Tepper

[bmichaud]

Gio,

 

I am of VERY similar mind to you on broad market valuation and holding cash (I actually tend to hedge with an SPY short more than anything due to my inability to pass up attractive individual stocks and special situations), and paid the price for much of this year with extreme underperformance (until recently :)). I came into the year convinced the toxic combo of broad market overvaluation, Euro depression and a slowing China warranted a fully hedged portfolio. Our fellow poster moore capital and I battled it out late last year on whether it was a good time to be fully invested if not leveraged - he certainly bested me, to say the least. However, I learned a tremendous amount as a result of the debates we had as I set out to determine why I was so wrong and how I could improve going forward....

 

I originally adhered strictly to GMO/Hussman/Schiller long-term valuation methods for determining my exposure to the broad market - as demonstrated by my underperformance through most of this year and Hussman's horrific performance since march 2009, these methods do not work over the medium term, which is driven primarily by A) sentiment and to a lesser extent B) momentum. All that to say, I have attempted to come up with a model that incorporates valuation, short and long term over/under-boughtness and momentum in order to keep myself in the market even in times of overvaluation. It is a very crude model that still needs work...but from what I can tell has worked quite well since the mid-1920s (as far back as I can go right now).

 

I used Adam Hamilton's (of Zeal LLC - h/t moorecapital) method of measuring the market relative to its 200dma as a springboard. EG when the SPX is at 110% of its 200dma it's in overbought territory, and when it's at 80% it's oversold. Using this sole ratio through history does not work, but it works over shorter time frames as a sentiment indicator. So I added a medium-term relative ratio - the SPX's 50dma divided by its 200dma - and multiplied it by the original ratio. The higher the ratio the more at risk the market is - so if spx is overbought at 1.1x the 200dma but medium term oversold with the 50dma at .90x the 200, the "trading ratio) is .99x. Whereas if 1.1x 200 and 1.1 50/200, trading ratio is 1.21x.

 

So I back-tested the "trading ratio" and came up with better results than just using price/200dma, but still not good. Then I added a third component - schiller PE relative to the long-run schiller PE. So right now it's at 19 versus long run avg of 16 or at 1.18x - I call it the "relative PE". I multiply the rPE by the trading ratio to come up with the "Adj. Trading Ratio" (ATR) - so now you have a market indicator that incorporates long-run valuation, short-term over-/under-boughtness and medium-term over-/under-boughtness.

 

Final step is momentum. I add this by dividing the ATR by the absolute value of the 100-day growth rate of the market's 100dma (minimum of 5%). Basically the slope of the 100-day moving average. So by dividing the ATR by the % growth, you give the market the benefit of the doubt for its long-term trend - up or down. Sounds weird but it works.

 

Those are the key pillars of the model - a good amount more goes into it such as buy, sell and hold signals etc...but you get the idea.

 

I've had too much coffee and am up late typing on my phone without access to the model - but off the top of my head, since the early 1950s the model...

 

A) keeps you fully in the market from early 1950s through 1968

 

B) gets you back in the market part way through the 1973/4 bear - so doesn't do a great job here...but

 

C) keeps you in the market from the mid-1970s through the early 1990s

 

D) has you in and out of the market a couple times in early 90s 

 

E) back in the mkt with a buy signal in 1996 and 1998 before....

 

F) a sell signal in 1999 just before the crash

 

G) back in the market in 2001/2002 and no sell signal until...

 

H) early 2008

 

I) Back in the market October 2008

 

J) out of market early 2010 and back in mid-2010 - this was a poor sell signal as the market was largely flat during that time

 

K) out of the market early 2011 and back in..

 

L) Aug/sept 2011

 

M) model remained a buy through early 2012 and has been on a hold signal ever since

 

This model does not keep you out of every market correction, but helps avoid the bulk of large-scale declines. Most importantly, IMO, it keeps you from the making the mistake Peter Lynch refers to in his quote, "more money is lost waiting for a decline than in the decline itself".

 

In order to avoid short term 5 to 10% corrections, I believe sentiment indicators are BY FAR the best tools. Sentiment can be measured in various ways - put to call ratios, AAII surveys etc... - but if one has access to Ned Davis Research, the Crowd Sentiment and Daily Trading Sentiment charts are two of the best charts on the planet...again IMO.

 

So Gio, why am I babbling on? A) I love to learn, B) I like sharing what I've learned to help others and/or receive feedback and C) I relate to virtually every post you write about the broad market and holding cash!! I feel your pain of underperformance.

 

From an outside perspective it appears you and your firm are in a Berkshire-type situation where you always have free cash coming in the door...thus I don't see why you ever need to hold an inordinate amount of cash (outside of some type of buffer such as the $10B minimum Buffett imposes on BRK) when you can find the  attractive owner-operator opportunities such as Fairfax below BV. What if takes two years for the market to correct down to 10x earnings and in the meantime fairfax's BV climbes 20% per year and its stock price never corrects below where it currently is? Point is, your firm, like BRK, always has a cash buffer in the form of monthly free cash flow, so unless opportunities are scarce, why build cash? Just continue to build your positions every month in dribs and drabs as valuations allow, and if you feel the need to hedge, come up with some type of model (or subscribe to - think Ned Davis Research) that allows you opportunistically hedge your portfolio of owner-operator stalwarts! Thus you won't miss out on the inevitable growth of the underlying businesses by not owning/under owning those stocks.

 

Just one man's thoughts and opinions - probably worth far less than two cents.

[giofranchi]

Think of the market as a zero sum game like a coin flipping contest.  Your portfolio is $200, half in cash and half in market index fund. Frictional costs and interest income are small and disregarded.  Mister Market flips heads and the stock portion of your portfolio doubles.  You now have a portfolio value of $100 cash +$200 index fund = $300, and you rebalance to 50:50 by selling some of your index investment. You now have $150 in cash and $150 in index fund.

 

Mr Market's next coin flip is tails. The index fund and your $150 investment in the index loses half its value.  The value of your index fund investment is now $75.  The value of your $150 in cash is unchanged. The value of the market index is now back to exactly where it was before the coin flipping game began, but the value of your portfolio is now greater, $75 + $150 = $225 , compared to the $200  portfolio value when the game began.  You rebalance to $112.50 cash and $112.50 in the index fund and wait for the next coin flip.

 

This is a very pleasant game to play.  :)

 

The reason, why I hold twacowfca is such a high esteem, is that he has the rare gift of making you see things under a light you have never seen them before. I guess it is the trait of a true teacher, the one only a few people, like Mr. Buffett, Mr. Munger, Mr. Kahneman, Mr. Taleb, Mr. Herbert Simon, Mr. Michael Lewis, Mr. Malcolm Gladwell, Mr. Dan Ariely, and few other authors, can truly claim to posses.  :)

 

giofranchi

[twacowfca]

Think of the market as a zero sum game like a coin flipping contest.  Your portfolio is $200, half in cash and half in market index fund. Frictional costs and interest income are small and disregarded.  Mister Market flips heads and the stock portion of your portfolio doubles.  You now have a portfolio value of $100 cash +$200 index fund = $300, and you rebalance to 50:50 by selling some of your index investment. You now have $150 in cash and $150 in index fund.

 

Mr Market's next coin flip is tails. The index fund and your $150 investment in the index loses half its value.  The value of your index fund investment is now $75.  The value of your $150 in cash is unchanged. The value of the market index is now back to exactly where it was before the coin flipping game began, but the value of your portfolio is now greater, $75 + $150 = $225 , compared to the $200  portfolio value when the game began.  You rebalance to $112.50 cash and $112.50 in the index fund and wait for the next coin flip.

