Wrap Up of FY 2013 Performance

With the liquidation of the US portfolio almost complete, I thought I look back and summarize the results of the past 2 ¾ years. While this site will still remain up, I will be refocusing my efforts on building up The Asia Report.

Please check it out here.

Since inception in 2011, we have achieved an annualized return of 27.23% and a cumulative return of 93.93%. This compares favorably with the iShares S & P 500 Total Return Index, which achieved an annualized return of 21.54% and a cumulative return of 70.99% over the same time period.

To put that into perspective, an initial investment of $10,000 would have yielded $19,393 by the end of June 2014. A similar investment in the S & P TR index would have yielded $17,099.

The results have been more than satisfactory. However, the advances in market prices have resulted in a dearth of investment opportunities in the US market.

Conversely, the emerging markets look far more attractive. We have liquidated the US equity portfolio not with a view to move into cash, but rather to reinvest where it makes sense for us to do so.

We have on our radar companies listed on the Hong Kong Stock Exchange, the Tokyo Stock Exchange and the Bursa Malaysia. The recent decline in prices has created interesting opportunities with favorable investment characteristics.

To end off, it’s been a pleasure writing to everyone. As the partnership shifts to the emerging markets and deals with investments in illiquid stocks, I will no longer be able to provide readers with portfolio updates.

However, I will be highlighting some individual investments, and providing some case studies in the future.

I look forward to seeing you at my new site, The Asia Report.

Reflections of Investing From 2011 – 2013

This will be my final piece on investing as I look to take a break from writing. It represents the culmination of not only my own investing experiences to date, but the work of countless others that have come before me. They form the foundation of all that I know about investing, and I hope you find it useful.

The markets are generally efficient at pricing securities. So in that way, I do agree with the general notion of the efficient market theory. What we exploit, and how we invest is to find pockets of market inefficiency, and to exploit the differences between price and intrinsic value.

To understand where to look for market inefficiencies, it’s easiest to examine the underlying assumptions of the efficient market theory. I will be covering the ones which I feel most pertinent.

Imperfect information:

The more coverage a stock receives, the harder it is to find divergences in intrinsic value based on traditional forms of valuation. They exist sporadically and infrequently – and right now, we are betting on two highly publicized companies in the US where coverage is high – Bank of America & AIG (our thesis is that the legacy problems that have led to recent lackluster results are being resolved, and their true earnings power will eventually be realized).

One has to take healthy stock in their own abilities as an investor. People who work in the financial industry are generally smart and highly motivated. It is extremely hard to possess an informational edge on companies that widely covered since so many people are working on the same problem as you are. Is it possible to generate superior insight by the careful study of annual reports and financial data? Yes. But the task inevitably becomes much harder, and the payoff far less rewarding with high profile names as such inefficiencies are inevitably arbitraged away as information about the business becomes commonplace.

Following that train of thought, it is logical to deduce that gaining an informational edge is much easier by looking where no one else is. Take for example, the Singapore Stock Exchange. While there are about 450 companies listed, only about 50 companies receive widespread institutional coverage. Gaining an investment edge through rigorous analysis of the remaining 400 thus offers a much higher probability of success since there is little competition. Valuations that typically exist during recession like conditions in more developed financial markets like the United States & the United Kingdom (or Greece now) are commonplace in Singapore.

Inevitably as the markets develop in Asia, such opportunities will cease to exist. But such developments do not happen instantaneously. The evolution of the financial industry in Wall Street took decades to play out. If history is of any relevance to us, I daresay that the development of the industry in Asia will take a similar path, and it will be many years before such opportunities cease to be.

As such, the well-worn path is one that we must avoid if your goal is superior market returns. There is nothing inherently wrong with investing in a benchmark index. However if one aspires to do better than the market, it is inherently illogical that you can achieve that goal by investing like everyone else is. Markets such as Singapore & Japan provide fertile ground for the enterprising and hardworking investor, and as markets continue to open up in Asia – notably China, Thailand & Myanmar among many others – there will be ample opportunities to exploit.

