Active investors on the forum

Investing / Others
31

This thread is a GEM, and we should all thank @Julianek for his free lessons on investing here!

I was one of those who 5 years ago thought “I’ll never be an active investor because it’s baaaaaad and they always lose!”

But then I realized that it’s not black/white. It’s not a 100% passive vs 100% active game.

I myself am picking an “asset allocation”, which inevitably makes you an active investor of some sort. How much stocks? How much bonds? Which stocks? Which index? What the hell is “the market”? Buying VT is the market? S&P 500? The Dow? Does one who invest only in NASDAQ is beating the market? What is the market? Am I “passive”? No! I’m both choosing among indexes, and trying to deploy my money into the market with some discretionality in timing (i.e. I’m moderately timing the market)

On the other hand, an “active investor” who picks 10 stocks and stick with them for the next 50 years, never logging in into their brokerage account forever… looks pretty passive to me!

The more I read, the more I understand that YES, the market (however you define it) is beatable, even in the long term. It’s a tough job, it has costs (your effort and time), it has high chances of failure, but it’s beatable. I clap to those who succeed in that. It requires a lot of skills (mostly psychological), and it’s the reasons why it pays much more than being Cristiano Ronaldo.

Does it mean I’ll change my mind and become a true active investor? No, for now. Maybe one day I’ll be more active. I’m ok with considering myself 80% passive, 20% active at the moment. Maybe in future I’d like to try that “job” of understanding businesses and investing in the good ones.

But at the moment I’m not putting in my time, and I shouldn’t even be as active as I am right now. I should be more 90/10, and my irrationality might cost me money. Just sheer luck that I sold at high in November and purchased (maybe) discounted stocks during Feb and March.

The point is: making it a “religions fight” is childish and plainly false. Active investing is a thing, and it works under some circumstances. The vast majority of people should not try that at home, but that doesn’t falsify the statement.

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32

Are you not afraid that the fund is getting to big and will lose it’s edge?

33

Out of curiosity:
Given that they are pretty open about the holdings (but perhaps not their proportions) - and that there are indeed very few of them - why not just replicate them yourself instead? (and do e.g. equal weight)
One could argue “it’s too late to buy because the price is high now vs. when he bought”, but that’s not the right viewpoint - he wouldn’t be holding them if he didn’t believe in their long term gains, no?

34

Time, effort, taxation.

35

You could but as you mentionned, you would have to equal weight, which they do not do. For exemple, if you read their 2013 annual shareholders letter, you will see that they sold five of their holdings during the year and he explains why. Here, I will just quote the first paragraph which is a more general explanation, afterwards, he gives individual reason for each stocks.

Although our turnover was once again very low in 2013, we sold five holdings: McDonald’s, Schindler, Serco, Sigma-Aldrich and Waters Corporation. There may seem to be an inherent contradiction between the fact that we sold five holdings yet our turnover was low. Part of the explanation is that some of these holdings had already become an insignificant proportion of our portfolio because we had been struggling to add to them as their valuations had become too high to represent good value in our view. Once this point is reached it begs the obvious question of whether we should in fact sell our holding to make way for an investment which offers better value, either within our existing portfolio stocks or from within our wider Investable Universe of stocks on which we maintain research.

So if you would do an equaly weighted portfolio, you would have reinforced those five stocks while they were, according to them, overvaluated. So if you want to do that, you start to need a valuation model similar to theirs. I guess that this can be done to some extend since they explain which characteristic that look at.

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36

If they are buying and selling that often, then the comments above of “passivity” and “buying for the long run” fail. :slight_smile:
What taxation? You are not doing day/month trades with this, you are holding them longer I suppose.
Time and effort - not much really (again not trading daily or monthly as per their strategy).

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37

Two additional points on this:

  • Just to confirm that our brain is absolutely horrible at handling compound interest (an exponential process), here is an interesting link on the topic. Quick summary: you may think that the brains thinks at least linearly, but it is even worse: most often the brain behaves logarithmically. For instance, when we handle millions, billions or trillions, we do not have a grasp of the scale change, we just add zeros in our minds. Juggling with an exponential process is then absolutely impossible.

