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I am film and television producer who writes a value investing oriented blog called Chromainvesting.com. I try to explore the Deep value orientation of Graham, with an updated perspective that includes the work of Behavioural Finance gurus such as James Montier.
  • What is Your Investing Edge? 0 comments
    Mar 13, 2011 6:41 PM

    If you scroll down his recent 2010 Letter Seth Klarman asks, "What's your edge?" He asks this question in the context of developing a framework for investing success. It is a vital question. And if you don't have an answer, it is time to develop one.

    We all have some advantages over other investors. Are you a good at analyzing financial records? Are you patient? Do you have intimate knowledge of the biotech industry? You get the idea. These are all advantages that one person could have over another investor.

    Before we turn to Klarman's next point, let me point out some great investor's "edges."

    -Monish Pabrai has reminded me that checklists aren't just good for surgeons and airline pilots. I am still developing a comprehensive checklist.

    -Warren Buffett- Mental discipline. "Be greedy when other are fearful," is easy to say, much harder to live when you are uncertain. Think March 2009 when most investor's were soiling themselves.

    -Joel Greenblatt- Probably has two edges. Mechanical Investing ( such as Magic Formula Investing) probably has some merit. Figuring out which criteria are currently important is your edge. He also reminds us about the importance of special situations, especially spin-offs and the oddities involved in mergers (although not Merger Arbitrage).

    -Benjamin Graham- cigar butt stocks. Despite the ongoing positive investing results from Net Net stocks, some people can not invest in such "Ugly" companies. That has often been my edge. Apparently, I like warts when I invest.

    -Seth Klarman- Complexity. He is a master investor because he and his team analyze the difficult to analyze and discover where the market has mis-priced something, usually significantly. If you can master the detail and complexity you are in good company. Everyone thinks they can do this, I am not one of them.

    -George Soros - reminds us that investors behavior affects other investors decisions in ways that affect price. That brings us to Klarman's next point in his 2010 letter.

    "There is a second element in designing a sound investment approach: you must consider the competitive landscape and the behavior of other market participants." So, it is not enough for you to have an edge to be a successful investor, according to Klarman, you must see how others are behaving in the markets. Not everyone  will be like us, value investors, some will be speculators, others Technical Traders. The point is if you aren't clear what the rest of the people investing against you are doing, you can be hurt by them. Klarman uses a football analogy. If your opposition is defending against the run: Pass. Even if you have great running back. This may seem obvious. But as humans we tend to be seduced by the herd, the trend, the momentum. Whatever you want to call it. Value Investors are ultimately contrarians with a refined attitude. We need to remember, if too many people are afraid of something, it is worth a look. And if everyone you know loves something, tread with caution.

    "When observing your competitors, your focus should be on their approach and process, not their results." This could have been said by James Montier. Klarman says we shouldn't replicate other investors portfolios, but "looking for opportunities where they are not." Is it in housing debt or Greek equities. Talk about fearful places to look. There are opportunities in investing that you have to search out. Here a few investment ideas that Klarman alludes to, and you ignore Klarman at your own peril.

    -Bond prices don't just fall when they fall below BBB- High grade bond funds are often forced to sell in that situation- possible buying opportunity.

    -A mortgage security will be downgraded when it can't return par to bondholders. This will cause a rash of selling. Forced sellers are at a disadvantage to you. Know your edge.

    -When a stock suspends dividend, some  funds must sell. Look at the fundamentals. Perhaps their is opportunity.

    -Does the value of a stock change when it is deleted from an index? To index funds, that stock must be sold, even though the value may not change. Obvious. Yes. Opportunity, if you don't have to sell. Also yes.

    -Finally a significant drop in a stock price can be enough to make investors bolt for the door. Momentum and Technical traders can lose their edge here. Don't assume the market knows better.

    If Klarman is pointing out anything, it is the inefficiencies that can benefit someone with an investing edge that the seller of that investment doesn't have.

    If you liked this post, please check out my blog at: chromainvesting.com

    If you want to read a long excerpt of the 2010 Klarman letter I have referred, to which only briefly touches on the them I have discussed, please follow the link to My Investing Notebook. The letter is worth reading in its entirety.

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