Ordinarily, I don't enjoy the moment that friends or relatives ask for investment advice. I'm happy to talk about what I like, but I have found that the proviso that I can change my mind gets lost as the conversation progresses into the detail and occasionally I have had to talk about an unpleasant result for them long after I had realised my mistake and gotten out.
But I got asked a question this week that freed me of the stock detail. A friend said they were putting some money away for their child and wanted to discuss a general approach that would be easy to apply and that the child might get interested in as the years progressed. The individual concerned is a research scientist who has made a hobby of reading about investing, but without dipping in very much as yet. Obviously, mine will be just one voice among many as he works out how to start.
Our conversation was colored by the tone of the debate around the investment industry currently, so active managers are useless, hedge funds are finished, the machines are taking over, smart beta...all of that. But despite his doubts about "the industry", what I like about this guy is his desire to win and not just index on the assumption that all discretionary management - whoever does it - is self defeating. He implicitly trusts himself and thinks the human factor has to be valuable somewhere.
The first thing I told him was that he's got the highest quality capital of all: his own money. The problems facing the average discretionary fund are obvious. Interestingly enough, people don't write off professional sports as an "industry" based on the average performance of all teams, but they do in fund management. This aside, what doesn't get discussed that often is the impact of the pressures faced by professional money managers, which collectively can be termed "keeping the clients happy". It's more fun perhaps to just slate these generally hardworking folk as charlatans. But anyone who has been there understands. Once when marketing a fund I felt a degree of sympathy for my competition when the fund of funds guy I was talking to told me he'd just finished talking to a manager whom he had put on notice "to provide some alpha soon" or the fund of funds would be redeeming. Such instructions are not conducive to providing the alpha the guy wanted and I nearly said, "just take your money out now - he'll blow it up trying to keep your business".
My own counterpoint to the broad and general attacks on professional managers is that I know many of them, in many different types of fund, and while their professional performance differs, a great many of these people are very successful investors on their personal account (PA). When it's their money, their knowledge of stocks, economies and markets become a powerful investment weapon when in their professional context it is often reduced to a mere vehicle for discussion with colleagues and clients. Size limits, benchmarks, the mindblowing tedium of the weekly (or God forbid, daily) investment committee meeting, the neutralizing effect of debate among the over educated and much else all act to dull the tools developed over a long career. But when unleashed in a private capacity these tools suddenly become very effective. Actually, pro sports are relevant here too. Take a bottom of the ranks pro sportsperson in the game of your choice and put them on the field with the best amateur you've ever seen at your club.
A PA star
Recently I learned one of these managers had increased her PA six fold over the last decade. I said something along the lines of: "let's can that into a product now". She shook her head and said, "Nah, it's unsellable". "How can that be?" I wondered. Her reply stunned me: "Well, I can hardly say I just sit there with index futures and cash and wait for something obvious to come up in the stocks, then I put 20% into it and stop out if it goes wrong" As I absorbed this as a "system" it occurred to me I has seen this process in action. "So when you called me about Bank of America (NYSE:BAC) last February....?"
BAC Share price
....and Charlie Munger
It seems to me this approach is well aligned with the conclusion you would draw from my favorite Charlie Munger quote:
"It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it, who look and sift the world for a mis-priced bet, that they can occasionally find one."
When my Star-PA manager friend called me about Bank of America (or actually banks in general) I had just spoken to another friend who works as a financials sector specialist equity salesperson. This was at the height of the bank "crisis" of early 2016 and he spoke of heavy program selling with momentum based algorithms hammering the worst performing stocks. I remember plenty of articles being written in the financial press that retrospectively justified the price action, but what could well have been taking place was essentially a fundamentally erroneous market move driven by machines designed to follow market moves. Regardless of what caused the charts to go where they did, it was good ol' human insight when a very experienced investor came across the situation and saw what Munger might call a "mispriced bet" (this regardless of whether Munger himself would have stepped in on that occasion) and then did the very human thing of calling a friend who knows a lot about that area before pulling the trigger in major size, but with a client who would forgive her if it didn't work (herself!).
Sadly this story doesn't lead to some magic investment formula. But what did I tell my friend who is searching for a method?
I gave him that Munger quote and the example of my friend who's achieved a near double in BAC over the last year. Munger (and Buffett of course) advises individual investors to mostly stick to index instruments, but they wouldn't deny them the fun and opportunities of well thought out forays into individual stocks.
I did advise him not to "put 20% into" the first thing he likes and indeed not to try that until he's been going a long time. Find something he's comfortable with and can absorb losses on (say 5% of his NAV) and start there. My PA star friend has more than 25 years experience as a fundamental investor and uses stops (for good or bad) to protect those big concentrations and my guess is she doesn't think twice about missing things that aren't obvious to her. Emotion doesn't come into it. The stop loss isn't at all from the Book of Buffett and Munger but the great men might at a pinch appreciate the discipline and consistency with which she applies it. However I told my pal to think hard about applying stops at all especially when his departures from the index and cash are limited in size. After all, equities are long duration assets and all forms of impatience are dangerous.
I said that the cash and index instruments mix, to my own mind, is really a question of valuation interfaced with risk. US stock indices are not cheap but enjoy a conducive backdrop with the atmosphere around Trump's tax talk, and current US macro data make a huge correction unlikely. Pullbacks of 10-12% do seem very likely as Trump is stirring up so much in terms of international relationships and it's also possible that higher interest rates will weigh on risk perception if inflation strengthens a little more than expected. To demonstrate this thinking, I showed him the FIG Ideas US Financials Portfolio, which is 23% in cash and would probably be a bit longer cash if it weren't a financials book, since financials seem to me to be a little better placed than the overall market right now.
Thoughts on investment method and inspiration for individual investors greatly welcome.
Disclosure: I am/we are long BAC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.