Successful investing requires an open mind to approach complex problems. Investors are a confident bunch, but it’s dangerous to assume you know a lot of things. Flexibility and humility allow us to admit what we don’t know, and accept that there is little to gain from investing as it should be.
A strong moral compass will do many things for you in life, but it will not help you navigate capital markets. Seeing the world as it is rather than as you wish, will.
Investors are chasing momentum and buying more of what has gone up the most. The fear of missing out on the climb to new highs has blinded investors to the risk of falling back to reality. Valuations don’t matter as long as there is a greater fool to buy your shares at a still higher price. There are always plenty of fools around to play this game. They just aren’t around very long.
Nothing clouds judgment more than watching your neighbor get rich. But you don’t get rich by taking risk at the end of the cycle. You get rich by buying cheap assets. You stay rich by being patient.
Only a focus on the inputs can determine the long run success of the outputs.
We must replace the question “Did it have a good outcome?” with the more difficult question, “Was it a good decision?” Was our judgment correct? Was it reasonable given the information available at the time?
In evaluating any investment, we begin with a thorough consideration of risk. We ask what could go wrong. We quantify how much we can lose if we are wrong. We estimate the probability of loss. And we consider our time horizon before purchasing a single share.
Time is the friend of a wonderful business. A good business can compound wealth for shareholders for decades. Lesser businesses, by contrast, are on the clock. If you buy a bad business at a low enough price, a positive surprise can give you the chance to sell at a decent profit. Like the proverbial cigar butt found on the street, it may not offer much of a smoke, but a bargain purchase can make that last puff all profit. Just be careful that you don’t get burned.
In a nutshell, this is precisely how investors confuse risk and volatility. The majority of investors incorrectly focus on volatility. Volatility is the 25% decline from $80 to $60. Trust me. It doesn’t feel good. But just because something doesn’t feel good, doesn’t mean it’s risky.
Volatility is like a visit to the doctor who tells you, “This is going to hurt,” right before he gives you the shot you need to get back in the game. At Broyhill, we focus on the only risk that matters - permanent capital loss – and we are willing to take our medicine to win the long term game.
Returns are greatest for those willing to take the risk before the light at the end of the tunnel. Things often get worse before they get better and the best returns typically come when things appear darkest, just before the light begins to shine.
The majority of investors recognize this concept of a “value-premium” described above. Yet most investors still find the urge to micromanage the day-to-day volatility of individual positions Simply Irresistible.
Increased competition for returns has resulted in shorter time horizons. It’s human nature.
We’ve all read the same research that clearly demonstrates the benefits of patience and the costs of increased trading. We all understand the potential gains that come with a longer-term horizon. Yet, the temptation is just too great for most to overcome. There are so many buttons to push in a given day, butmost of them do little more than provide a brief dopamine high.
The only thing we can do to stop a dopamine loop, and make better decisions for our investors, is to turn off the cues. While many managers measure their importance by the number of screens on their desk, we reserve our desks for books and company filings. While others measure their P&L minute-tominute, we have relegated our Bloomberg terminal to its own room, where it is unable to pester us unless invited. Perhaps including a “Break Glass in Case of Emergency” sign would work even better.
Patience is a virtue. It’s also the greatest advantage we have in a world where price is set by investors focused on the next tick. This world is highly competitive. This world makes it impossible to purchase an asset worth $107.50 for $80 if you fear it may first make a brief stop at $60. But the path it takes is impossible to know in advance. We can only improve our odds by correctly assessing value and waiting for the market to agree with our assessment.
This world forces our peers to overlook long-term opportunities for fear of short term underperformance. We can’t win in this world. Winning here requires dozens or perhaps hundreds of correct decisions in a given year. Very few can do this consistently. It’s a hard game to win. So we don’t play it.
To win in the long term, we must do something different. We see little to gain in staring at our screens all day. Rather, our odds are greatly improved by making fewer decisions over a longer time horizon where competition has dwindled.
For those willing to stomach some short-term volatility, the long term rewards are as great as they’ve ever been. By playing in a different arena than the crowd, we can expect to beat them.
The future performance of any investment strategy is significantly altered once it has been widely imitated. Don’t write off active management just yet.
Doing nothing is hard to do, especially when we are paid to do something. Inaction is easier said than done. Inactivity may be confused with not doing anything, but the decision to do nothing is an active one. And it is often far more difficult than doing something, which probably explains why it is far more rewarding.
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