Trial by Fire

Wow – what a year. From the start of the year where we thought the Australian bushfires would be the worst thing to happen, we’ve gone through a pandemic (ongoing), the sharpest drawdown in financial markets on record followed by an unusually swift recovery, global lockdowns, millions of unfortunate deaths, and a light at the end of the tunnel with a vaccine on its way to a hospital near you. As an investment advisor, in our first year of business, it’s been a trial by fire. While we came out of it just fine, with all client portfolios outperforming their benchmarks (most significantly so), we do have a number of scars to show for it. Below, we’ll take you through some of our scars (read: lessons), with the hope you can learn along with us or take solace in knowing you’re not alone if you bear some of the same.

1)      The appropriate holding period for assets you don’t like, or are uncomfortable with, is zero years, zero months, zero days, and zero seconds.

In late Feb we took on a new client just before the market started to tank. The client had a few assets on their portfolio we didn’t like. While we recommended the client remove 50% of those assets immediately, we told them to hold on to the rest. This was foolish; we knew they were weak assets and not ones we wanted the client holding over the long-term, but didn’t recommend selling in case markets bounced. The market did not forgive our “thumb-sucking”. We eventually recommended that they sell the entire position, but by this time it was at a much lower value.

2)      Fear is the mind-killer

Ok we may be a bit too excited for the new Dune movie to be released, but this line from Frank Herbert’s classic novel is all too true in a year that saw the VIX spike to 80+. We’re still to meet an investor who doesn’t feel fear, perhaps there are a few out there who don’t, but we’re yet to meet them. That said, the best investors don’t let that fear overtake their decision making process. A couple of ways we found to tackle this fear was 1) Ensure you/your clients have at least 6 months to a year’s worth of expenses in cash, as this removes any sort of day-to-day fear and keeps you focused on the task-at-hand 2) focus on the long-term: thinking past the lockdowns/virus into the next couple years gave us a good sense that March was an buying opportunity; and 3) think about value not direction. In March and April we bought because we saw good value not because we were sure about which direction the market might go. This framework also helps us when the fear of investing too early turns into the fear of missing out, and keeps us from overpaying for assets. We, at certain times this year, did let fear get the better of us, and it lead us to make some sub-optimal recommendations. Luckily these were just at the margin and didn’t make any sort of material impact on client portfolios, and on the whole we fought the fear and made good decisions.

3)      Don’t use limit buy orders as a crutch

While placing limit orders is a great technique to use in order to take decision making out of your hands in a downward market, it can sometimes become a crutch. We used it too heavily in the September sell-off, thinking that because we had recommended limit orders to clients and placed them for our own portfolio, that we didn’t have to monitor certain prices for assets. We believed we could just let the limit order operate independently. But far too often those assets came within a hair of our limit buy orders only to bounce back very quickly and for our clients to miss out. The lesson learned here is if your target assets get within 3-5% of your target, you might as well buy. If you’re wrong, the 3-5% buffer won’t help you very much, and if you’re right, then paying 3-5% extra will make almost no difference, especially if you have a multi-bagger on your hands. We eventually did recommend buying those positions outright, just at much higher prices.

4)      Don’t sell too early

One of the most coined phrases in the investment world that we’ve come to most disagree with is “you never go broke taking a profit.” While on the surface this is true, because you won’t go broke, the truth is you won’t get very rich either. Several famous investors have made most of their money based on just a few investments that they held for a very long time. For Buffett it was GEICO, Coca-Cola, and AMEX, for Munger it was Costco, and for Nomad, it was Amazon. This concept is best articulated by Peter Lynch in this short clip, where he kicks himself for selling Toys“R”Us and the Home Depot way too early. This idea hit home for us when we were conducting a portfolio review for a client, and noticed that 80% of the profits they made this year were driven by 15% of the positions – all because they didn’t sell their big winners early (even though they were up 4-5x YTD). While we didn’t make the error of selling any entire positions too early this year, we did make the error of recommending clients trim certain positions as they got larger. We believe it’s ok to trim (or sell) if you feel returns going forward are going to be fundamentally lower than other opportunities you have available. However, we can’t even use this excuse as; we recommended trimming simply because we thought the stock prices had run up too fast. We did this despite believing that the companies had great opportunities ahead of them. In hindsight, these recommendations to trim were quite short-sighted. 

5)      Never underestimate anyone in this game

This isn’t a ‘scar’ per se, but a lesson nonetheless. If this year was a competition, it seems like retail investors would take the prize. When most institutions/professional investors were sticking to their cash or predicting a lower bottom at the end of March or in April, retail investors, supplied with cheap options, no trading fees, and stimulus checks were going guns a blazing into the market buying tech stocks, EV companies, and cryptocurrency. This article suggests that retail investors made hero calls were made in tech, airlines, and alternatives much before it the institutions did. While it’s hard to judge how retail investors did in aggregate, the Eurekahedge Hedge Fund Index estimates that hedge funds returned just 8.14% this year (Nov YTD) versus the MSCI World that has returned close to 12%. Now, we know that in the long run aggressive behavior by retail investors doesn’t typically end well, but for 2020, retail investing seems to have come out ahead. This teaches us that we must constantly stay humble and keep learning. Even after everything we learned this year, we still believe we have mound and mounds of experience and information still to internalize. We’re not sure after how long mastery in investing is achieved, but ask us when we’re 70+, and we hope at that point, our answer is “we still don’t know.”

We hope some of the lessons we learned this year are useful to you. If you also have scars from this year, please share them with us, we would love to hear about them. This will be our last blog post for 2020, so we’ll sign off by wishing you and yours a great end to the year and all the success in 2021. Happy Holidays and happy investing!