  • To answer your exact point about spreadsheets, i thought the same. I have an hypothesis about it, but so far i am not sure yet if i developed it fully (beware, it is a bit technical)

    • as said before, most analysts will do a discounted cash flows valuation to value a business (i am not fan of this, but this is what is taught in most business schools)
    • the discounting rate is usually around 10%, and for exceptional businesses like the ones held by Fundsmith, there is no reason to think that it should be higher
    • Now look at our businesses: they are compounding at 15+%. When you do discount cash flows growing at 15% with a discount rate of 10%, it does not converge, the value is infinite…
    • Therefore, in most spreadsheet models, the analysts say that the business is going to grow at 15% for let’s say 10 years, after which the growth will be more modest due to increased competition (usually the 4% GDP growth). With this adjustment, the model converges to a value.
    • Now it happens that your valuation is very sensible to the limit you set for the number of years of good growth: many analysts use 5 years for normal businesses, 10 years for businesses with good visibility, etc. But what happens if the business actually continue to grow for 20+ years at a good rate? Your valuation will be wrong by a 100% margin… This could explain why analysts are so off the mark when valuing businesses, but as said before it is just an hypothesis, i need to dig it further…

For Fundsmith, investors outside the UK need to subscribe to their Luxembourg SICAV (a kind of mutual fund). You send them directly the money, it is not listed on an exchange. Smithson on the other hand is a closed end fund listed on the London Stock exchange, and thus available on IBKR.

Fundsmith is currently $20 billion AUM. It has around 30 holdings, all of which have a market cap of more than 70 billion. 20b/30 = 700 million to allocate in each position, which is still quite liquid. Using the same principles, Buffett grew BRK to $500 billion so I am not too worried.

Yet San_Francisco is spot on: if I’d do it myself, even if i do not trade, I have still 30 businesses to manage, which implies:

  • reading all financial reports, making sure that the businesses are still impeccable, looking for financial shenanigans/management mislead. You could say that since they are in FEF portfolio it should be OK, but Fundsmith communicate on buys/sells only once a year, and i could learn about an issue way too late
  • This is an awful lot of time, given that it is not my full time job. I am much more at ease with 8-9 positions to manage. This way i know these 8-9 companies from the inside out, rather than 30 + businesses that i know vaguely. To give you an example, @ecthe spends quite some time calling directly CEOs/management of companies he is investigating. Imagine doing that for 30 companies every quarter…
  • Others might be more comfortable with less diligence; I know it is not for me though, as I tried something similar in the past.
  • And finally, although it is not a decisive factor, i can assure you that it is not a pleasant moment to fill your tax declaration (especially the Wertschriftenverzeichnis), when you have so many holdings that you need two additional sheets… 10 holdings is much better :slight_smile:

So in a nutshell, i am more comfortable outsourcing it to Fundsmith/Smithson, having one big line in my portfolio that will provide good returns with low volatility, and which acts as the opportunity cost for my other 8-ish lines.

But i concede that you are right, Fundsmith is quite open about their holdings, and in theory you could approximate their portfolio once every year…

Well thanks a lot MrRIP! Happy that it did provide some food for thoughts…

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38

When holding individual stocks: Are you going to reclaim withholding taxes on (applicable) dividend payments from a multitude of foreign tax authorities? Is it even worth to get the required documents issued from your broker?

Granted, if you don’t, the (potential) loss in unreclaimed withholding taxes on individual stock holdings will be less than the costs and charges in Fundsmith - but it does narrow the gap.

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39

Interesting observation, and intuitively it seems correct.

Why are you not a fan? What other way would there be to calculate present value of future cashflows?

Your theory certainly gave me food for thought. It is indeed tricky to calculate. Still, I think that people who really influence the price with their trades have a good understanding of how it works. I can’t imagine that someone like you or me, even if there are millions of us, can keep the market constantly out of balance?

40

Discounted cash flow (as well as discounted dividends) doesn’t really measure value generated. A company can have a negative cashflow (e.g. because of big investments) and has still generated a profit. Investments generate cash flow, but investments often cost cash at a much earlier time. Stephen Penman says

we preferred to call free cash flow a liquidation concept rather than a value-added concept and, in doing so, called into question the idea of forecasting free cash flows to value firms’. We recognized, of course, that forecasting free cash flows for the long run captures value. But that goes against our ctiterion of working with relatively short forecast horizons and avoiding speculative valuations with large continuing values.

