LFDE on managing investments in the current environment
While this Covid-19 pandemic is different in terms of speed, transmission and widespread effects, there are several lessons that I have learned from those past crises that still apply when investing in markets today.
I have been in the investment management business for over 30 years and I have experienced some bursting bubbles (Japan in 1990, Internet in 1999), some currency catastrophes (Mexican Peso in 1994, Asian Contagion in 1997), some sovereign debt disasters (Russia in 1998, Eurozone in 2010), some US created problems (US losing its AAA rating in 2011, government shutdowns in 1995, 2013, 2018) and even a couple of financial crises (Savings & Loan crisis in 1991, financial crisis in 2008). I have seen two US wars involving Iraq, a terrorist attack on the US in 2001. And I have worked through pandemics (SARS in 2003, H1N1 in 2009, MERS and Ebola in 2014).
The core of being an investment fund manager is making intelligent decisions. The first lesson is that if a situation cannot be analysed, then no intelligent decision can be made. If an intelligent decision cannot be made, then do not make any decision, because without analysis, any decision is merely a guess, and the last thing one wants to do when investing is to be guessing. If no intelligent decision can be made, then the best course of action is to make no new decisions. Since nobody can tell you how the Covid-19 pandemic is going to play out, nothing can be analysed. So, I have made no significant changes in my fund through this market panic of the last month.
However, when a situation is analysable, it is imperative that a fund manager do so and make an intelligent decision. Early in March, Saudi Arabia and Russia started an oil price war, demolishing oil company equities. This was an analysable situation. One of my basic rules is that if a stock plummets, as the oil stocks were doing, you need to analyse the situation and make a decision. Either you buy more, because you’re convinced that you are right about the stock, or you need to sell it because you were wrong. A lot of investors just wait and hope that the stock will recover. But hope is not a strategy. In this specific instance, our analysis showed the price drop was more than justified due to the new fundamentals and we took our lumps, admitted the mistake and exited our position. Importantly, I did not wait. One of my other learned lessons over 30 years is that often your first loss is your best loss. If you want to sell, then sell. If your new analysis is correct, you likely will not get a better price than right now.
This highlights another lesson that I have learned: making mistakes is good. Many investors believe the goal should be to avoid mistakes, to avoid risk. This is the wrong way to try to make money. If you want a risk-free return, stick to a US Treasury bill. Very little risk, but that also means very little return. Risk prevention, in my opinion, is a losing strategy for an equity investor. It might be a decent strategy, for career protection for a fund manager, but will not accomplish much for your investors. Instead, my approach is to accept risk, as long as I am being adequately compensated for taking that risk.
How do I feel confident that I am being adequately compensated for taking that risk? By keeping a very concentrated portfolio, I can focus on my best ideas and be better informed about the risks and potential return of each investment. Therefore, in my opinion the ideal number of stocks to hold in a portfolio is around 30, because I feel that I cannot thoroughly analyse and evaluate 50 or 100 stocks.
The final piece of advice in these volatile markets: quote my #1 rule: “Great stocks are rarely cheap; cheap stocks are rarely great.” Over 30 years, I have found that to be true. However, with the kind of rapid market decline that we have had recently, for me this is one of those rare times where you can find cheap, great stocks.
Some elements of this analysis are based on the fund manager’s view and may evolve over time. There are risks in loss of capital for any investment in financial markets.
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