As absolute return investors, we often need to look different, sometimes a lot different, than the benchmarks and our peers. To generate attractive absolute returns over a market cycle, it’s important to be able to pull back when others are pushing forward and push forward when others are pulling back. Fighting the seductiveness and comfort of being included in the crowd is very difficult – a tremendous amount of discipline is required.
Discipline is a trait every investor claims to possess. What professional investor starts a presentation with, “Hello, my name is Bob. I’m an undisciplined portfolio manager. Will you hire me?” While everyone claims to be disciplined, it’s extremely difficult to maintain discipline throughout an entire market cycle, especially the type of cycles (asset bubbles) we’ve had over the past 20 years.
This is my third market cycle. Each cycle my investment discipline has been put to the test. Given today’s markets are extraordinarily expensive and the overvaluation is so broad, the current cycle has been particularly challenging. Despite these challenges, I believe I’ve remained disciplined as I have in past cycles. In fact, the commitment I have toward my investment discipline is one of the reasons I recommended returning capital to clients and moved to 100% cash. Considering valuations within my opportunity set, investing in small cap stocks today would most likely cause me to violate my discipline. I don’t want to be like the portfolio manager “Bob” mentioned above, so here I am. [If your name is Bob, please forgive me!]
The discipline of professional investors is often communicated as a set of rules and guidelines. Investment guidelines are typically listed front and center in presentation booklets. Guidelines are used by asset managers to communicate how a strategy will be managed. Guidelines are also used to reassure clients or potential clients that the manager will stay in their appropriate style box. For relative return investors, remaining in a style box is important, as many are hired with the assumption that they will act a certain way relative to a benchmark and peers. For example, if you’re a mid-cap growth manager, rules and guidelines will be set to make sure you invest like a mid-cap growth manager.
In my opinion, an investment discipline founded on how a manager is labeled is often too restrictive and encourages conformity. By following label-driven guidelines, a manager who follows their discipline is – by definition – following the crowd. A manager’s investment beliefs and opinions can be overridden by rules and mandates. In other words, how the manager wants to invest and how he or she is allowed to invest, may be two entirely different things. In my opinion, this isn’t investment discipline, it’s compliance – there’s a big difference.
I view discipline differently than a set of rules that keep a manager from stepping outside of a particular style box. I view discipline as a set of core investment beliefs and principles. While I have rules and guidelines, most are meant to increase flexibility, not decrease it. If I believe something to be true or have a strong opinion, I can act on it. My discipline is not restrictive and does not commit me to a particular style or label. Furthermore, most of my guidelines are qualitative in nature and do not impose strict quantitative limits. Instead of a rigid set of rules and guidelines, my discipline revolves around defining what I believe is most important to me as an investor and a person.
In previous posts, I’ve referred to a couple of guidelines as part of my Ten Investment Commandments. I’ve listed all of them below.
Eric Cinnamond’s Ten Investment Commandments
- Do not overpay (be willing to be patient).
- Take risk when getting paid (be willing to be aggressive).
- Think independently (be willing to invest differently and uncomfortably).
- Do not value what can’t be valued (avoid speculating).
- Do not extrapolate (normalize).
- Do not combine operating and balance sheet risk (avoid major losses).
- Do not manufacture opportunity (use realistic valuation variables).
- Do not manage money to get hired (don’t play the AUM game).
- Know your names; be dedicated to your opportunity set (300 name possible buy list).
- Obtain fundamentals from companies, not the government, media, or sell-side research.
What’s important to you as an investor? Throw away the generic rules and policies. Also toss out all of the best-selling investment books and your favorite Warren Buffett quotes. Make a list of the things that YOU believe are important, not others. The list should be based on individual beliefs and not driven by a style box or how you believe others want you to invest. What defines you as an investor?
The next time you question an investment or your discipline, go to your list and you’ll often find the answer. Furthermore, I believe you’ll find a personalized list will help define and differentiate yourself. In an investment world that is moving more and more to passive investing and conformity, I believe different will be a precious investment resource when the current cycle ends. Without a unique discipline, few will be able to offer it.