Market prices do not always reflect intrinsic value:

The underlying assumption behind ALL fundamental analysis is that the markets will eventually recognize the underlying value of the security. If you are long a stock, you believe that there’s a divergence between price and value – and that the markets are incorrectly pricing it below what it’s actually worth. If you are short a stock, you believe that the market is placing a far greater value than whatever the business is actually worth.

In truth, learning how to value a business is the easiest part of investing. Through careful study and due diligence, it is not hard to arrive at an estimate of what a business is worth. The difficulty comes in waiting for the market to recognize what we believe to be true.

The traditional bread and butter approach of a value investor is to find companies trading at a discount to intrinsic value, and than waiting for the markets to revalue them to what they are really worth.

Let me present to you a variation of this, one still anchored from the foundations of a focus on intrinsic value, but borne out of my own experiences from how financial markets work. For us to do that, we need to establish the premise behind exploiting this “market inefficiency”.

Humans are rationally irrational. Even after thousands of years, all of us, regardless of our origins are governed by the same fundamental emotions of greed and fear. Investment opportunities that are widely purported to make money (whether they do so is another question) are often exploited by other people. Witness the junk bond mania of the 1980s, the dot-com frenzy of the 1990s, and the sub-prime crisis of the 2000s.

Thus while we invest on the premise that the price of an underlying security and its intrinsic value will eventually converge, the truth is that for the most part, they don’t. Believing that markets operate rationally is the surest way to folly as they reflect so little of what reality is. In the short run, the stock market is like a voting machine. It’s driven by a herd like mentality – and emotions.

Consider this, while value investors like to talk about investing for the “long-run”, the truth is no one knows just when this revaluation will take place, if it ever does (if you know someone who does, my advice is to run for the hills). It could be weeks, months or years. The whole point of speaking in broad specifics is that it affords us the margin of error seeing that we have no clue when it would happen. We have our rough ideas and our expectations, but they are rarely right. If there existed an exact science of forecasting, investors would have no need of portfolio diversification.

In the real world, prices for most transactions are governed by the fundamental laws of demand and supply. When the number of buyers exceeds the number of sellers, prices rise, and when the reverse happens, prices fall. The deeper the market, the greater the liquidity, the smaller the mis-pricings between the prices of what buyers and sellers demand.

The real investment opportunity comes when the normal state of the markets are thrown into turmoil without warning. Consider for example, panic selling in the wake of market wide declines. The number of sellers who want to get out of their positions far outweighs those who are trying to get into the market. They are highly motivated to get out and sometimes not because they want to, but because they are forced to due to margin calls, excessive leverage etc. You are essentially playing the role of a trader, exploiting the differences in positioning that both parties have.

And that’s why sometimes intrinsic value doesn’t matter at all. If you are a large institutional firm taking a huge short position, and word gets round that you need to get out for your position, you are screwed. The market is going to make use of your need to cover your shorts to extract the highest possible price because you have no say in the matter. It doesn’t matter whether your thesis is right or wrong. Let’s say you’re house is being foreclosed and being auctioned off. Now, the value of your property conservatively valued might be $500,000. But more often than not, you won’t get anywhere close to that sum. You aren’t in a position to bargain. Intrinsic value doesn’t matter.

One of the reasons why distressed debt investing is so profitable isn’t that the underlying businesses behind them are great. They aren’t. Rather investors can pay such depressed prices for their debt that it far compensates them for any risk that they are required to assume. They are placed in a superior bargaining position to demand lucrative prices. If you pay 20 cents for bond with a par value of $1, a lot can go wrong and you can still make a lot of money!

If I could sum this “market inefficiency” in one sentence, it’s that investors should be waiting for situations where the number of sellers far exceeds the number of buyers. This is different from the traditional associated form of “value investing”, because it requires you to be highly tuned in to the market. You take on the mind of a trader, keeping up with the latest developments, waiting for situations to unfold. These investment opportunities normally only exist for short spans of time.