 

This is a very pleasant game to play.  :)

 

The reason, why I hold twacowfca is such a high esteem, is that he has the rare gift of making you see things under a light you have never seen them before. I guess it is the trait of a true teacher, the one only a few people, like Mr. Buffett, Mr. Munger, Mr. Kahneman, Mr. Taleb, Mr. Herbert Simon, Mr. Michael Lewis, Mr. Malcolm Gladwell, Mr. Dan Ariely, and few other authors, can truly claim to posses.  :)

 

giofranchi

 

You are too kind in your remarks.  The truth is more like the scene of the appearance of the Old Guy waxing his car with circular motions in the movie, The Karate Kid, when the student is ready:  "Karate is really simple.  Wax on. (clockwise motions) Wax off." (counterclockwise motions) , demonstrates The Old Guy. 

 

When wisdom is ready to be received, it will appear.  "Seek,and you will find." Knock, and the door will be opened. Ask, and it will be given."  :)

[giofranchi]

Gio,

 

I am of VERY similar mind to you on broad market valuation and holding cash (I actually tend to hedge with an SPY short more than anything due to my inability to pass up attractive individual stocks and special situations), and paid the price for much of this year with extreme underperformance (until recently :)). I came into the year convinced the toxic combo of broad market overvaluation, Euro depression and a slowing China warranted a fully hedged portfolio. Our fellow poster moore capital and I battled it out late last year on whether it was a good time to be fully invested if not leveraged - he certainly bested me, to say the least. However, I learned a tremendous amount as a result of the debates we had as I set out to determine why I was so wrong and how I could improve going forward....

 

I originally adhered strictly to GMO/Hussman/Schiller long-term valuation methods for determining my exposure to the broad market - as demonstrated by my underperformance through most of this year and Hussman's horrific performance since march 2009, these methods do not work over the medium term, which is driven primarily by A) sentiment and to a lesser extent B) momentum. All that to say, I have attempted to come up with a model that incorporates valuation, short and long term over/under-boughtness and momentum in order to keep myself in the market even in times of overvaluation. It is a very crude model that still needs work...but from what I can tell has worked quite well since the mid-1920s (as far back as I can go right now).

 

I used Adam Hamilton's (of Zeal LLC - h/t moorecapital) method of measuring the market relative to its 200dma as a springboard. EG when the SPX is at 110% of its 200dma it's in overbought territory, and when it's at 80% it's oversold. Using this sole ratio through history does not work, but it works over shorter time frames as a sentiment indicator. So I added a medium-term relative ratio - the SPX's 50dma divided by its 200dma - and multiplied it by the original ratio. The higher the ratio the more at risk the market is - so if spx is overbought at 1.1x the 200dma but medium term oversold with the 50dma at .90x the 200, the "trading ratio) is .99x. Whereas if 1.1x 200 and 1.1 50/200, trading ratio is 1.21x.

 

So I back-tested the "trading ratio" and came up with better results than just using price/200dma, but still not good. Then I added a third component - schiller PE relative to the long-run schiller PE. So right now it's at 19 versus long run avg of 16 or at 1.18x - I call it the "relative PE". I multiply the rPE by the trading ratio to come up with the "Adj. Trading Ratio" (ATR) - so now you have a market indicator that incorporates long-run valuation, short-term over-/under-boughtness and medium-term over-/under-boughtness.

 

Final step is momentum. I add this by dividing the ATR by the absolute value of the 100-day growth rate of the market's 100dma (minimum of 5%). Basically the slope of the 100-day moving average. So by dividing the ATR by the % growth, you give the market the benefit of the doubt for its long-term trend - up or down. Sounds weird but it works.

 

Those are the key pillars of the model - a good amount more goes into it such as buy, sell and hold signals etc...but you get the idea.

 

I've had too much coffee and am up late typing on my phone without access to the model - but off the top of my head, since the early 1950s the model...

 

A) keeps you fully in the market from early 1950s through 1968

 

B) gets you back in the market part way through the 1973/4 bear - so doesn't do a great job here...but

 

C) keeps you in the market from the mid-1970s through the early 1990s

 

D) has you in and out of the market a couple times in early 90s 

 

E) back in the mkt with a buy signal in 1996 and 1998 before....

 

F) a sell signal in 1999 just before the crash

 

G) back in the market in 2001/2002 and no sell signal until...

 

H) early 2008

 

I) Back in the market October 2008

 

J) out of market early 2010 and back in mid-2010 - this was a poor sell signal as the market was largely flat during that time

 

K) out of the market early 2011 and back in..

 

L) Aug/sept 2011

 

M) model remained a buy through early 2012 and has been on a hold signal ever since

 

This model does not keep you out of every market correction, but helps avoid the bulk of large-scale declines. Most importantly, IMO, it keeps you from the making the mistake Peter Lynch refers to in his quote, "more money is lost waiting for a decline than in the decline itself".

 

In order to avoid short term 5 to 10% corrections, I believe sentiment indicators are BY FAR the best tools. Sentiment can be measured in various ways - put to call ratios, AAII surveys etc... - but if one has access to Ned Davis Research, the Crowd Sentiment and Daily Trading Sentiment charts are two of the best charts on the planet...again IMO.

 

So Gio, why am I babbling on? A) I love to learn, B) I like sharing what I've learned to help others and/or receive feedback and C) I relate to virtually every post you write about the broad market and holding cash!! I feel your pain of underperformance.

 

From an outside perspective it appears you and your firm are in a Berkshire-type situation where you always have free cash coming in the door...thus I don't see why you ever need to hold an inordinate amount of cash (outside of some type of buffer such as the $10B minimum Buffett imposes on BRK) when you can find the  attractive owner-operator opportunities such as Fairfax below BV. What if takes two years for the market to correct down to 10x earnings and in the meantime fairfax's BV climbes 20% per year and its stock price never corrects below where it currently is? Point is, your firm, like BRK, always has a cash buffer in the form of monthly free cash flow, so unless opportunities are scarce, why build cash? Just continue to build your positions every month in dribs and drabs as valuations allow, and if you feel the need to hedge, come up with some type of model (or subscribe to - think Ned Davis Research) that allows you opportunistically hedge your portfolio of owner-operator stalwarts! Thus you won't miss out on the inevitable growth of the underlying businesses by not owning/under owning those stocks.

 

Just one man's thoughts and opinions - probably worth far less than two cents.

 

Well, WOW! bmichaud, thank you very much! You just wrote a treaty!!

 

You see, by now I can claim to have read many posts on this board, and I can say I have come to know a lot of great people and thoughtful investors (and you are certainly among the ones I admire and respect the most!).

So, please, I hope nobody takes what I am going to say as a criticism, but just as an observation I have made during these months of membership: generalization tends to be present a little bit too often on this board (I want to be clear: it is by far the best board I know of, and the only one I follow daily!), and generalization imho is very dangerous.

Let’s take, for instance, my firm’s performance in 2012:

1) It generated fcf equal to 16% (dividends excluded) of its capital on December 31, 2011;

2) It lost 4.78% of its capital on December 31, 2011, on short positions;

3) It lost 5.94% of its capital on December 31, 2011, on its long position in FFH;

4) It broke even on its other long positions;

5) It distributed dividends equal to 2% of its capital on December 31, 2011.

So, we increased capital by 16% - 4.78% - 5.94% = 5.28%. If you consider dividends, 7,28%.

Now, if FFH hadn’t declined from CAD$437 on December 31, 2011, to CAD$357 last Friday, our results would have been in line with the S&P Composite: 5.28% + 5.94% + 2% (dividends) = 13.22% (AMiS) vs. 10.84% + 2.11% (dividends) = 12.95% (S&P Composite).

Furthermore, if my firm’s long positions had done better than just break even, and FFH had advanced, instead of declining, we would have outperformed the S&P Composite by far (like it happened in 2011: AMiS +26% vs. S&P Composite +2.1%). And all of that without renouncing to the optionality that holding some short positions gives us! So, what’s my problem here? Well, the numbers seem to suggest my problem really is that I am not good at choosing my firm’s investments…! But that I SIMPLY CANNOT BELIEVE!! ;D No, really, I have the utmost respect for the people I have partnered with trough the stock market and I strongly believe I have never overpaid for their company and leadership: I am sure a lot of value will be created in the years ahead. So, where is the rub? Very simple, like Mr. Watsa has so often told us: our results will always be lumpy. There will always be years like 2012, but then there will also be years when we will grow by leaps and bounds. Results overall will be satisfactory (to say the least!).

