Adapting as an investor

I remember well how much I loved to program computers. As a cadet at the Air Force Academy taking lots of astronautical engineering courses, I had to do a lot of computer programming.  These projects were very complex, requiring precise calculations (to 8 significant digits) of the velocity and position of satellites, antenna pointing angles, terrestrial positions, etc. They were done on 286 Zenith computers without hard-drives, so some programs could rake as long as 24 hours to run.

I love the process, though. No matter how difficult the problem, I could always solve it. It was like a big puzzle: figure out what part of the program went askew, make changes to that one part and test it repeatedly, and keep doing that until you got it right. Then move on to the next part and repeat until you got it all solved. My classmates were frequently amazed that I would have the projects done weeks in advance. I just loved the process.

Investing doesn't work so easily. The difference is the noisy feedback loop. Orbital mechanics is like clockwork. You know the starting situation, you know the physics, so when something goes off track it is easy to see that it's wrong, and it is easy to figure out where to jump in and fix it.

With investing, the data is much more noisy. By noisy, I mean there are lots of false signals that things are going well when they won't in the long run, and that they are going poorly when they will go well in the long run. 

In other words, when you make a change to your investing process, it can take years, perhaps even decades to see if you really have it right. That's not the happy feedback loop of computer programming with instant and clear feedback.

But, that is the nature of the beast. When you see your results aren't doing what you expect, you need to make changes to adapt, and then wait another couple of years to see how that worked.

The process is the same as it is with computer programming, but the signal is very noisy, meaning you don't know if things have actually gone wrong or not, and the feedback loop takes years instead of minutes to complete. 

I have to admit, I still love to solve the puzzle. Just like with computer programming, I'm as committed and convinced that I can get it right.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The Lessons Of Oil

Not many outside the investing business have heard of Howard Marks. He is a very successful money manager at Oaktree Capital with a reputation built mostly around distressed debt investing.  

He also writes very well and publishes Memos that I eagerly read.

His latest is on the fall in the price of oil and what lessons we can learn from it.

I highly recommend it to anyone who wants clear thinking on the subject.

If you don't want to read it, here are some quick highlights:

"...what 'everyone knows' is usually unhelpful at best and wrong at worst."

"Not only did the investing herd have the outlook for rates all wrong, but was uniformly inquiring about the wrong thing."

"Asset prices are often set to allow for the risks people are aware of.  It's the ones they haven't thought of that can knock the market for a loop."

"Forecasters usually stick too close to the current level, and on those rare occasions when they call for change, they often underestimate the potential magnitude."

 "This is an example of how hard it can be to appropriately factor all of the relevant considerations into complex real-world analysis."

"Most people easily grasp the immediate impact of developments, but few understand the 'second-order' consequences...as well as the third and fourth."

"...it's hard for most people to understand the self-correcting aspects of economic events."

"If you think markets are logical and investors are objective and unemotional, you're in for a lot of surprises."

"A well-known quote from economist Rudiger Dornbusch goes as follows: 'In economics things take longer to happen than you think they will, and then they happen faster than you thought they could.'"

"The key lesson here may be that cartels and other anti-market mechanisms can't hold forever."

"...it's hard to analytically put a price on an asset that doesn't produce income." 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

There's no substitute for hard work

When it comes to improving at anything, there is just no substitute for good, old fashioned hard work.

I've been reminded of this lately as I build out my circles of competence through intensive research.

When I started out investing in 1996, I was still working full-time as a pilot in the Air Force and getting my MBA in night school. My research then was heavily focused on quantitative analysis, and my understanding of the qualitative side of investing was slim to none.

As I gained more experience, I also did a lot more research into the qualitative side of research starting in 1998. At that point, my investing results were about as good as the market's, which isn't outstanding, but is quite an accomplishment as a value investor at the end of one of the biggest bull markets in history.

As the dot-com bubble peaked and then exploded from 1999 to 2000, I found myself holding several very under-valued, small brick and mortar companies. Those companies' out-performance was just incredible over the following years.

That was around the time I got out of the Air Force in late 2001 and started as an investing professional.  At that point, I had a lot more time to do qualitative research, but my quantitative method was still working so well that I wasn't quite doing the best research I could. Because the quantitative method looked so easy at the time, I didn't see any good reason to dramatically change.  If it ain't broke, don't fix it.

I found myself beating the market by over 8% annualized from 1995-2002 (71% more, cumulatively, than market returns) and 1995-2003 (85% more, cumulatively, than market returns). It was like shooting fish in a barrel. Because I was having a harder time finding my quantitative darlings in 2004, I was sitting in a lot of cash, but my returns were still beating the market by over 6.5% annualized over 9 years (76% more, cumulatively, than market returns).

What I didn't realize at the time was that value investing was having it's best run ever from 2000-2005. The quantitative method that had served me so well was about to sunset.

That was when I started my own value investing shop. Bad timing.

I knew the quantitative side wasn't working like it had, but I didn't fully grasp why. As time went by, I worked harder and harder to master the qualitative side of investing, but I wasn't quite getting there because I was trying to do it without really working with as much focus as I needed to.

After beating the market by a small margin from 2005 to 2008, I started to realize I needed a more fundamental make-over of my investment research. Instead of quantitative screens, I needed to figure out which companies I wanted to own, qualitatively, and then figure out what they were worth.

I have been on that path ever since, and I've been working longer and longer hours at it. Getting to know one company, and all its competitors, all the other companies in the industry, and the company's suppliers and buyers, the substitute products that may kill the business, and so on takes many hours of reading, re-reading, learning, researching, analyzing, etc.

When it comes time to improve, nothing really beats hard work. Hard work isn't fun, per se, but it does produce great value. I'm ashamed to say that it took me so long to find and pursue this path, but now that I'm on it, I'm not sure why I thought any other method would work.  