Now, you can try to predict value added, but that has the chance of not materializing in cash when it’s necessary. I’m not sure (yet?) what the right way to go about this is, but @Julianek probably can say much more about this.

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41

"For the vast majority of investors a passive or index fund is a far better way to invest.

“…most active fund underperform the index. Most active fund managers are basically index-huggers.”

[We set up] "…a really active fund. Not in the sense of frenetic dealing but in the sense of differing from the index.

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42

Never heard Terry Smith speak until now. Strikes me as a very reasonable and humble man. And he basically uttered a threnody for Jack Bogle there, +1 for that.

Ugh… if only I had the courage to invest with him…

@Julianek: so did I understand right, you figured out recently that your net nets strategy is too time-consuming and that’s why you will invest a bigger portion of your portfolio with Fundsmith? May I ask what is your current overall allocation?

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It is mainly that lately the market had gotten so high that the number of available net nets is absolutely tiny. As these are usually mediocre companies, you could not find enough to diversify (net-nets work well as a basket, but are way riskier individually). They are usually less time consuming though: you know already that they are mediocre companies, so you don’t have to check again and again that they are good businesses (quality checking is more time consuming).

So i have currently the below allocation.

  • The cash is high but comes from a recent bonus.

  • As you see i am mainly invested in Smithson (the small/midcap version of Fundsmith, available on IB), which provides the base line of my portfolio for good returns/low volatility.

  • It is also the basis for my opportunity cost. Anything I add to the portfolio should improve my opportunity cost.

  • I am also considering opening an account at their SICAV for Fundsmith (as it is a mutual fund, non-UK investors have to go through the SICAV in Luxembourg).

  • Finally, i guess most people on the forum should discard the last line(individual stocks) and replace it by the fund of their choice as I guess they won’t go into individual businesses.

Position Percentage
Cash 7%
Second Pillar 9%
Smithson 37%
8 other companies 47%
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44

What books and resources would you recommend to someone just starting with active investment to learn about all these topics?

45

If you don’t do point 2, but take e.g. VT - would you bother with / care about balancing out the small-mid-large cap “misalignment” which comes with overweighting small/mid with SSON?

46

Accounting

If you don’t know accounting, you will have to learn it, one way or another. Accounting is the language of business, and you need to know how profitable a business is, how much capital it needs, and how much of its profitability you can expect to benefit you.
Any book will do, but as the topic is quite dry, for newbies i would recommend chapters 4 to 8 of The five rules for successful stock investing, by Pat Dorsey.

What makes a good business

  • Berkshire Hathaway, letters to shareholders, 1965-2019. Buffett’s letters are famous for a reason, and i learned a lot about what makes a good business in them. The topics are a bit random every year, so if you want them more organized, Lawrence Cunningham ranked them by topic in his book The essays of Warren Buffett : Lessons for Corporate America

  • The blog and lectures of Sanjay Bakshi. Sanjay is an indian professor and successful practitioner of value investing. Over the years he has amassed a lot of wisdom that he shares freely on his lectures (they can be a bit messy, but full of treasures, especially the company analyses), as well as on his blog. In particular, this article is a masterpiece.

  • Quality Investing by Lawrence Cunningham will give you the building blocks of what are excellent businesses

  • You will need to be able to evaluate management. This might look like a vague and daunting task, but your priority is to know if they are good capital allocators. No better book has been written on the subject than The Outsiders, by William Thorndike

Valuation:

  • Financial Statement Analysis and Security Valuation, by Stephen Penman, so you can get an idea of how the characteristics of a business make it worth more or less. You can also have a look at Accounting for value, by the same author.