 

So, here is why generalization is dangerous: what is right and works for moore capital might be right and work for you in your unique situation… or it might not! Furthermore, your situation will surely change in time, and what works for you today might not work tomorrow. Are you more comfortable accepting lumpy results, or following the new market-timing system you have so shrewdly devised? I don’t know, I cannot answer. What I know is that I am not a trader, and I am not a financial advisor, and I am not a money manager. I am a businessman. And astute businessmen hoard cash, or buy some protection, in prosperous times, while investing very aggressively when the game gets tough.

 

Another example: both longterm and writser wrote about investments in special situations. Once again, it might be right for them, it surely is not right for me… I have two goals: a) to maximize my firm’s fcf, and 2) to invest it soundly in owner-operators. Those two goals keep me busy from 7 a.m. until 7 p.m., 7 days a week. Then, from 7 p.m. to 9 p.m., I go to the gym… So, what should you do, if you were me? 1) stop trying to maximize my firm’s fcf, to study special situations? 2) stop monitoring the owner-operators I am interested in for my firm to purchase an ever increasing partial ownership, to study special situations? 3) would you stop going to the gym? And risk losing my athletic prowess girls love so much?!?! Don’t even think about that!!  ;D  ;D  ;D And, please, forget about that Macro “Musings” thread of mine: those are things I read just for fun and to relax!

 

twacowfca is also a businessman, though much more versed in financial matters than I am. But, even among businessmen, situations can be vastly different. Once he wrote me that his firm’s portfolio is now worth 20 times his firm’s operating business. twacowfca, please correct me if I am too way off the mark: assigning a 10x multiple to the fcf generated by his operating business, that means the yearly fcf of twacowfca’s business is more or less 1/200 of the capital he has invested in the stock market right now. And, assuming the capital he has invested in the stock market is all equity, that translates into a 0.5% fcf yield from his operating business. Much different from my firm’s 16% fcf yield! He simply must have accumulated much equity year after year, with an operating business that almost didn’t grow. Also my operating businesses probably won’t grow, but I am still at the beginning and haven’t accumulated much equity yet. So, the fcf from operating businesses is now almost meaningless to twacowfca, while it is still very relevant to me!

twacowfca might surely be more interested in dabbling in special situation investments than me. Alas! Probably, he now must manage too much equity for special situations to be a meaningful part of his portfolio…

 

One last thought, an obvious one, but anyway… You said my firm resembles BRK… well, too kind of you! But surely you meant the BRK of the ’60… well, if you meant a mini-BRK of the ’60, I just can be flattered and fool myself into overlooking the absurdity of the comparison! ;D And just like the fcf of BRK during the ’60 was far from being assured, also my firm’s fcf is very much at risk. We manage two businesses: 1) engineering services in the civil and infrastructure sector, 2) a for profit education master school inside the Politecnico of Milan. 1) is incredibly under pressure in Italy nowadays. Until now we have fared better than average, but the future is uncertain and we cannot go on swimming against the tide much longer… 2) has proven until now to be a reliable business in a recession, and we have strong links to our main sponsor (Italcementi Group S.p.A.), but we must deal nonetheless with the bureaucracy of a large public University… unfortunately, anything could happen!

So, the need to be prudent.

 

Ok, this is already way too long! But you gave me a lot of food for thought, and I hope I have now provided you with some more.

 

Thank you again and take care,

 

giofranchi

[berkshiremystery]

Gio,

 

I am of VERY similar mind to you on broad market valuation and holding cash (I actually tend to hedge with an SPY short more than anything due to my inability to pass up attractive individual stocks and special situations), and paid the price for much of this year with extreme underperformance (until recently :)). I came into the year convinced the toxic combo of broad market overvaluation, Euro depression and a slowing China warranted a fully hedged portfolio. Our fellow poster moore capital and I battled it out late last year on whether it was a good time to be fully invested if not leveraged - he certainly bested me, to say the least. However, I learned a tremendous amount as a result of the debates we had as I set out to determine why I was so wrong and how I could improve going forward....

 

I originally adhered strictly to GMO/Hussman/Schiller long-term valuation methods for determining my exposure to the broad market - as demonstrated by my underperformance through most of this year and Hussman's horrific performance since march 2009, these methods do not work over the medium term, which is driven primarily by A) sentiment and to a lesser extent B) momentum. All that to say, I have attempted to come up with a model that incorporates valuation, short and long term over/under-boughtness and momentum in order to keep myself in the market even in times of overvaluation. It is a very crude model that still needs work...but from what I can tell has worked quite well since the mid-1920s (as far back as I can go right now).

 

I used Adam Hamilton's (of Zeal LLC - h/t moorecapital) method of measuring the market relative to its 200dma as a springboard. EG when the SPX is at 110% of its 200dma it's in overbought territory, and when it's at 80% it's oversold. Using this sole ratio through history does not work, but it works over shorter time frames as a sentiment indicator. So I added a medium-term relative ratio - the SPX's 50dma divided by its 200dma - and multiplied it by the original ratio. The higher the ratio the more at risk the market is - so if spx is overbought at 1.1x the 200dma but medium term oversold with the 50dma at .90x the 200, the "trading ratio) is .99x. Whereas if 1.1x 200 and 1.1 50/200, trading ratio is 1.21x.

 

So I back-tested the "trading ratio" and came up with better results than just using price/200dma, but still not good. Then I added a third component - schiller PE relative to the long-run schiller PE. So right now it's at 19 versus long run avg of 16 or at 1.18x - I call it the "relative PE". I multiply the rPE by the trading ratio to come up with the "Adj. Trading Ratio" (ATR) - so now you have a market indicator that incorporates long-run valuation, short-term over-/under-boughtness and medium-term over-/under-boughtness.

 

Final step is momentum. I add this by dividing the ATR by the absolute value of the 100-day growth rate of the market's 100dma (minimum of 5%). Basically the slope of the 100-day moving average. So by dividing the ATR by the % growth, you give the market the benefit of the doubt for its long-term trend - up or down. Sounds weird but it works.

 

Those are the key pillars of the model - a good amount more goes into it such as buy, sell and hold signals etc...but you get the idea.

 

I've had too much coffee and am up late typing on my phone without access to the model - but off the top of my head, since the early 1950s the model...

 

A) keeps you fully in the market from early 1950s through 1968

 

B) gets you back in the market part way through the 1973/4 bear - so doesn't do a great job here...but

 

C) keeps you in the market from the mid-1970s through the early 1990s

 

D) has you in and out of the market a couple times in early 90s 

 

E) back in the mkt with a buy signal in 1996 and 1998 before....

 

F) a sell signal in 1999 just before the crash

 

G) back in the market in 2001/2002 and no sell signal until...

 

H) early 2008

 

I) Back in the market October 2008

 

J) out of market early 2010 and back in mid-2010 - this was a poor sell signal as the market was largely flat during that time

 

K) out of the market early 2011 and back in..

 

L) Aug/sept 2011

 

M) model remained a buy through early 2012 and has been on a hold signal ever since

 

This model does not keep you out of every market correction, but helps avoid the bulk of large-scale declines. Most importantly, IMO, it keeps you from the making the mistake Peter Lynch refers to in his quote, "more money is lost waiting for a decline than in the decline itself".

 

In order to avoid short term 5 to 10% corrections, I believe sentiment indicators are BY FAR the best tools. Sentiment can be measured in various ways - put to call ratios, AAII surveys etc... - but if one has access to Ned Davis Research, the Crowd Sentiment and Daily Trading Sentiment charts are two of the best charts on the planet...again IMO.

 

So Gio, why am I babbling on? A) I love to learn, B) I like sharing what I've learned to help others and/or receive feedback and C) I relate to virtually every post you write about the broad market and holding cash!! I feel your pain of underperformance.

