You’ll be stunned (...Not)

Dr Adrian Saville, CIO of Cannon Asset Managers, ponders Chris Mayer’s recent article which notes that poor philosophy and bad processes make for poor investment results.

Chris Mayer, editor of Capital and Crisis as well as Mayer’s Special Situations, recently published an article on The Daily Reckoning that carried the title “Useless Investing Variables: We Are Our Own Worst Enemy”. In this article, he supports the view that the toolkit of successful investors includes an acceptance that to build portfolios that deliver results, it is necessary to be contrarian. In turn, this means that it is impossible to be right all the time. In other words, the successful investor should anticipate short-term underperformance as part of the journey to achieving great results. Successful investors, then, are far sighted and skilled as well as experienced in managing the stress of short-term disappointment in portfolio results. Also, whilst investing is often paraded as a complex, intricate and highly sophisticated practice, the best decisions tend to be those that are based on simple principles, a point that Buffett put well in noting “investing is simple, but not easy”.

To develop these arguments, Mayer goes to the data, and draws on the experience that investors have had in Ken Heebner’s CGM Focus Fund, a thirteen-year old, non-diversified, US fund that invests in companies regardless of their size or market capitalisation. In examining the evidence, Mayer happens to draw heavily on the recent work of James Montier whom I consider to be one of the sharpest thinkers in the world of investment philosophy and strategy.

Method aside, Mayer notes that although the CGM Focus Fund was the best performing US fund of the past decade, rising an average 18% per annum, the average investor in the fund earned just 7% per annum, missing out on a staggering 11% of the total average annual return (according to research by Morningstar).

In turn, this result relates to the sad situation that many investors find themselves in when relying on investment managers to look after their portfolios: investors tend to be disappointed by portfolio results, but this often is caused by their own action of disinvesting when the manager has performed poorly and reinvesting when the manager has shown strong gains. This is exactly the same as buying shares when they are peaking and selling them only after they have collapsed, in a complete reversal of the fundamentals of successful investing.

Value investing requires an enormous amount of self-discipline and nerves of steel. It is emotionally easier and psychologically seductive simply to follow the herd, to panic when performance is poor or prices are low and to become greedy when prices have risen. As Mayer says: “Psychologically, it’s hard to do the right thing in investing, which often requires you to buy what has not done well of late so that you will do well in the future. We’re hard-wired to do the opposite.”

Extending this point, and quoting Montier from his book Value Investing: Tools and Techniques for Intelligent Investment, Mayer notes that the Brandes Institute has conducted research which shows that, in any three-year period, the best investment managers are among the worst performers about 40% of the time.

This can be scary stuff for tentative investors. “The point being you can’t worry too much about short-term performance. Investing is a game won by determined turtles, not hares. That means you have to stick with solid ideas, instead of trying to catch what the hottest thing is,” says Mayer.

When it comes to process, the message is clear: focus on the key elements and ignore the rest. Investors need to eliminate the “noise” of irrelevant details. Experiments have shown that people make increasingly poor decisions as the volume of information increases. In short, the phenomenon of information overload in investing is a very real one.

Mayer remarks that “My investment process aims to do that by boiling down the many details of investing in a company into four major areas. Too many details spoil the broth, but most investors haven’t learned this.”

He also comments on the fallacy of forecasting: “I read quite a bit of investment research in any given year and I am always amused at the detailed modelling (and forecasting) that goes on. If an idea depends on such finely tuned analysis, then odds are it is not such a great deal.”

In summary, as a disciple of deep-value, contrarian investing each of these arguments speaks loudly to me and, importantly, is supported by a deep body of evidence. To achieve great investment results, successful investors employ processes that are focussed, understandable, replicable and willing to be contrarian. To boot, these processes are far-sighted and underpinned by a long-term strategy that does not provoke knee-jerk reactions to market noise.