"they are all in"

[finetrader]

I agree that volatility is a good thing when you know how to concentrate on fundamental.

 

Asset allocation explain 90% of performance, so it can be a good idea to be invested in cash from time to time. From hindsight, a year ago, if someone was invested in bond and cash like Fairfax was, it was the place to be. It seems hard to do, but if we remember, all the news were talking about a recession in the beginning of 2008. Even Buffett said at that time that by any measure the US was in a recession. Unfortunately, I was fully invested in stocks back then( I thought I'd be fine by not having US stocks exposure). But I think it is possible to see the long term cycle of the economy and act properly to be in synch with it.

[SharperDingaan]

 

Keep in mind that career risk is the biggest risk for a PM - as the industry pushes the PM to always be 'all-in', & rewards only short-term gains. So long as the fund does the same as the herd, & loses less than its benchmark, the PM will be OK. The promotion is a low risk gamble & if it pulls in additional $, everyone gets paid more. Your interests as investor, are pretty much irrelevant.

 

If you really believe inflation is coming, simply mortgage your existing house on a long-term fixed rate & put the $ into a long term floating rate Treasury. You are your own renter, & you're paying because you need a place to live. If the expected inflation occurrs the floating rate on the treasury will simply increase, the principal will never fall much below 100, & you retain a liquid asset that can repay the mortgage in full. When the inflation occurrs you get paid out a rising spread, every month, & in cash. Inflation becomes your friend!

 

SD

 

[scorpioncapital]

"Multiple successes multiplied by zero is still zero"

 

True, but we are not talking about zeroes, rather stocks that decline 50-60-70% temporarily, without major bankruptcy risk, no big deal.

 

I do agree that one's needs should dictate whether to invest or not, however, there are many well selected stocks that did very well over the last decade, that had a reasonable positive outcome above and beyond the index.

 

Your argument speaks FOR smart investment (or not investing at all), not against buy and hold. I agree that choosing a poor manager is as bad as choosing no manager and holding cash. Alternatively that person could just buy some bonds and get 3-4% or something like that.

[EdWatchesBoxing]

If you are a port. mgr for a mutual fund where you need to be "all-in", it is very easy to mitigate career risk. You just make sure you are more diversified than the market benchmark. You want to make sure you smooth out the returns so that you underperform in a bull market and lose less when it's a bear market. People will withdraw less. I'm sure you will not lose your job if you do this. You don't need to be in the top 20-30%. You just need to be mediocre.

 

If you're running a hedge fund/partnership, you hope that your "alpha" period lasts long enough to make you enough in performance fees before that "career risk" event takes place. This type of thing can hit anyone. Munger got hit bad in the 70s and I'm sure many people asked for their money back. Buffett avoided it by rolling his funds into Berkshire.

 

Volatility may be a friend to an investor, but everyone else can't stand it.

[maxprogram]

Again, that is true the 49 years out of 50, but unfortunately that 50th year does eventually come around.  Multiple successes multiplied by zero is still zero.  How many hedge funds perished last year...25-30%?  And that hedge fund number would have more than doubled if they couldn't lock up the capital.  How many value fund managers got killed last year...85-90%?  How many pension funds got mangled last year...65-75%?

 

This reminds me of a good Seth Klarman quote:

 

"An investor is more likely to do well by achieving consistently good returns with limited downside risk than by achieving volatile and sometimes even spectacular gains but with considerable risk of principle. An investor who earns 16% annually over a decade, for example, will end up with more money than an investor who earns 20% for 9 years and then loses 15% in the 10th year."

 

I think both methods are justifiable. Consideration also has to be given to whether you are an individual investor, or are managing other people's money (and in that case, how good of a partner base you have).

[scorpioncapital]

"An investor who earns 16% annually over a decade, for example, will end up with more money than an investor who earns 20% for 9 years and then loses 15% in the 10th year."

 

I think you guys are missing the point of the idea that lumpiness means nothing. 16% per year does NOT mean 16% per year. It could mean for example, -10% year 1, then +30% year 2, then 5% year 3, then 22% year 4, etc.. for an average of 16. The only person who got 16% per year exactly was Madoff.