 

From an outside perspective it appears you and your firm are in a Berkshire-type situation where you always have free cash coming in the door...thus I don't see why you ever need to hold an inordinate amount of cash (outside of some type of buffer such as the $10B minimum Buffett imposes on BRK) when you can find the  attractive owner-operator opportunities such as Fairfax below BV. What if takes two years for the market to correct down to 10x earnings and in the meantime fairfax's BV climbes 20% per year and its stock price never corrects below where it currently is? Point is, your firm, like BRK, always has a cash buffer in the form of monthly free cash flow, so unless opportunities are scarce, why build cash? Just continue to build your positions every month in dribs and drabs as valuations allow, and if you feel the need to hedge, come up with some type of model (or subscribe to - think Ned Davis Research) that allows you opportunistically hedge your portfolio of owner-operator stalwarts! Thus you won't miss out on the inevitable growth of the underlying businesses by not owning/under owning those stocks.

 

Just one man's thoughts and opinions - probably worth far less than two cents.

 

Well, WOW! bmichaud, thank you very much! You just wrote a treaty!!

 

You see, by now I can claim to have read many posts on this board, and I can say I have come to know a lot of great people and thoughtful investors (and you are certainly among the ones I admire and respect the most!).

So, please, I hope nobody takes what I am going to say as a criticism, but just as an observation I have made during these months of membership: generalization tends to be present a little bit too often on this board (I want to be clear: it is by far the best board I know of, and the only one I follow daily!), and generalization imho is very dangerous.

Let’s take, for instance, my firm’s performance in 2012:

1) It generated fcf equal to 16% (dividends excluded) of its capital on December 31, 2011;

2) It lost 4.78% of its capital on December 31, 2011, on short positions;

3) It lost 5.94% of its capital on December 31, 2011, on its long position in FFH;

4) It broke even on its other long positions;

5) It distributed dividends equal to 2% of its capital on December 31, 2011.

So, we increased capital by 16% - 4.78% - 5.94% = 5.28%. If you consider dividends, 7,28%.

Now, if FFH hadn’t declined from CAD$437 on December 31, 2011, to CAD$357 last Friday, our results would have been in line with the S&P Composite: 5.28% + 5.94% + 2% (dividends) = 13.22% (AMiS) vs. 10.84% + 2.11% (dividends) = 12.95% (S&P Composite).

Furthermore, if my firm’s long positions had done better than just break even, and FFH had advanced, instead of declining, we would have outperformed the S&P Composite by far (like it happened in 2011: AMiS +26% vs. S&P Composite +2.1%). And all of that without renouncing to the optionality that holding some short positions gives us! So, what’s my problem here? Well, the numbers seem to suggest my problem really is that I am not good at choosing my firm’s investments…! But that I SIMPLY CANNOT BELIEVE!! ;D No, really, I have the utmost respect for the people I have partnered with trough the stock market and I strongly believe I have never overpaid for their company and leadership: I am sure a lot of value will be created in the years ahead. So, where is the rub? Very simple, like Mr. Watsa has so often told us: our results will always be lumpy. There will always be years like 2012, but then there will also be years when we will grow by leaps and bounds. Results overall will be satisfactory (to say the least!).

 

So, here is why generalization is dangerous: what is right and works for moore capital might be right and work for you in your unique situation… or it might not! Furthermore, your situation will surely change in time, and what works for you today might not work tomorrow. Are you more comfortable accepting lumpy results, or following the new market-timing system you have so shrewdly devised? I don’t know, I cannot answer. What I know is that I am not a trader, and I am not a financial advisor, and I am not a money manager. I am a businessman. And astute businessmen hoard cash, or buy some protection, in prosperous times, while investing very aggressively when the game gets tough.

 

Another example: both longterm and writser wrote about investments in special situations. Once again, it might be right for them, it surely is not right for me… I have two goals: a) to maximize my firm’s fcf, and 2) to invest it soundly in owner-operators. Those two goals keep me busy from 7 a.m. until 7 p.m., 7 days a week. Then, from 7 p.m. to 9 p.m., I go to the gym… So, what should you do, if you were me? 1) stop trying to maximize my firm’s fcf, to study special situations? 2) stop monitoring the owner-operators I am interested in for my firm to purchase an ever increasing partial ownership, to study special situations? 3) would you stop going to the gym? And risk losing my athletic prowess girls love so much?!?! Don’t even think about that!!  ;D  ;D  ;D And, please, forget about that Macro “Musings” thread of mine: those are things I read just for fun and to relax!

 

twacowfca is also a businessman, though much more versed in financial matters than I am. But, even among businessmen, situations can be vastly different. Once he wrote me that his firm’s portfolio is now worth 20 times his firm’s operating business. twacowfca, please correct me if I am too way off the mark: assigning a 10x multiple to the fcf generated by his operating business, that means the yearly fcf of twacowfca’s business is more or less 1/200 of the capital he has invested in the stock market right now. And, assuming the capital he has invested in the stock market is all equity, that translates into a 0.5% fcf yield from his operating business. Much different from my firm’s 16% fcf yield! He simply must have accumulated much equity year after year, with an operating business that almost didn’t grow. Also my operating businesses probably won’t grow, but I am still at the beginning and haven’t accumulated much equity yet. So, the fcf from operating businesses is now almost meaningless to twacowfca, while it is still very relevant to me!

twacowfca might surely be more interested in dabbling in special situation investments than me. Alas! Probably, he now must manage too much equity for special situations to be a meaningful part of his portfolio…

 

One last thought, an obvious one, but anyway… You said my firm resembles BRK… well, too kind of you! But surely you meant the BRK of the ’60… well, if you meant a mini-BRK of the ’60, I just can be flattered and fool myself into overlooking the absurdity of the comparison! ;D And just like the fcf of BRK during the ’60 was far from being assured, also my firm’s fcf is very much at risk. We manage two businesses: 1) engineering services in the civil and infrastructure sector, 2) a for profit education master school inside the Politecnico of Milan. 1) is incredibly under pressure in Italy nowadays. Until now we have fared better than average, but the future is uncertain and we cannot go on swimming against the tide much longer… 2) has proven until now to be a reliable business in a recession, and we have strong links to our main sponsor (Italcementi Group S.p.A.), but we must deal nonetheless with the bureaucracy of a large public University… unfortunately, anything could happen!

So, the need to be prudent.

 

Ok, this is already way too long! But you gave me a lot of food for thought, and I hope I have now provided you with some more.

 

Thank you again and take care,

 

giofranchi

 

Gio,...

 

It seems to me that you speak of the MIP- Politecnico di Milano School of Management, if I'm not mistaken. I'm just wondering if the MIP in Milan has a similar department like Prem's old Richard Ivey School of Business with it's Ben Graham Centre for Value Investing.

 

MBA full time Scholarship

http://www.mip.polimi.it/mip/en/globals/news/MBA-full-time-Scholarship-italcementi.html

 

MIP Politecnico di Milano

http://www.mip.polimi.it/

 

http://www.italcementigroup.com/ENG/Careers/Training/Training+courses/

 

MIP Politecnico di Milano

The School of Management of the Politecnico di Milano @ Wikipedia

http://en.wikipedia.org/wiki/MIP_Politecnico_di_Milano

 

----

 

Welcome to MIP, Business School of Politecnico di Milano.

Gianluca Spina, President - MIPPolimi

YouTube.com - Video

http://m.youtube.com/watch?v=nkKydzMWyOk&feature=m-ch-fea

 

 

 

 

 

 

 

 

 

[biaggio]

Gio, always enjoy your posts.

 

I struggle with the same thoughts.

 

Professionally I am in the same position as you. Except I have been working for >20 years- up until most recent I have made the best investment one can make and that is in yourself and your family- now I am fortunate in being in the position of investing almost all the income that comes in. I struggle because I am closer to the end of my career + I am almost in the position where I don t really have to go to work (but I go because I enjoy it. Its great not having to go to work for the pay check)- so I don t want to do anything too stupid.