Closer to home, let’s take the situation of the locally listed company – Olam.

When word that Muddy Waters had taken a short position in Olam, market value of its listed debt and equity declined considerably in value. Investors were highly motivated to get out of their positions. Like every other time, it was a case of do first, think later. Now, depending on what you though Olam was actually worth, there was a significant chance to buy the same company at a significant discount to what it was trading just a couple of days earlier – literally a contrarian trade with a short time horizon and not one where the holding period was years.

Individual investors don’t need to do anything when there’s nothing to do:

More than anything else, this is the biggest advantage that individual investors have over institutions. Institutions thrive on activity, and they need to be doing something or anything to justify their fees. Funds have to be fully invested, opinions have to be given even when no intelligent conclusions can be formed, and institutions in general, tend to crowd into the same trades.

Individual investors face none of that burden, and it’s the most powerful advantage you have. You can wait for indefinite periods of time for the right pitch to surface before moving, and you should exploit this advantage to the fullest.

Let me walk through how advantageous by highlighting an example close to home.

Those of you familiar with me know that I generally hold a bearish view of the property market in Singapore. Prices have risen considerably, and the general sentiment of the average investor is far too bullish for me to be comfortable, especially with what is essentially a highly geared investment. An investment idea which combines high levels of debt, and the assumption that interests rates continue to remain depressed indefinitely and that prices of houses continue to rise (or remain level at least) is one that in my view, doomed to end badly (this is what the sub-prime crisis in essence was).

But this is where the individual investor has a huge advantage. If I do not want to invest in property, I don’t have to! Sure, the average person might feel the compelling need to since all his friends are getting rich doing so, but that is different from an obligation to do so.

Now, consider this, if you were running an institutional fund and property stocks or REITs just had a terrific run, you certainly might have reached the same conclusion as me that they were overvalued. But, calls from your clients would soon come in, asking why you weren’t loaded up with property stocks when rival fund manager XYZ who had done much better than you, was. Clients would soon start leaving you, feeling you out of touched with the “new-age” of investing, and soon your livelihood – directly correlated to the amount of assets you managed would be threatened. You would be compelled to start making investments in these assets despite your own personal beliefs – not because you wanted to but because you had to.

Sound farfetched? It isn’t.

What I’ve described has repeated itself countless times throughout history. It’s the same reason why funds are normally crowded into the same trades all at the same time. It’s far better (and easier) to fail conventionally, together, than it is to succeed unconventionally, alone.

In my view, this is really the biggest advantage that individual investors have. The ability to do nothing when there’s nothing intelligent to do, and to swing for the fences when the right pitch comes is fundamental to generating market beating returns. The only way to achieve superior results is to do what no one else is doing.

Final thoughts:

I have drawn upon the works of countless others, coupled with close to three years of investment experience to reach the conclusions above. While not exhaustive, they provide the bulk of what has come to define my own approach to investing, and like all things, will continue to evolve as the years roll by. While I’ve enjoyed it, this will be my last piece of investment writing for a long time coming. To end off, I echo the words of Benjamin Graham which apply not only to investing, but life as well – you are never right or wrong because of what other people say, but because of your research and because of your reasoning. If both are sound, have the conviction to stick to your beliefs and stay the course, no matter what others may say, and in time, you will be duly rewarded.

Value Letters – 20 August 2014

We start off with an observation that may appear self-evident:

1. Great investors are not necessarily great businessmen and
2. Great businessmen are not necessarily great investors

This has created an interesting paradox. How can different people have such different views on the same subject matter – chiefly the investments in common stocks?

What happens in the business world and what is taught in the vast majority of finance courses is striking different. For example the projecting of future cash flows or the calculation of intrinsic values of business are uncontroversial parts of any business school curriculum.

