then coals, then diamonds, then flint stones then morning dew, then tears,” spring to mind. Only the passage of time will tell which will be the more apt given the outcomes for this largest holding in particular are particularly uncertain.

In any case, the concept that ‘nobody ever went broke taking a profit’, i.e. lock in your gains, fits very poorly with my personal experiences of selling Lo-Q at an average of £2 per share (having bought in at an average of £1) to now see it quoted at over £16 per share. I even remember saying how £6-8 was possible in certain scenarios, and yet the short-term profits seemed so high relative to my original investment that further gains didn’t seem likely or even possible, so in the end a conservative valuation for the business and other factors led me to sell too soon (my last sale was at £2.40 and there really was no solid reason to sell at the time apart from a 20x trailing earnings multiple).

More recently I sold my holdings in a UK sports-focused retailer despite a valuation for the business of almost twice the levels at which I sold them. I reasoned that they could go lower through earnings. This worked out poorly as they are up over 20% in the past week (post-earnings), but as they say – win some, lose some. Another sale that seemed prudent (and even lucky) at the time was Ferrexpo – sold for an average of 56p/share (despite a valuation multiples of this higher) and recently changing hands for over £2/share. Holding stocks of a lower quality, it seems, requires something of a stomach for short-term declines in quoted market prices. The gut truly is a more important organ than the brain at such times, and sticking to a process and maintaining a logical appraisal of a firm’s prospects and fair values for the potential outcomes matters more than the instinctive response to either gather more information to understand the odds of future outcomes better (hint: it rarely helps) or to cut the position to stem the feelings of pain that losses can induce.

Conversely, it certainly seems wise to sell when a stock has done well on the back of limited new information, i.e. merely a change in the mood of Mr Market vs a clear change in the underlying fundamentals, and yet this could mean walking away from large future potential profits should the business have future outcomes not fully discounted at the time the decision is made. Note, however, it is the prospects of the business that require appraisal, not that of the share price. The former is important and elements will be knowable, whilst the latter is a blend of a scoreboard for the business and the mood swings of an ever manic-depressive business partner, known as Mr Market.

On Dealing With Bear Markets

My last post noted that there were limited obvious bargains available back in March 2015, and yet sensible investing requires the identification of superior businesses (which, by definition, will significantly grow earnings over time). In the absence of bargain-priced securities there are two broad options available. (1) Stay fully invested and stomach the inevitable downturn when it comes (note, given that markets are clearly cyclical over time it should not be controversial to say 'when' rather than 'if' with respect to a future downturn). Or (2) Sell investments in order to build a cash balance which will mean available firepower to make the most of potential bargains in the months or years ahead.

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.