I’m occasionally asked by younger investors for career and investing guidance. I’m happy to provide it. Usually it relates to developing an investment process, investment discipline, and business valuation methodology. Young investors are often trying to figure out what philosophy and technique makes the most sense to them. They’re curious, which is healthy. While addressing common investment topics is important, I have a few other suggestions that have helped me get through the past three market cycles (I should say 2 ¾ cycles as I’m still plowing through the third cycle).
As an absolute return investor, it’s very important to be willing to invest differently from your peers and benchmarks. Being a contrarian isn’t easy and can create stress, especially in a prolonged period of overvaluation. To make it through the cycle, it’s important to be prepared mentally, physically, and financially.
Here’s advice I’m sure you’ve heard, but is especially important for absolute return investors investing differently. Exercise is essential. Exercise is a proven and healthy way to reduce stress and improve mental awareness. My analyst isn’t going to appreciate me writing this, but he provides a good example. After joining my absolute return process he lost 50 pounds! It was an incredible achievement and I was proud of him. However, just between us, it was a setback for me as his tennis game improved considerably. I went from beating him after the first few games (he’d get tired), to him routinely beating me! Occasionally he’d let me win since I gave him the corner office. Despite the losses on the tennis court, I understood and appreciated his focus on being physically fit. In addition to returning to his athletic form, by exercising he was better able to manage stress and think clearly during a difficult period of contrarian positioning (a large weight in cash and miners in 2014-2015 – it doesn’t get more painful and contrarian than that!).
I didn’t plan on discussing this topic, but since I brought up my analyst, it reminded me of another very important trait of successful absolute return investing. One thing my analyst did very well, was he quickly understood the important variables in an equity investment. Some investors get so bogged down in minor details, they run the risk of misallocating their time and resources. Instead of identifying the most important variables of an investment, they’re locked in their office perfecting detailed models and spreadsheets. I’ve found there are usually 3-5 important variables that determine the future cash flows of a business and the success of an equity investment. Know these future cash flow determinants and know them well. If there are too many variables to consider, ask yourself if the investment is overly complex and if it can be valued with a high degree of confidence. If too many things must go right to generate attractive absolute returns, you may not be investing, but speculating.
Another helpful hint to surviving full market cycles is to have hobbies and allocate sufficient time outside of the office. Among other things, I like to play tennis, participate in activities with my kids, hunt for shark teeth, and watch my Jacksonville Jaguars lose again and again. The market and the office can be very distracting. Don’t become an office rat (I’ve been guilty of this) – find time to get away. And if you feel you need to remain connected, do an activity outside while working. When I hunt for shark teeth I like to listen to conference calls and investment podcasts. During the 2008 and 2009 crisis, I organized my thoughts and planned the next day’s trades (purchases) while taking long walks with my dogs. It was a very volatile period. Long walks helped me get away from the noise and think clearly. Some of my best investment decisions were made outside of the office during or after long walks.
Finally, and this is important, manage your personal finances prudently. You’re paid to be financially responsible with other people’s money. Lead by example, and don’t mismanage your own finances. As you succeed in investing, your paycheck will most likely grow. Don’t allow your expenses to grow at the same rate as your income. Similar to companies, professional investors have earnings cycles. As such, it’s important to avoid extrapolating peak personal income. Whether I was managing $20 million or over $1 billion, our lifestyle stayed relatively the same. Part of this was a result of our modest backgrounds, but another reason was I didn’t want our lifestyle to influence how I managed money.
As an absolute return investor there are periods when investing differently is required. Contrarians MUST take considerable career risk. Sorry, there is no way around this. As such, it’s important to be prepared to lose assets under management and eventually take a pay cut. If you supersize your lifestyle and expenses, you may be reluctant to take the necessary action to protect investor capital and maintain your investment discipline. If you have a big mortgage, boat, expensive cars, etc., how will you respond when the time comes to make the difficult decision of assuming career risk?
This brings up another topic I also didn’t intend to address, but I’ve always found interesting. How are portfolio managers influenced by money? Is it similar to professional athletes who sign lucrative contracts? Some lose their desire to perform, while others continue to be very passionate about their trade. When portfolio managers have money falling out of their pockets, are they as motivated as they were earlier in their careers when they were striving to prove themselves? I don’t have the answers – and it definitely depends on the individual – but I think it’s an interesting topic that isn’t discussed frequently.
I researched the topic of portfolio manager finances briefly and found an interesting study that was mentioned in an NPR interview (link below). The study focused on how distractions and emotional distress impact portfolio manager performance. For example, the study noted that hedge fund managers that get divorced underperform 7.4% on average. Interestingly, recently married portfolio managers also performed poorly. Although divorce and marriage aren’t the same as having money problems (some would argue otherwise), the point the study is making is they can be distracting. This was discussed in the interview, “…when something’s going on in your personal life – a divorce – it’s going to affect you at work.” And maybe that’s a good way to conclude on the topic of personal finances. Don’t allow your finances and lifestyle to become a distraction that interferes with your investment decision making process.
There is more, but it’s the weekend and I’m heading to a t-ball game. Back to earnings season next week. I have about fifty conference calls I need to read early next week, so my posts will be hit or miss. So far earnings season appears to be in-line with my original thinking (see last week’s posts). Outside of the impact from easier comparisons, management commentary and outlooks suggest there won’t be a meaningful rebound in Q4 2016. I’ll be surprised if the supposedly “data dependent” Fed raises rates. The data, or at least the data being reported by corporate America, isn’t supportive.
For professional investors playing the relative return game into year-end, I don’t think valuations or fundamentals support higher prices. Maybe the highly anticipated year-end rally will bail out aggressively positioned investors trying to beat their peers and benchmarks. If it doesn’t and the year-end rally fails, I hope portfolio managers speculating on ever-higher stock prices didn’t extrapolate their peak cycle incomes and supersize their lifestyles.