Approach a businessman with the same set of projections and hilarity ensues.

How can financial analysts proclaim to have precise calculation of business values when management themselves do not know with precision what lies ahead in the coming year? How can two experts in their field arrive at vastly different conditions?

My own observation and hypothesis is that both people are in fact looking at different sides of the same coin. The failure to appreciate the other point of view lies in the entrenched thinking that each possesses the entire tool-kit to analyze the issue at hand.

As Charlie Munger put it poignantly, “To the man with a hammer, everything looks like a nail.”

Let’s take enquiry a step further by engaging in what admittedly is an exercise not steeped in empirical research but my own observation and reasoning. It does not reflect that my own view is necessarily correct, but I hope it reflects the sincerity of my opinion.

As an individual with a legal background, I routinely deal with unquantifiable unknowns and the tool-set which we use to derive a solution involves a heavy use of precedent, observation and deductive reasoning.

Based on current academic research, we can say with a high degree of confidence that the average individual does not engage in reading or learning outside his or her job. The vast majority (or the consensus opinion) is thereby a rough reflection of the existing state of knowledge that is most commonly accepted within that period of time.

It is the nature of higher education that we are pigeon holed into “silos” of academic knowledge. You have accountants, lawyers, manager, financial professionals and so on. When analyzing a business however, the view of each tells a different part of the same story, albeit from a different point of view.

My own observation of courses that are meant to promote holistic thinking are that they are far often treated like a slideshow to the man event. Specialists in their respective field it seems are more richly rewarded than generalists.

There is a large degree of truth to this observation. What practical use is knowledge of history, ancient civilizations, languages and culture on a relative basis compared to the hard skills that lead to immediate financial rewards?

A technician or engineer is first hired not to allocate capital but to solve technical problems at an immediate and practical level. The route that the vast majority of market participants take is therefore quite rational.

The efficient market theorem postulates that the price today on an asset reflects its “correct” value.

Let’s try to dig deeper into what this really means.

Markets are inherently made up to buyers and sellers that are essentially institutions or individuals. The vast majority of these individuals are however untrained for the most part in financial analysis and business management. They represent people from all walks of life. Thus, what the market in essence reflects is what market participants with their own knowledge and experience think the asset is worth as opposed to what the asset value is inherently worth.

Although intrinsic values & perceived value may coverage, there are frequently times they do not.

I realize that I am now approaching on area that seems to have no definite or absolutes. We have left the realm of precision and entered the uncertain world of relatives. How does one measure the value of something if conventional models do not work?

Experience has taught us that to understand how the financial markets work, you need to grasp the fundamentals of human psychology and neuroscience. The field of behavioral economics shows great potential in unlocking these mysteries.

Consider this.

It is well known that different people can have vastly different inspections of the same event. The brain deletes, distorts and outright manipulates what we think we see as opposed to what really happens. However, there must ultimately be only one true account of the incident. In the court it is often the role of judges to piece the most rational and plausible explanation of what happened.

The same is true in investing. Take for example a hort term price decline in the price of a company as a result of an earnings miss. The result in the short term is often a knee-jerk reaction, based upon the experiences of those who are actively buying and selling in that instance.

The motion of a mis-priced, undervalued security provides a logical conundrum. How can a security be mispriced and not be snapped up to its right value? And again how can an overpriced security be overpriced? Can it be said that the markets are truly efficient when the share price of a stock trades at $200 on one day and $0 in the next year? These are some of the questions that we will continue to explore in our subsequent memos.

Value Letters – 13 August 2014

Dear Clients,

As a general policy, we refrain from giving specific investment ideas. There is little upside to revealing our investments in specific, publicly traded companies. On the contrary, there is significant downside in telegraphing our methods and trade secrets that will ultimately hamper our ability to act discretely and quickly.  I will thus refrain from discussing specific investment ideas outside of regulatory requirements.

