A Value Investing Blog

Posted on 23 Mar 2017 by Daniel Mueller

Going Super Mental

Going Super Mental


Today’s AFR contains an interesting article on housing affordability and a new front on the crisis. It addresses the emerging issue of retirees draining their superannuation savings to pay off their mortgages and then go on the aged pension. Effectively defeating the purpose of superannuation.

But in my view, the article fails to highlight the root cause of this.

Continue reading “Going Super Mental”

Posted on 02 Mar 2017 by Daniel Mueller

Bears, Bulls and Barbecues

Bears, Bulls and Barbecues


Want to know what a pretty picture looks like in the eyes of a contrarian investor? Today’s Australian Financial Review (AFR) provides the answer. For those who have a hard copy, turn to page 15 of today’s edition. There are three very bearish articles on three different asset classes, Australian stocks, global stocks and Australian bonds. All three quote experts in their field, forewarning investors that all three assets classes are to be avoided, at least for 2017. And if you flick through the pages there are some very bearish articles on the banks and Telstra (TLS). So why am I not partaking in the gloom and doom?

Continue reading “Bears, Bulls and Barbecues”

Posted on 02 Nov 2016 by Steve Johnson

How To Lose When the Odds are With You

How To Lose When the Odds are With You


“What would you do if you were invited to play a game where you were given $25 and allowed to place bets for 30 minutes on a coin that you were told was biased to come up heads 60 per cent of the time?”

So begins a research paper* by Richard Haghani, founder and chief executive of Elm Partners, and Richard Dewey, from bond fund manager Pimco. It shouldn’t surprise you that quite a few people were willing to play. Haghani and Dewey limited their experiment to 61 participants playing an online version of the game (with real monetary rewards).

It also shouldn’t surprise you to know that, while they knew that the odds were in their favour, most people didn’t know the optimal strategy for maximising their profit over the 30 minutes available. That’s because, outside the professional gambling fraternity, few people have heard of the Kelly Criteria.

This mathematical formula, published by John Kelly in 1955, optimises profit in games of chance where the odds are skewed towards the player. We won’t go into the details here (Matt wrote a Kelly Criteria blog post a few years back) but, given the game described by Haghani and Dewey, a profit maximising participant should bet 20 per cent of their available funds on each flip of the coin. Bet any more than that and the inevitable run of bad luck is going to be ruinous. Bet less and you are leaving too much profit behind. Continue reading “How To Lose When the Odds are With You”

Posted on 24 Oct 2016 by Daniel Mueller

Coal Provides 2016’s Biggest Lesson

Coal Provides 2016's Biggest Lesson


Want to learn the biggest lesson of 2016? Look no further than commodity prices. The first 10 months of the year have seen an extraordinary rebound in sentiment towards commodities, particularly coal. There was a lot of money to be made as well as an important lesson to be learned.

But first, let’s set the scene.

Successful contrarian investing involves going against the crowd. And sentiment is a measure of what the crowd is thinking. How to measure sentiment? One way is to read media articles, particularly newspaper headlines. This gives us a qualitative insight as to what stage sentiment is at.

Continue reading “Coal Provides 2016’s Biggest Lesson”

Posted on 16 Aug 2016 by Alvise Peggion

Red Devils Don’t Anchor

Red Devils Don’t Anchor


Last week Manchester United (NYSE: MANU) signed up French football-star Paul Pogba after paying a record transfer fee of €105 million to Juventus (BIT: JUVE). This raised more than a few eyebrows. Four years ago Pogba was already a United player but was let go to Juventus for a meagre €1 million fee.

To the football community Juventus looks like the clear winner here, pocketing a huge windfall on the sale. Inevitably, United ends up looking like a fool spending such a huge amount of money to resign the player; even more so when he hasn’t yet proved on the pitch that he is worth as much as soccer gods like Cristiano Ronaldo and Lionel Messi.

Even the stock market seems to imply this – Juve’s share price is up about 16% since the rumours of the possible transfer spread in early July.  On the other hand, United’s share price is up a modest 6%.

In my opinion, though, Manchester United got a great deal.