 

I agree with your strategy of investing in owner operators (I am trying to do the same. I would be happy with a lumpy 10-15% return over the next decades).

 

I think you are being to hard on yourself with the performance. You re looking at short term performance. As you know short term the market is a voting/popularity machine. If we re in the right companies I think it will show up in the next 3-5 years. Year to year we know that the market will fluctuate.

 

I am mindful of macro issues, general market/business sentiment and how it may or may not effect our companies . I monitor VXX, VXO, and http://money.cnn.com/data/fear-and-greed/)

 

I know I am a very poor trader, and very poor at trying to time the market- despite this I still have the mindset to try at times

 

My strategy going forward FWIW:

-is to average into owner operators, great businesses over time- buy when I think they are undervalued, continue to hold unless they become grossly overvalued or I realize I have made a mistake.

-keep a good chunk of cash at all times- that way I am happy when prices go down

-prepare myself emotionally/psychologically for possible severe downward fluctuation in my holdings by focusing on the micro- i.e stay up to date on the companies, have an idea what they are worth - that way I have the courage + conviction to at least hold on thru the storms if not add in. Unfortunately I always feel better about adding in when the sun is shining- its only human nature - I keep this in mind + I find it helps.

-I am mindful of position sizes- I would find it hard to add to position that is >25%- I would probably continue to hold if it was a great company/owner operator provided it was not grossly over valued.

 

Today it seems the choices seem obvious

 

i. cash -not a good thing to hold in the long term

ii bonds/income producing products-  grossly overvalued?

iii real estate- may be a good area if you re willing to accept the hassles

iv tangible assets like gold, silver - seems like there has been a lot of hype here in last few years + who knows  what they will be worth

v common stock- seems like a good thing to be in

vi private business -good if you have the opportunity

vii other things I have not thought of

 

http://greatinvestors.tv/video/zeke-ashton-on-how-michael-burrys-advice-helped-him-become-a.html

One needs to know what works for you.

 

Its challenging and fun.

 

Good luck to all

[giofranchi]

Gio,...

 

It seems to me that you speak of the MIP- Politecnico di Milano School of Management, if I'm not mistaken. I'm just wondering if the MIP in Milan has a similar department like Prem's old Richard Ivey School of Business with it's Ben Graham Centre for Value Investing.

 

MBA full time Scholarship

http://www.mip.polimi.it/mip/en/globals/news/MBA-full-time-Scholarship-italcementi.html

 

MIP Politecnico di Milano

http://www.mip.polimi.it/

 

http://www.italcementigroup.com/ENG/Careers/Training/Training+courses/

 

MIP Politecnico di Milano

The School of Management of the Politecnico di Milano @ Wikipedia

http://en.wikipedia.org/wiki/MIP_Politecnico_di_Milano

 

----

 

Welcome to MIP, Business School of Politecnico di Milano.

Gianluca Spina, President - MIPPolimi

YouTube.com - Video

http://m.youtube.com/watch?v=nkKydzMWyOk&feature=m-ch-fea

 

Hi berkshiremystery,

no, the Consortium MIP is the largest, and by far the most popular, of its kind inside the Politecnico di Milano. But it is not the only one. The master school we mange is an organization founded 82 years ago by the Pesenti family of Italcementi, which remains its main sponsor to this day. Unfortunately, we are renewing our website, so only the homepage is available right now: www.masterpesenti.it. Anyway, if you are interested, you can download there a brief presentation of the school. The Consortium we belong to is the Consortium CIS-E (www.cise.polimi.it), which we also manage.

 

Unfortunately, no such thing as “value investing” is known in Italy yet…!!  ;D ;D

Next February I think I will be the first to teach some classes about value investing at the Politecnico di Milano! Very basic stuff: practically, I will read and comment “Margin of Safety” by Mr. Klarman to some engineers and architects. Professor Reggiani of the Bocconi University, who wrote many articles with Professor Penman of the Columbia Business School, will lend me a much needed hand… it will surely be funny!  :)

 

To start something like the Ben Graham Centre for Value Investing at the Politecnico di Milano would really be fantastic! I know the Dean of the Politecnico di Milano very well, but I lack the “economic background” to be convincing in this kind of matters… remember that I have studied to become a technician… well, it is true now I am a “Hero Member” of the “Corner of Berkshire and Fairfax Message Board”… that is great, but also the only credential in the field of investing I can show and be proud of!!  ;D ;D ;D

Unfortunately, whenever a large organization, like the Politecnico di Milano, is involved, what you know and believe is important, but not enough… also curricula and appearances matter!  ::)

 

giofranchi

 

[giofranchi]

http://greatinvestors.tv/video/zeke-ashton-on-how-michael-burrys-advice-helped-him-become-a.html

One needs to know what works for you.

 

Its challenging and fun.

 

Good luck to all

 

Thank you very much biaggio,

I always enjoy your posts too! And I hadn’t seen the video of Mr. Zeke Ashton yet, but I think it fits perfectly with what I was trying to say. I probably run a more concentrated portfolio (9 positions, with a very large one in FFH) than Mr. Ashton’s, but wide diversification seems to be what works for him and what he is comfortable with, right?  ;)

 

giofranchi

 

[bmichaud]

Gio you are far too kind - I hardly deserve to be a member of this great board let alone be mentioned in the same breath as some of those on here!!

 

I understand your concern with generalizations - I don't expect a model such as mine or anyone else's to perfectly suit your needs. My primary point was that there are tools available to more effectively gauge market risk than just looking at valuation - it baffles me why Hussman does not employ such methods and puts his shareholders through such pain. My model is by no means a timing model - it can go years on a single signal - but rather an attempt to holistically gauge market risk versus relying upon only valuation. Ned Davis provides such a service if ur willing to pay. A lot of frctional cost an be avoided if one does not hold cash and/or shorts through a three year bull market - think Fairfax short position since late 2009 and Hussman's short since early 2009.... Most importantly though, it would keep you from under owning wonderful companies such as Fairfax and BRK - if those companies compound intrinsic value at 15% per annum and you get them at around or just above book, why under own for three years waiting for a market decline?

 

My point in comparing your company to BRK is this - a portfolio of operating companies spinning off free cash flow paired with a stock portfolio provides a natural hedge. For example you said your FCF return on capital was 16% this year - so at the beginning of this year, had you been fully invested on the equity side, and had the broad market declined taking your equities along with it in lock-step, you still would have outperformed the market on a consolidated basis due to the 16% FCF ROC and had cash to invest in a downturn. Thus it appears redundant for a HoldCo such as yours to hold excess cash when attractive stocks are available, since you generate cash on a continuous basis!

 

Obviously if your operating companies are under pressure and require additional funds, then the discussion is moot - but I'm simply referring to the principle of the enviable position your firm is in to have a continuous stream of FCF available to hedge performance AND provide additional capital to deploy in a downturn.

 

No need to divert your attention from finding wonderful owner operators, OR (perhaps more importantly!) working out - it just seems you have a unique ability to identify wonderful owner operators and could take advantage of that skill by more aggressively deploying capital into them regardless of the broad market. I speak from a position of envy, as I would love to one day be in a situation such as yours (I.E. redirecting FCF from operating COs into stocks) and have put much thought into how I would go about it  8)

[berkshiremystery]

Gio,...

 

It seems to me that you speak of the MIP- Politecnico di Milano School of Management, if I'm not mistaken. I'm just wondering if the MIP in Milan has a similar department like Prem's old Richard Ivey School of Business with it's Ben Graham Centre for Value Investing.

 

MBA full time Scholarship

http://www.mip.polimi.it/mip/en/globals/news/MBA-full-time-Scholarship-italcementi.html

 

MIP Politecnico di Milano

http://www.mip.polimi.it/

 

http://www.italcementigroup.com/ENG/Careers/Training/Training+courses/

 

MIP Politecnico di Milano

The School of Management of the Politecnico di Milano @ Wikipedia

http://en.wikipedia.org/wiki/MIP_Politecnico_di_Milano

 

----

 

Welcome to MIP, Business School of Politecnico di Milano.