What I hope to impart through these memos is the business and investment policy of our partnership. We are not in the business of predicting the fluctuation of markets. Our expertise lies in seeking out discrepancies between value of price in mis-priced securities i.e common/preferred stock, warrants or bonds.

We view shares in a company as a very real & tangible ownership in the business. Mindful of the fact that we are minority shareholders, we typically seek businesses that are awash in cash, either as a result of their intrinsic earnings power or from the potential liquidation value of their assets.

While most investors typically treat the market like a casino, we take a different view. It is a constant that investment markets exhibit the same pendulum like swing time and time again between unwarranted euphoria and downright depression.

As avid students of the financial markets, we note with confidence that these price fluctuations often have little bearing on the economic condition of the business itself. We stand with conviction not because of unwarranted optimism, but cautious practicality. We place a large emphasis on the presence of tangible assets and demonstrated earnings power to help serve as anchors to reality.

This long term approach help sets us apart from the crowd. There are no free lunches in the world, none the more so in investing. At the heart of our investment policy is a central question we ask ourselves: Would we take control of entire ownership of the business given the chance?

If the answer is no, we do not hesitate to seek better investment opportunities.

Our job is to deliver longterm returns and not to focus on short term out-performance. A common question that often follows is whether investing is really just down to luck?

The answer is not at all. In the short run, any investor can make money through outright speculation and even magnify his returns with the use of leverage. On the basis, luck plays a crucial role in your success.

However, over the course of hundreds of investments, skill inevitably matters more. No matter how one rationalizes it, luck is not a consistent long term strategy to building wealth.

Most of the investment operations that we undertake in are unorthodox and other run against the grain of “common wisdom”. Our investment philosophy frequently leads us to businesses experiencing temporary economic distress. We favor such investments not for the sake of acting in a contrarian manner, but because they afford better opportunities for out-sized gains.

While seeking investments in distressed assets, we are mindful of John Maynard Keyne’s maxim, “Market can remain irrational longer than you can remain solvent.” We only seek investment opportunities that have the demonstrated capacity to withstand persistent declines in economic conditions.

We will eschew the use of leverage in the vast majority of circumstances. Our chief most responsibility is firstly the protection and preservation of the capital under our stewardship.

It is our firm belief that if one can avoid the losses; the winners will take care of themselves. This also explains our propensity to favor businesses that are backed up with substantial asset values. They are in our experience much more reliable determinants of value than projected earnings.

Value Letters – Reflections from Investing

With the winding down of the US Portfolio, I’ve renamed the blog in view of the upcoming shift in theme of what I hope to cover.

In the coming months, I’ve decided to focus on publishing a series of investing memos that I’ve written. Each piece will focus on different aspects of investing.

Together, they represent my own philosophy and approach. Many of you know that I adopt a long term, fundamental based approach towards investing. I hope to refine and clarify my own thoughts on the subject, and to engage and encourage you to think about it in your free time.

There is no shortage of information available with the advent of the world wide web. However, what is perhaps lacking as a direct result of the easy availability of “knowledge” is a lack of what Howard Marks calls “second-level” thinking.

Things cannot be taken at their face value. As the old adage goes, there’s a good reason why something is done, and the real reason behind it. I hope these memos will spark some interesting discussions, and lead you to arrive at your own conclusions about the subject.

What 153 SGX Companies Have Paid Dividends For The Past 5 Years?

Dividend Champions (Click For The Google Spreadsheet)

I am working on a exciting new database of dividend champions. 

A company’s dividend track record is one of the most critical tools in assessing whether a company has a real sustainable business model. We are looking for companies with sustained and persist track records in paying dividends.

The following are the 153 companies which have met the stringent criteria of having a track record of 5 years of dividend payouts.  It’s a great starting point for all investors.

I have excluded financial companies, China companies listed in Singapore, and REITs and business trusts.

Access it here on The Asia Report.

Dividend Champions

I am very excited about this project. Let me know what you guys think!