I thought I would go with this heading after seeing so many financial pundits on social media focusing on how right they were shortly after the recent correction.
A couple of things stood out to me from recent events. Firstly, the same investors warning the S&P500 index was overdue for a correction for years were proudly boasting how it was obviously well overdue. Admittedly I fall in the category of being quite defensive ever since blogging in early 2016. Therefore, the last thing I wanted to do was to make this post about claiming to be the guy that successfully traded around the correction. I have been wrong on so many market events since blogging.
Secondly the same applies to Bitcoin. Are you that much of a guru if you labelled it a huge bubble as it passed 3,000? I am probably in that category, so I don’t consider the recent falls make me that smart on the subject.
Admitting you are wrong.
One of the hardest things to do in investing is admitting what you got wrong and coming to terms with it. This includes minimising the damage such mistakes cause to your portfolio returns. I thought I would explore a few areas (of many more to choose from), that I have got wrong since blogging.
What I have noticed is when it comes to glaring errors, some of my opinions on top down macro themes stand out as being way off the mark. I suppose that is not that surprising. In a bull market we are not as likely to see as many mistakes in terms of nominal losses on individual stocks. The potential to dramatically underperform surging global equity indices may be the biggest theme to bring investors undone in the last two years.
On that front it is quite embarrassing to note that during the correction in markets in early 2016, I was confidently saying the risks that this turns into a large bear market are high!
I also blogged earlier on when the AUD was less than 70 cents that despite not being very bearish, the risks were still for a lower Aussie!
Back then I thought most commodity related stocks did not offer very attractive opportunities. Most have gone on to produce fantastic returns!
I labelled the FANG stocks were way too risky a long time ago!
I could keep going of course. But I think you get the point so let’s stop for a moment!
Please let me stop.
One conclusion is that macro-economic views and timing various indices is probably a mug’s game as I have shown.
Despite the recent correction, such views I have had above certainly have been costly. Hopefully though I can show that they don’t have to be too costly.
Looking at my portfolio returns, they have done comfortably better than the ASX200 accumulation benchmark over the last couple of years. That is not a massive achievement, since the ASX has been one of the laggards in terms of global equities markets. At the time of writing though my returns have been reasonably close to the S&P500 total returns since the start of 2016. Although if this rapid bounce back from the recent correction continues at this pace, I may struggle to keep saying that!
For that to be the case (given my silly calls above!), I like to think it can come about due to thinking of “upside risk management” strategies.
As far as this blog goes I have tried to streamline things a bit in terms of how some of the discussed stocks have performed. Then having a small list of current holds mentioned in the one spot to keep an eye on. You can click on the categories headings on the right to view. Please understand it is not meant to reflect any claimed audited investment returns, just some fun and to add a bit of interest to the discussions here.
WHY IS UPSIDE RISK MANAGEMENT ALSO IMPORTANT?
I thought these two below links were good posts that explains the potential risk of firstly taking profits too early and largely cashing out of the market. The second one covers the opposite extreme about getting seduced into the latest risky star market performers.
I know I mention Forager a lot, but they also touched on the issue of keeping your returns up when “animal spirits are running”. Below is a recent hour-long webinar on the subject.
I liked when they used the analogy of the good tennis players that are maybe going through a bad patch in a match. An inferior player may steal a set off one of the established greats by taking some risks and being fortunate enough to land plenty of winners that are unplayable. A high-risk strategy of going for make or break huge shots can do that. The top ranked player would not respond by changing their plan and playing a similar game. They would stick to their game plan and rely on it likely prevailing over five sets.
With investing it can help to just ignore those who have been talking up their recent paper gains in investments that probably wouldn’t come under the value investing criteria. Don’t be disillusioned if you are underperforming those that are talking up their riskier winners. Just prior to Christmas it was easy to feel a bit left out as others were shouting about large paper gains in the likes of Bitcoin, GetSwift and Big Un. Since I focus a lot on LICs, I was also well aware I missed out on the huge run up in Henry Morgan shares. I am not that bothered by this now.
Sticking with Forager’s tennis analogy for a moment, you just try and stay in the game with your regular plan and maybe the competition blows themselves up eventually. With investing that can mean rather than taking your racquet and ball and going home (e.g. selling up and holding 80% in cash because you fear a crash), sticking to your plan with some upside risk management techniques in place.
WHAT ARE MY UPSIDE RISK MANAGEMENT TECHNIQUES?
These techniques below may be wrong for many investors out there. You need to find a strategy that you are comfortable with. I just list these below for discussion purposes, as they have been strategies that I have felt comfortable with in the past.
Having your own benchmark – If like me you are a private investor and not running a fund for external clients, perhaps some of the well performing benchmarks are not that relevant? Therefore, I don’t stress out like a fund manager may. If I feel my outright returns are acceptable for the risk I am taking, I am not going to lose sleep over some underperformance of certain global equities indices during a strong bull run. I was reading some of the early Buffett partnership letters recently. It is often mentioned that if returns only keep pace with the market indices during very strong bull markets then that it is likely to be acceptable. Of course he ended up doing far better than that though most of the time!
Asset allocation targets – In the about me section of the blog I have referred to this. Even though my gut feel early in 2016 was that there were reasonable chances of a bear market, this rule of mine made sure I didn’t hold too much cash compared to my set targets.