Gianluca Spina, President - MIPPolimi

YouTube.com - Video

http://m.youtube.com/watch?v=nkKydzMWyOk&feature=m-ch-fea

 

Hi berkshiremystery,

no, the Consortium MIP is the largest, and by far the most popular, of its kind inside the Politecnico di Milano. But it is not the only one. The master school we mange is an organization founded 82 years ago by the Pesenti family of Italcementi, which remains its main sponsor to this day. Unfortunately, we are renewing our website, so only the homepage is available right now: www.masterpesenti.it. Anyway, if you are interested, you can download there a brief presentation of the school. The Consortium we belong to is the Consortium CIS-E (www.cise.polimi.it), which we also manage.

 

Unfortunately, no such thing as “value investing” is known in Italy yet…!!  ;D ;D

Next February I think I will be the first to teach some classes about value investing at the Politecnico di Milano! Very basic stuff: practically, I will read and comment “Margin of Safety” by Mr. Klarman to some engineers and architects. Professor Reggiani of the Bocconi University, who wrote many articles with Professor Penman of the Columbia Business School, will lend me a much needed hand… it will surely be funny!  :)

 

To start something like the Ben Graham Centre for Value Investing at the Politecnico di Milano would really be fantastic! I know the Dean of the Politecnico di Milano very well, but I lack the “economic background” to be convincing in this kind of matters… remember that I have studied to become a technician… well, it is true now I am a “Hero Member” of the “Corner of Berkshire and Fairfax Message Board”… that is great, but also the only credential in the field of investing I can show and be proud of!!  ;D ;D ;D

Unfortunately, whenever a large organization, like the Politecnico di Milano, is involved, what you know and believe is important, but not enough… also curricula and appearances matter!  ::)

 

giofranchi

 

Gio,...

 

I personally also think that value investing outside of the Anglo-American landscape seems to me unheard-of, at least I couldn't name legendary capital allocator's that have become a billionaires like Buffett or the late Sir John Templeton. Ok, there's Guy Spiers in Zurich, but he is mostly unknown outside these boards here. It seems to me like value investing still seems to me some Anglo-Saxon tradition. So it might be a very hard way to build-up some legendary european academic insitution as some Graham Value Investing Center.

[txitxo]

  Gio, nice to see you quoting Capablanca. He was truly an artist.

 

  I fully agree with Howard Marks, and he was vindicated by 2008-2009. But I am very reluctant to hold large amounts of cash. I've looked a lot into timing systems, and I think I've found a very good one but I am still skeptical about it because there has only been a couple of bear markets to test it. And I've done many backtests which prove that unless you time exceedingly well your entry and exit points, your performance will be inferior with respect to buy and hold. 

 

So putting together macro and micro, the optimum strategy should be to buy cheap stocks in cheap markets. You do your  favorite variant of value investing, either mechanical investing as I like, owner-managers which is your specialty, Grahamesque cigar-butts, or Buffett-like palaces with moats. But you buy those stocks in markets which are statistically cheap according to all the possible indicators you can muster. You only go to cash if all the markets in the world become expensive at the same time.

 

Right now my model indicates that sometime before the end of next quarter, US, Canadian and Australian stocks are about to start a big decline. The UK market is pretty rich too. This is a statistical prediction, and I have no idea what will be the actual detonator of the decline. But if that does not happen, this time will be truly different.

 

On the other hand, Euro-zone markets are very cheap and buying value stocks there should work very well in 2013. It is a pity that there are no real equivalents of LUK, BRK, MKL, FFH, etc. in the Eurozone. That would simplify the life of the part-time investor significantly...

 

Is your probabilistic prediction entirely based on your observtion that there is an overabundance of expensive junk in the market now, or other factors too?  What factor(s) influence the timing? 

 

Thank you for your interesting comments.

 

  Yes, the fraction of expensive junk in the US market is about the same level it was at the end of 2007. Since 1990 this indicator has only been triggered three times: 2000, 2007 and now. 

 

  In the EU it is below its long term average, which usually means good returns during the next year for a value strategy (the correlation between this signal and the overall market is slightly weaker).

 

[txitxo]

 

I personally also think that value investing outside of the Anglo-American landscape seems to me unheard-of, at least I couldn't name legendary capital allocator's that have become a billionaires like Buffett or the late Sir John Templeton. Ok, there's Guy Spiers in Zurich, but he is mostly unknown outside these boards here. It seems to me like value investing still seems to me some Anglo-Saxon tradition. So it might be a very hard way to build-up some legendary european academic insitution as some Graham Value Investing Center.

 

  Well, you have García-Paramés, but he is from Galicia, the Spanish Celtic fringe (where people are famously tightfisted).

 

  In general, Mediterranean societies put an enormous value on conformity. If you go against the majority, it is often considered morally wrong, even if you happen to be intellectually right. Take Keynes "it is better for the reputation to fail conventionally than to succeed unconventionally" and multiply it by 10.

 

[rjstc]

Think of the market as a zero sum game like a coin flipping contest.  Your portfolio is $200, half in cash and half in market index fund. Frictional costs and interest income are small and disregarded.  Mister Market flips heads and the stock portion of your portfolio doubles.  You now have a portfolio value of $100 cash +$200 index fund = $300, and you rebalance to 50:50 by selling some of your index investment. You now have $150 in cash and $150 in index fund.

 

Mr Market's next coin flip is tails. The index fund and your $150 investment in the index loses half its value.  The value of your index fund investment is now $75.  The value of your $150 in cash is unchanged. The value of the market index is now back to exactly where it was before the coin flipping game began, but the value of your portfolio is now greater, $75 + $150 = $225 , compared to the $200  portfolio value when the game began.  You rebalance to $112.50 cash and $112.50 in the index fund and wait for the next coin flip.

 

This is a very pleasant game to play.  :)

 

The reason, why I hold twacowfca is such a high esteem, is that he has the rare gift of making you see things under a light you have never seen them before. I guess it is the trait of a true teacher, the one only a few people, like Mr. Buffett, Mr. Munger, Mr. Kahneman, Mr. Taleb, Mr. Herbert Simon, Mr. Michael Lewis, Mr. Malcolm Gladwell, Mr. Dan Ariely, and few other authors, can truly claim to posses.  :)

 

giofranchi

 

You are too kind in your remarks.  The truth is more like the scene of the appearance of the Old Guy waxing his car with circular motions in the movie, The Karate Kid, when the student is ready:  "Karate is really simple.  Wax on. (clockwise motions) Wax off." (counterclockwise motions) , demonstrates The Old Guy. 

 

When wisdom is ready to be received, it will appear.  "Seek,and you will find." Knock, and the door will be opened. Ask, and it will be given."  :)

 

Sounds a lot "Being Rational". Which is where you want to be when investing & where I think twacowfca excells.

[LongTerm]

 

I personally also think that value investing outside of the Anglo-American landscape seems to me unheard-of, at least I couldn't name legendary capital allocator's that have become a billionaires like Buffett or the late Sir John Templeton. Ok, there's Guy Spiers in Zurich, but he is mostly unknown outside these boards here. It seems to me like value investing still seems to me some Anglo-Saxon tradition. So it might be a very hard way to build-up some legendary european academic insitution as some Graham Value Investing Center.

 

  Well, you have García-Paramés, but he is from Galicia, the Spanish Celtic fringe (where people are famously tightfisted).

 

  In general, Mediterranean societies put an enormous value on conformity. If you go against the majority, it is often considered morally wrong, even if you happen to be intellectually right. Take Keynes "it is better for the reputation to fail conventionally than to succeed unconventionally" and multiply it by 10.

 

Well, I think there is also the issue of a 'level playing field'; in other words, you need to have a stock market that treats minority shareholders more or less on the same footing as controling shareholders (and I use that statement quite loosely). This is not the case in many, if not most, mediterranean countries where controlling shareholders routinely abuse minority shareholders with impunity. How can there be value investing if 1) there is poor disclosure, 2) there is unequal disclosure (i.e. you can't be sure that you are acting on the same information as other investors, particularly company insiders), and 3) there is little or limited recourse against abuse (shareholders can expect little help from the legal system for righting even those limited abuses that are proscribed).