Various good books

  • You can be a stock market genius, by Joel Greenblatt. Worst book title ever, but best book on special situations. Additionaly, the author has compounded at 40% per year for 20 years in case you needed credentials.
  • One up on wall street by Peter Lynch will teach you how to think about growth.
  • The joys of compounding by Gautam Baid: a nice recent surprise. I was pleased to see the number of important topics this book covers. I’d recommend it as soon as you have a broad idea about how business and investing work in general
  • 100 baggers , by Chris Mayer: the author spent his life studying businesses that made a x100 in the stock market. While he admits he can never be sure how well he avoided survivorship/hindsight bias, he draws interesting conclusions always worth keeping in mind.
  • Everybody quotes The intelligent Investor by Benjamin Graham, but the book is really, really dry. I would advise reading chapter8 (the Mr Market Allegory) and chapter 20 (on the margin of safety).

Qualitative thinking

  • Poor Charlie’s Almanack, by Charlie Munger: in this book you will learn more about how to think , as well as about your cognitive biases, than anywhere else.
  • Seeking Wisdom and All I want to know is where i am going to die so i’ll never go there by Peter Bevelin: builds up on Poor Charlie’s Almanack.

More importantly:

  • Read financial reports. Reading books is good, but applying lessons and figure out stuffs for yourself will make you learn 10 times more. Pick a company you are curious about and download its annual reports for the last 5 years, and see how it evolved over the period. Did it get better at allocating capital? Did it grow earnings BUT reduced profitability, making it less valuable? Is management candid and telling things the way they are, or are they putting lipstick on a pig (you’d be surprised how often companies managements talk about “adjusted EBITDA” to try not to look bad…)

Well, there are so many books to read, but with those you should have an idea about where you want to go next…

Oh, and one more thing: don’t neglect the Sanjay Bakshi resources: they are really that good. Don’t be rebuffed by the Indian units he’s using, it is worth learning to understand his articles (1 lakh = 100’000, and 1 crore = 10’000’000).

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48

If all the fund manager die in an accident, i would expect the company to liquidate the fund and return capital to shareholders. The value of the holdings would not move : the value of Microsoft does not change because a fund manager holding Microsoft passed away. Any other outcome would be an arbitrage opportunity.

I don’t know, I don’t think in terms of market exposure, but in term of opportunity cost. If my portfolio is expected to return 10% over the long term, then my opportunity cost is 10%. Every time i consider a new investment opportunity, i compare it to my portfolio opportunity cost. If I can reasonably think that I should expect 8%, then i don’t add it. If i have no clue (happens a lot), then i don’t do anything.
But the rules of the game is to try to increase the opportunity cost of my portfolio with sufficient margin of safety…

So to answer your question, with SSON i’d expect around 14-15% over the long term, same for FEF… VT would not make sense in this case.

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50

If nobody (fit to run the company) is around anymore, someone else would be appointed liquidator.

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Hey, just wanted to thank you for giving these resources, which are valuable as a primer on the topic.

Also, I wholeheartedly agree one should some (at least sometimes) try to think outside of the box and look not limit one’s horizon to US and, maybe, British sources, literature and research.It’s easy to become biased towards them for the simple fact that the biggest exchanges and financial firms are located are in these countries - and the language, obviously.

E.g., not discount resources because they originate from a supposedly “less developed” region or market in the world.Be that in more broader terms of “human development”, or in a narrower sense of less developed equity markets.

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53

I assume the majority on this forum has a “buy and hold” strategy. But has anyone tried to sell out of the money, short maturity, call options on their underlying holdings?
Say one has a long 1000 shares position on company/fund XYZ at an average price of 4.00 $/share (i.e. total amount invested to date $4k). Let’s assume current price is maybe lower, say around 3.50 $/share, and a 4.00$/share call option with maturity 20th of May will be 0.05-0.25 bid-offer. What if you can sell 1 call option for say 0.15 $/share, then you can receive 15$ in premium. If the option will expire worthless (say price will be <=4.00 $/share at maturity) then you cash 15$ and your long position remains unchanged. If on the other hand the option expires in the money (i.e. price at maturity is >4$/share) then you’ll have to sell 100 shares of XYZ to the option buyer at 4 $/share. You still realized the 15$ profit but you lose the opportunity to gain more by selling the 100 shares at higher market price. In this case, the adjusted portfolio will be 900 long shares @ same average price of 4$/share + 415$ in cash. This of course works if you have a view that on 20th of May the price for this share won’t settle higher than 4 $/share.
Any thoughts?