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Life lessons from a very successful hedge fund manager

Jonathan Tepper is a very successful hedge fund manager. When I saw him in a TV interview, I envied his intellectual honesty and self-confidence. His track record is outstanding.

John Mauldin recently posted a article by Tepper on life lessons he wanted to give to his nephews (during an airplane ride with heavy turbulence). It's great big-picture thinking, and a great way to start the new year. Happy reading.

Letter to My Nephews

By Jonathan Tepper
December 29, 2014

You can learn a lot from books, but many things can only be learned the hard way by living, suffering and enjoying life.

A year and a half ago, I was in a plane with very bad turbulence, and I worried that if the plane went down, many of the lessons I’ve learned in life would end up at the bottom of the ocean.  I wrote a letter to my nephews for them to read when they were older.  I hope they’ll find it useful.

—————–

Dear nephews,

I’m writing this on a plane. The reason I started writing this was that I feared the plane might go down, and if it went down, all the lessons I’ve learned in life would disappear with me. By writing this, I hope to pass on the few lessons I’ve learned.

The most important lesson is that the vast majority of things you worry about will not bother you the next day. A year later you will not even be able to remember them if you try. When you grow older, you will not worry about what grades you got. You won’t worry about games you lost.   You won’t worry about what other people thought about you. Most of the things you worry about will never happen. Even if the worst things that you worry about happen, life will still go on. Learn to enjoy every day, and try to enjoy it as if it is your last. It has taken me a long time to understand this, and I wish I had understood it sooner.

Happiness is not a destination but a journey. You will never be smart enough, rich enough, have a pretty enough girlfriend, boyfriend, husband or wife, or win enough prizes and awards. Whatever it is you want, there is always something better. Enjoy the journey of learning, working, and living. If you enjoy the journey, you’ll probably achieve a lot more than if you focused on goals.

Money can provide security, but once you have security, more money cannot buy you more happiness. If you show me someone who thinks money can buy happiness, I’ll show you someone who has never had a lot of money.

Things don’t make you happy, but memories will always stay with you. Whatever it is that you buy, you will soon get used to it. It will make you happy for a short while, but it will not make you happy forever. Experiences and memories can make you happy forever. I can’t even remember most of the toys I’ve had in my life, but I still think of my times with Timothy and your Grandmom with great happiness and fondness. I remember walking Timothy to school and how happy we were. I remember hugging your Gradmom when I came home for a weekend. Those memories will never go away. The happiest memories of my friends are my travels and dinners with them, not the things I’ve bought for myself. You’ll remember dinners and travels with friends and family more than any shiny things you’ll ever have.

Your family is the most important thing you have in life. Friends, boyfriends, girlfriends and co-workers come and go, but the only thing that you can always count on is your family. (If you find a friend who is always there for you, you’re extremely lucky. They exist, but they’re very rare.) One day, you will have your own family. You must love them and look after them. You will understand one day that just as your grandparents die, your parents will as well. Strive to be a good son and daughter. One day, you will be like your parents. Your parents are not perfect, and you will not be either. But you can be loving and be a good son and daughter. One day you can be a good parent.

Never stop learning, and always be ready to teach yourself things you don’t know. The only things you will remember are things you care about. You will forget about all the rest. You must teach yourself and care about what you learn. No one can teach you everything you need to know at school or university. You will also forget most of what you study, and that is fine. As Jacques Barzun said, “Civilization is all that remains after you have forgot all that you specifically set out to remember.”

Never live someone else’s life. Find your gifts and the things that give you pleasure, develop those gifts, and pursue them.   Do what makes you happy and be great at it. You have skills and gifts that no one will ever have or see again. If you’re a businessman, build businesses. If you’re a writer, write. If you’re a scientist, discover. If you do what you love and love what you do, you will work very hard, but you will enjoy every day.

One of the things that most influenced me was something Steve Jobs once said:

When you grow up, you tend to get told that the world is the way it is and your life is just to live your life inside the world, try not to bash into the walls too much, try to have a nice family life, have fun, save a little money.

That’s a very limited life. Life can be much broader once you discover one simple fact, and that is that everything around you that you call life was made up by people that were no smarter than you. And you can change it, you can influence it, you can build your own things that other people can use. Once you learn that, you’ll never be the same again.

And the minute that you understand that you can poke life and actually something will, you know if you push in, something will pop out the other side, that you can change it, you can mold it. That’s maybe the most important thing. It’s to shake off this erroneous notion that life is there and you’re just going live in it, versus embrace it, change it, improve it, make your mark upon it.

I think that’s very important and however you learn that, once you learn it, you’ll want 

to change life and make it better, cause it’s kind of messed up, in a lot of ways. Once you learn that, you’ll never be the same again.

I hope that you will find what you love and you will change the world.

Life is full of struggle, and many bad things will happen to you. This is one thing that I can guarantee you. Most of my friends died of AIDS, and your uncle Timothy died in a car accident and your Grandmother committed suicide after suffering from a very bad brain tumor. These things happened and cannot be changed. Many people suffer great tragedies and live full and happy lives. Remember the people you love and mourn them. Accept that terrible things happen, and try to live as if each day is your last with those you love. There is nothing else you can do.

The best way to avoid anxiety, stress and unhappiness is to avoid internal contradiction. Don’t think that one thing is right and do the opposite. Listen to your conscience and obey it. Be a good person and live according to your convictions. You cannot answer for other people, but you can always answer for yourself. As long as you live according to your most basic beliefs, you will not have regrets or guilt. You will be able to die happily knowing that you looked after the poor and needy, that you were loving to those around you, and that you failed often but did your best. You will not lose a night of sleep if you always try to do your best.

I love you very much.

Much love,

Uncle Jonathan

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.