[Guest kawikaho]

Sanjeev, I like your arguments and way of thinking.  They say Tiger Woods never dominates one hole.  He's just consistent, and that's why he always wins.  I have posted a topic several months ago about asset and money managers that had stellar returns until last year.  Those returns were absolutely decimated this year.  I'm talking about guys with 10 year track records of 22-33% annual compounded returns getting whittled to 7-12%.  Trapeze, ZPRIM, Pabrai, CGMFX, not to mention countless hedgies and what not, are a few names.  All it takes is one massive blow up.  

 

[Guest kawikaho]

"An investor who earns 16% annually over a decade, for example, will end up with more money than an investor who earns 20% for 9 years and then loses 15% in the 10th year."

 

I think you guys are missing the point of the idea that lumpiness means nothing. 16% per year does NOT mean 16% per year. It could mean for example, -10% year 1, then +30% year 2, then 5% year 3, then 22% year 4, etc.. for an average of 16. The only person who got 16% per year exactly was Madoff.

 

You definitely have a point there, although, I think they're talking about massive blowups.  One small down year won't make a big difference to your returns, but one massive down year will cause serious mean reversion.  

[bargainman]

 

The industry is primed to always stay fully invested.  It's the greatest statistical Trojan Horse in the financial world!  Always stay fully-invested...buy, hold & prosper...missing the 30 best days reduces your results by 50%...etc. This is what statistics tell us, so the investment managers fully buy into it, and in turn they feed their clients the same information.  

 

The problem is that the buy and hold crowd never points out the opposite side of the statistic.  What if you missed the 30 worst days?  What would your returns be like then?  I can't remember where I saw it, but it was very significant.  Siegel in his book showed that doing something simple, like tracking the 200 sma, got you close to S&P returns with a significant reduction in volatility.  I agree it all has to do with context though...

[maxprogram]

I think you guys are missing the point of the idea that lumpiness means nothing. 16% per year does NOT mean 16% per year. It could mean for example, -10% year 1, then +30% year 2, then 5% year 3, then 22% year 4, etc.. for an average of 16. The only person who got 16% per year exactly was Madoff.

 

I don't think anyone ever said 16% every single year. I believe Klarman's point was that any loss on your portfolio is difficult to make up for, and can wipe out a lot of previous gains.

 

The quote was from "Margin of Safety." Of course, Mr. Market is irrational, there will be mark-to-market losses, etc. But overall, as Klarman discusses, being extremely conservative with valuation estimates, having sufficient (but not excessive) diversification, holding cash in lieu of bargains, and opportunistic hedging will minimize downside. Rules #1 and #2 of investing.

 

One example, as most on this board know, is Mohnish. I think that he will be fine in the long run, as will all his partners who stuck around. But after a 60% loss, it takes a long way to go to make up for it, even after a 50% gain. He's still trouncing the market and will probably continue to do so. I just think the purpose of Klarman's quote was to say that a string of 25-40% returns followed by a 50% loss is the same in the end as a string of 13% returns. Two different styles of investing with the same results.

[SharperDingaan]

 

Keep in mind that there are many kinds of hedging, & a Klarman investor has proficiency in all of them;

  1) Defensive hedges. Intuitive, protection against downside loss.

  2) Offensive hedges. Less intuitive, protection against the stock 'running away on you' 

  3) Capital hedges. Non intuitive, protection against moderate adverse changes.

 

Most folks know 1), less used is 2), & least understood is 3). Type 3) hedges are typically against macro variables (liquidity, inflation, FX, volatility, loss of job, etc.) & can be thought of as risk management overlays - there should be a cost to them, but often there will not be.

 

A typical liquidity hedge would be a long T-Bill/Cashl+long call.

You're in a hostile down market, but you think that for the stock in question there may be a change - & if it happens there will be a significant bounce. You have upside but you retain very high liquidity untill you choose to use it.

 

SD