 

[txitxo]

 

Well, I think there is also the issue of a 'level playing field'; in other words, you need to have a stock market that treats minority shareholders more or less on the same footing as controling shareholders (and I use that statement quite loosely). This is not the case in many, if not most, mediterranean countries where controlling shareholders routinely abuse minority shareholders with impunity. How can there be value investing if 1) there is poor disclosure, 2) there is unequal disclosure (i.e. you can't be sure that you are acting on the same information as other investors, particularly company insiders), and 3) there is little or limited recourse against abuse (shareholders can expect little help from the legal system for righting even those limited abuses that are proscribed).

 

Oh, that explains why all the big frauds happen with Italian or Spanish companies: Enrone,  Mundocom, Los Hermanos Lehman, MFI Globale, etc. :)

 

  More seriously, when you look at how simple value investing methods work in different EU countries, you see that they tend to do better in deeper markets, those with more listed companies, like France, Germany and of course the UK. They do mediocrely in smaller countries, like Holland or Spain, probably because there is more scrutiny of each company by local funds, which forces markets to be more efficient. 

 

  But corporate governance may certainly be a factor too, I remember Jim Grant complaining that net-nets do not work in Japan because of that.

 

[Sportgamma]

 

Well, I think there is also the issue of a 'level playing field'; in other words, you need to have a stock market that treats minority shareholders more or less on the same footing as controling shareholders (and I use that statement quite loosely). This is not the case in many, if not most, mediterranean countries where controlling shareholders routinely abuse minority shareholders with impunity. How can there be value investing if 1) there is poor disclosure, 2) there is unequal disclosure (i.e. you can't be sure that you are acting on the same information as other investors, particularly company insiders), and 3) there is little or limited recourse against abuse (shareholders can expect little help from the legal system for righting even those limited abuses that are proscribed).

 

Oh, that explains why all the big frauds happen with Italian or Spanish companies: Enrone,  Mundocom, Los Hermanos Lehman, MFI Globale, etc. :)

 

 

Haha, me gusta.

[giofranchi]

My point in comparing your company to BRK is this - a portfolio of operating companies spinning off free cash flow paired with a stock portfolio provides a natural hedge. For example you said your FCF return on capital was 16% this year - so at the beginning of this year, had you been fully invested on the equity side, and had the broad market declined taking your equities along with it in lock-step, you still would have outperformed the market on a consolidated basis due to the 16% FCF ROC and had cash to invest in a downturn. Thus it appears redundant for a HoldCo such as yours to hold excess cash when attractive stocks are available, since you generate cash on a continuous basis!

 

Obviously if your operating companies are under pressure and require additional funds, then the discussion is moot - but I'm simply referring to the principle of the enviable position your firm is in to have a continuous stream of FCF available to hedge performance AND provide additional capital to deploy in a downturn.

 

In theory there is no difference between theory and practice. In practice there is.

 

You very well know who said that!

Let me tell you a story. Gino is the father of Giuditta. And Giuditta is a partner of mine in AMiS. Well, Gino is by any standard a very successful real estate operator in the area of Bergamo, 30 km outside Milano. It happened that in 2007 he possessed a big, still undeveloped, lot of land for residential and commercial construction. And he decided to invest 25 million Euros (at the time they were more or less $37.5 million) to build 80 apartments, a commercial plaza, and many underground parking lots. I still remember that I objected: “Gino, are you sure you want to go “all in” and use the entirety of your cash reserves? Who knows what might happen!”. He answered: “Don’t worry. I possess other 20 buildings, more or less 300 apartments which assure me a continuous stream of cash, via rent payment, each month. Furthermore, also my commercial activity (he is a wholesale dealer in construction materials) provides me with more than enough cash.”

Well, you might guess what actually happened: at the end of 2012, five years later, he has sold only half of the 80 new apartments, 2/3 of the apartments he possesses are delinquent and have ceased paying the rents due, his commercial activity is in a slump. The only thing that saved him is the fact he is completely debt free (a sort of protection). But don’t even think of looking for opportunities in the real estate market right now…! His capital is frozen and completely locked in troublesome situations.

So now, would you tell me why something like that couldn’t happen to me?

Mr. Ray Dalio is famous, among other things, for the following rule:

Make sure that the probability of the unacceptable (i.e., the risk of ruin) is nil.

Well, I have my own rule, which is even more demanding:

Make sure that the probability of not being always able to take advantage of the situation, whatever might happen, is nil.

As I have already said, it all comes down to know yourself and your situation. And I know that, if a correction comes, and I had all my firm’s capital already invested, and the stream of new cash dried up, exactly like it happened to Gino, I would torture myself! Instead, having sub par returns for a few years is something that, although not pleasant, I can manage with ease. Moreover, as I hope I have shown you, if my longs start performing well, returns might be not bad at all!  ;)

Once again: that is me and only me! And if you think about it, in fact I am a little weird… Because most people would feel the exact opposite! They would suffer much underperforming while the market is in rally mode, instead they would bear quite well with a downturn (provided that at least Mr. Dalio’s rule is not broken…), because everybody else is helpless too.

 

it just seems you have a unique ability to identify wonderful owner operators and could take advantage of that skill by more aggressively deploying capital into them regardless of the broad market.

 

Thank you very much, but I have no unique ability. If I had a unique ability, that would be the best protection by far! That’s why I think it is dangerous to try and imitate Mr. Buffett!

I simply try to do what any businessman should do: to find great managers. What I have just read on the subject in Mr. Taleb’s “Antifragile” follows:

 

The sociologist of science Steven Shapin, who spent time in California observing venture capitalists, reports that investors tend to back entrepreneurs, not ideas. Decisions are largely a matter of opinion strengthened with “who you know” and “who said what”, as, to use the venture capitalist’s lingo, you bet on the jockey, not the horse. Why? Because innovations drift, and one needs flâneur-like abilities to keep capturing the opportunities that arise, not stay locked up in a bureaucratic mold. The significant venture capital decisions, Shapin showed, were made without real business plans. So if there was any “analysis”, it had to be of a backup, confirmatory nature. I myself spent some time with venture capitalists in California, with an eye on investing myself, and sure enough, that was the mold.

Visibly the money should go to the tinkerers, the aggressive tinkerers who you trust will milk the option.

 

I totally ignored I had some of the venture capitalists genes in me!  8)

 

giofranchi

 

[LongTerm]

 

Oh, that explains why all the big frauds happen with Italian or Spanish companies: Enrone,  Mundocom, Los Hermanos Lehman, MFI Globale, etc. :)

 

 

touche! funny! But, really, perhaps it explains why there is limited participation in those stock markets and therefore the markets are not very deep. Which goes to your point about value investing working in counties with deeper markets.

 

 

[PlanMaestro]

Where is some research of this issue of shallow financial markets? I'm very interested in it.

Now regarding Mundocom and Hermanos Lehman (LoL!) those are the kinds of issues that can be anticipated with some financial literacy. The problem is when you are completely robbed of legitimate assets because of lack of control. This is not completely absent in the USA either (Biglacough!) but you have to have a sense of proportion, and if you have ever invested in Latin America ... 

 

The most outrageous example is Salinas Pliego in Mexico (Elektrta, TV Azteca) and he is not the only one. That issue substantially reduces the size of ponds that are small to begin with. Most firms are under very tight control with a near impossibility of activist investing.

 

There is still a tradition of value investing  in Latin America but with CONTROL, where cash can take advantage of financial crisis to buy companies under duress (Giofranchi's rule?). But is a game for the big guys. For example, Anacleto Angelini though he was an Italian immigrant that rode trucks in Abisinia still started relatively big with his own paint factory and married into local money.