Cash Equivalents – Forager also touched on this in their webinar. There may be investment opportunities that can be relatively defensive and expected to turn into cash at different points in time in the future. They may also have the potential to earn near the returns of equities but with a little less risk. If they are likely to “mature” at different stages in the future it can give you a cash flow that can be quite powerful to use if markets are slumping at the time. They maybe in the area of takeovers or wind ups. Again referring to the early Buffett partnership letters many will think of this category as known as ”workouts”. Stocks that spring to mind in this bucket for me since blogging include GJT, AIQ, UPG, AJA, WCB, AGF, VNL.LN. My cash / cash equivalents bucket often is half made up of these types of plays.
Very minor uses of options on occasions – This has been a mug’s game for me generally until the very recent spike in volatility. For the vast majority of time I don’t think this is a great strategy for most investors. Last year though I did blog in September about the craziness of those shorting vol. I noted a news story of a manager at a Target store turning $500k to $12 million in a few years shorting vol! Reports were he quit his job and he had offers to run a $100 million fund! A warning sign perhaps? I also referred to a Livewire post from Samuel Terry Asset Management at the time and mentioned using options from either the bullish or bearish side can make sense.
You could potentially hold high cash balances with some out of the money calls. If animal spirits continue those options can make up for the drag that cash has on your portfolio and even more. Don’t take my comments on options as me trying to boast I made a huge windfall here. I realise I am telling you with a bit of Harry Hindsight. I clearly didn’t blog about any specific options or LIC options trades I made. A quick look up at Samuel Terry Asset Management’s performance in January though will tell you an interesting story of how this strategy can work when you go long calls at cheap levels.
The other way to keep up when animal spirits are running maybe to keep more fully invested but have put options. These surged as the initial correction took hold in early February. When vol was priced so cheaply before the correction this would likely not drag returns as much even if they expire worthless.
Unfortunately, the window to use these tools may have closed for the year. We may look back on the last year to two as a once in a decade type opportunity to take advantage of low vol. I only see this as something to consider when the VIX is more around the 10 level.
Momentum strategies & Stops – Some readers might be sceptical of these, but I do use them to a small degree. I personally tend to sell certain types of stocks too early when I make a good call. Running trailing stops has helped me get more out of positions in RMS, SSM, CEE:US, ILU in the past. It therefore has assisted in keeping up some performance but with plenty of risk management in place.
There has also been plenty written about the 200-day moving average as a broad tool signalling the trend of the S&P500. I don’t bet the whole portfolio on this! But I have some belief that using this as a guide can assist in getting equity like returns with less volatility. Because we have kept above this level for so long I have specifically refrained from raising too much cash. Should we break it on the downside I will be holding higher cash levels to some extent deliberately as a result. I believe the combination of expensive valuations and bearish momentum could be very unfavourable at some point in the future for US markets. I think one reason momentum can work is due to the performance chasing and shorter-term focus of the fund allocators and retail shareholders. The “career risk” nature of industry participants also contribute to trends. Another topic altogether to debate.
I expect plenty of scepticism at the above approach but investing has plenty to do with what you are comfortable with. For someone heavy into accumulation phase though I concede this momentum strategy is probably not very relevant.
Below is a bit more discussion on this topic from a blog piece I recently read. I can’t verify all the data but thought it was interesting nonetheless.
Simply chill out, ignore the bubble talk, keep closer to fully invested & focus on income not prices! – This is probably the simplest and best way most investors can prevent themselves from lagging the benchmarks in a major way. Switch yourself off from the noise of those making a killing on the latest speculative stock. Turn off your screen of daily price fluctuations. Perhaps once a year simply note the dividend income from the portfolio. It may surprise how remarkably stable this is compared to the fluctuation in popular stock indices. Spend some time away from your phone and the temptation of thinking about investing.
If you are at a barbeque and someone is chatting about their gains in Bitcoin, or the part time shop assistant is speaking of their 24 investment properties call a time out. Politely excuse yourself for a toilet break, get a beer and seek someone else to talk to.
On this subject I often think about Anton Tagliafero. In the tech boom it became quite frustrating watching others make gains, so he spent a lot of time visiting the Sydney aquarium to stop dwelling on it. He places a strong emphasis on dividends with his investing. It goes again back to sticking with your game plan.
Another good illustration is the book motivated money.
If you have children at university or only recently entering the workforce I recommend this book especially. It can be a good read for any investors for that matter.
Investing with this mindset will probably mean you shouldn’t lag in the bull markets too much. It will probably allow you to sleep at night well being quite fully invested. It will beat trying to achieve that sleep at night factor by cashing out half your portfolio trying to predict the next correction or crash.
I have noted the likely dividend income of my own portfolio and just jotted down the figure after applying a 25% cut to it. Focusing on that gives me quite a stress-free feeling during falling markets. If such a scenario will not hurt your life much, then even another GFC type event shouldn’t give you much stress.
Even though I described this as a simple approach, I would warn many still fail at it! During 2006 and 2007 I read countless posts on various forums from new investors promising that they would stick to this type of plan for a lifetime. Then they disappeared from the forums over the next few years as the bear market took hold.
Here is a Peter Lynch quote I have used before.
“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.” – Peter Lynch
Now that I posted that of course, we can be sure it marks a top and another correction or bear market is imminent!
Good article on capturing the discount compression in LICs.
Dominic McCormick has written quite a few good articles on LICs I have noticed over the years. This recent one captures a lot of how I think about the sector, but written better than I can manage. I suggest it is well worth a read.