 

http://variantperceptions.wordpress.com/2010/12/17/remembering-a-predator/

 

Some think that because these markets are more inefficient, opportunities must be plenty but it is still difficult to grow from scratch just as a value investor. And that is reflected in a large  tradition of  "tips" ... that in developed markets would be called inside information. Just recently, a couple of DyS (largest Chilean supermarket chain) directors were prosecuted over transactions done by related parties over the Walmart acquisition. Also in his previous life, the current billionaire Chilean president  had to give explanations over some big suspect transactions very close to a bad earnings release of Lanchile, company he controlled. And he was running for President  ... not even Berlusconi has that chutzpah.

 

Now, things are changing in several countries especially Chile where private pension plans has forced tougher regulation and regulators. Not that some European multinationals have not tried abusing minority shareholders  (ie: case Chispas, Endesa Espana) even there. But the problem remains that if you are a small investor in a shallow market the investing craft is difficult to practice. The internet with access to larger markets has been a blessing for the few of us in Latin America.

[txitxo]

 

Oh, that explains why all the big frauds happen with Italian or Spanish companies: Enrone,  Mundocom, Los Hermanos Lehman, MFI Globale, etc. :)

 

 

touche! funny! But, really, perhaps it explains why there is limited participation in those stock markets and therefore the markets are not very deep. Which goes to your point about value investing working in counties with deeper markets.

 

 

  Well, we certainly have many problems, insider trading is commonplace and people never get punished for it...but I think that the issue of market depth depends more on how companies finance themselves. For instance in Germany companies get loans from banks instead of issuing shares, so there are fewer companies listed in the stock market compared with typical anglo-saxon economies. 

 

 

[txitxo]

Where is some research of this issue of shallow financial markets? I'm very interested in it.

 

Well, I was running many backtests, using several mechanical value strategies in different continental European markets, and I noticed that there was a significant correlation between outperformance and size (number of stocks) in the market. The best markets for value investing were France and Germany. Italy's economy is comparable in size with France or the UK, but has many fewer listed stocks with a significant volume. My interpretation is that it is much easier for an Italian fund analyst to know very well all the stocks in their market than for French or UK ones to do the same, so mispricing does not happen so often. Unless you have a big shock like the one we are going through now...

 

 

 

[rjstc]

txitxo  "  Well, you have García-Paramés, but he is from Galicia, the Spanish Celtic fringe (where people are famously tightfisted)".

 

They seem to have done pretty well using Graham/Buffett style. You seem to have knowledge of them so are they good in your estimation?

[PlanMaestro]

Thanks txixo. Your big shock exception seems similar to what's been seen in Latam.

 

 

Well, I was running many backtests, using several mechanical value strategies in different continental European markets, and I noticed that there was a significant correlation between outperformance and size (number of stocks) in the market. The best markets for value investing were France and Germany. Italy's economy is comparable in size with France or the UK, but has many fewer listed stocks with a significant volume. My interpretation is that it is much easier for an Italian fund analyst to know very well all the stocks in their market than for French or UK ones to do the same, so mispricing does not happen so often. Unless you have a big shock like the one we are going through now...

[txitxo]

txitxo  "  Well, you have García-Paramés, but he is from Galicia, the Spanish Celtic fringe (where people are famously tightfisted)".

 

They seem to have done pretty well using Graham/Buffett style. You seem to have knowledge of them so are they good in your estimation?

 

I think they are pretty good. But as I mentioned in a previous thread, I am a bit concerned about the changes they implemented in the last few years, adding more managers and funds.

 

 

 

 

[bmichaud]

My point in comparing your company to BRK is this - a portfolio of operating companies spinning off free cash flow paired with a stock portfolio provides a natural hedge. For example you said your FCF return on capital was 16% this year - so at the beginning of this year, had you been fully invested on the equity side, and had the broad market declined taking your equities along with it in lock-step, you still would have outperformed the market on a consolidated basis due to the 16% FCF ROC and had cash to invest in a downturn. Thus it appears redundant for a HoldCo such as yours to hold excess cash when attractive stocks are available, since you generate cash on a continuous basis!

 

Obviously if your operating companies are under pressure and require additional funds, then the discussion is moot - but I'm simply referring to the principle of the enviable position your firm is in to have a continuous stream of FCF available to hedge performance AND provide additional capital to deploy in a downturn.

 

In theory there is no difference between theory and practice. In practice there is.

 

You very well know who said that!

Let me tell you a story. Gino is the father of Giuditta. And Giuditta is a partner of mine in AMiS. Well, Gino is by any standard a very successful real estate operator in the area of Bergamo, 30 km outside Milano. It happened that in 2007 he possessed a big, still undeveloped, lot of land for residential and commercial construction. And he decided to invest 25 million Euros (at the time they were more or less $37.5 million) to build 80 apartments, a commercial plaza, and many underground parking lots. I still remember that I objected: “Gino, are you sure you want to go “all in” and use the entirety of your cash reserves? Who knows what might happen!”. He answered: “Don’t worry. I possess other 20 buildings, more or less 300 apartments which assure me a continuous stream of cash, via rent payment, each month. Furthermore, also my commercial activity (he is a wholesale dealer in construction materials) provides me with more than enough cash.”

Well, you might guess what actually happened: at the end of 2012, five years later, he has sold only half of the 80 new apartments, 2/3 of the apartments he possesses are delinquent and have ceased paying the rents due, his commercial activity is in a slump. The only thing that saved him is the fact he is completely debt free (a sort of protection). But don’t even think of looking for opportunities in the real estate market right now…! His capital is frozen and completely locked in troublesome situations.

So now, would you tell me why something like that couldn’t happen to me?

Mr. Ray Dalio is famous, among other things, for the following rule:

Make sure that the probability of the unacceptable (i.e., the risk of ruin) is nil.

Well, I have my own rule, which is even more demanding:

Make sure that the probability of not being always able to take advantage of the situation, whatever might happen, is nil.

As I have already said, it all comes down to know yourself and your situation. And I know that, if a correction comes, and I had all my firm’s capital already invested, and the stream of new cash dried up, exactly like it happened to Gino, I would torture myself! Instead, having sub par returns for a few years is something that, although not pleasant, I can manage with ease. Moreover, as I hope I have shown you, if my longs start performing well, returns might be not bad at all!  ;)

Once again: that is me and only me! And if you think about it, in fact I am a little weird… Because most people would feel the exact opposite! They would suffer much underperforming while the market is in rally mode, instead they would bear quite well with a downturn (provided that at least Mr. Dalio’s rule is not broken…), because everybody else is helpless too.

 

it just seems you have a unique ability to identify wonderful owner operators and could take advantage of that skill by more aggressively deploying capital into them regardless of the broad market.

 

Thank you very much, but I have no unique ability. If I had a unique ability, that would be the best protection by far! That’s why I think it is dangerous to try and imitate Mr. Buffett!

I simply try to do what any businessman should do: to find great managers. What I have just read on the subject in Mr. Taleb’s “Antifragile” follows:

 

The sociologist of science Steven Shapin, who spent time in California observing venture capitalists, reports that investors tend to back entrepreneurs, not ideas. Decisions are largely a matter of opinion strengthened with “who you know” and “who said what”, as, to use the venture capitalist’s lingo, you bet on the jockey, not the horse. Why? Because innovations drift, and one needs flâneur-like abilities to keep capturing the opportunities that arise, not stay locked up in a bureaucratic mold. The significant venture capital decisions, Shapin showed, were made without real business plans. So if there was any “analysis”, it had to be of a backup, confirmatory nature. I myself spent some time with venture capitalists in California, with an eye on investing myself, and sure enough, that was the mold.

Visibly the money should go to the tinkerers, the aggressive tinkerers who you trust will milk the option.

 

I totally ignored I had some of the venture capitalists genes in me!  8)

 

giofranchi

 

 

Gio - you make a very good point here. Likely my BRK example is swayed by the diversity of BRK's cash flows....whereas your firm has two key companies where cash flow could dry up in a bad time.

 

Good discussion  8)