Continue reading “Red Devils Don’t Anchor”

Posted on 09 Jan 2014 by Forager

Forge Psychology: Value Investor Turned Day Trader

I like to think I’m pretty well wired for value investing. A natural inclination to go against the crowd and an absence of emotion tend to combine well.

But I have a couple of idiosyncrasies that cost us from time to time.

First, I don’t like pinching other people’s ideas. That’s dumb – other people pinch plenty of mine. But I just don’t get the same enjoyment out of buying someone else’s idea as I do from adding our own propriety idea to the portfolio. So I tend to shy away from them.

Second, not all profits are equal.

This is the way it is supposed to work. We find an unloved idea. We do a few weeks research. We buy the stock and we sit there and wait for the value to become evident to everyone else. We argue with management if necessary. We get lawyers involved if we have to. And then three years down the track we reap the profits and sit back content with the hard work we’ve done.

So what happens if a stock doubles or triples within three weeks of owning it?

We sell it, of course. The stock is no longer cheap and we just realised what we hoped to realise over three years in the space of a few weeks. What’s wrong with that?

Nothing, of course. We’ve made money and should be happy. But I just don’t get the same satisfaction out of the short profit. It’s a bit like a tennis shot that hits the net and drops just onto my opponent’s side of the court. I won the point, but I don’t feel like I deserved it.

The stock that made me think about this is Forge Group. In December we bought it and sold it twice. The average holding duration was about a week and we added 1.7% to the Value Fund’s net asset value.

Profitable for sure. But hardly traditional value investing is it?

*We’ve written a few pages on mining services for the December Quarterly Report. It will be available next week.

Posted on 14 Jun 2012 by Forager

Beware Layers of the Pyramid

Intelligent Investor Funds analyst Matt Ryan recently sat the third and final exam for his CFA candidacy. It’s strange (and unfortunately common amongst academic institutions) that they continue to teach things that they know are wrong. The CFA course teaches Value at Risk (VaR), a once widely used modelling tool used by financial institutions to measure risk that was completely discredited by the financial crisis.

The model looks back over historical prices and tells you that you can be 95% confident, for example that your losses won’t exceed a certain amount (it could be 99%, or 99.5%, it doesn’t really matter). The problem, as everyone found out in 2008, is that it doesn’t tell you how bad the worst 5% might be. It also doesn’t warn you about anything that hasn’t happened before because it isn’t in the historical data. House prices hadn’t fallen since residential mortgage backed securities were invented, so the historical data model tells you the risk of loss is zero.

It’s a very limited tool in the real world, as the collapse of Lehman, takeover of Bear Stearns and JP Morgan’s recent US$2bn trading loss makes patently clear. The CFA institute know that. The shortcomings get a few paragraphs in the text book.  But they keep on testing it nonetheless. Teach what is testable, not what it is right, seems to be the way.

Anyway, once we flush the codswallop out of his system, there’s plenty of useful material that came out of the course. One of my favourites was an explanation of the shortcomings of goal-based or pyramid investing.

They are referring to an approach where people segment their portfolio to meet specific goals. For example, you might separate money for an upcoming holiday from your regular savings account. You might think of your superannuation as a separate pool of savings from your non-super savings and invest accordingly. Or you might separate the children’s education from your own retirement funds.

Along these lines, financial planners often recommend clients develop their portfolio allocations using a ‘pyramid’ approach, where the bottom layer of the pyramid is filled with the safest assets to meet the client’s most important objectives. Higher layers are then allocated to progressively riskier investments for the client’s less critical objectives until the portfolio is complete.

This approach is easy to understand and intuitively seems ‘responsible’. In fact, we probably all do it to some extent. It can, however, lead to a flawed overall investment strategy. By segmenting your assets you may not consider the correlations between these assets, which means you may take too much risk or be excessively conservative. An example will help demonstrate the issue:

Joe has $300k of personal savings, and in 5 years time when Joe retires he will be eligible for a pension paying $50k per year. Joe’s goal is to have $400k of savings as a safety buffer by the time he retires. Joe is comfortable taking some risk, however he has been told by a friend that someone his age shouldn’t have more than 30% of assets in equities and so allocates his savings $90k to shares and $210k to bonds.

So what’s Joe’s problem? By focussing solely on his $400k target when allocating his savings, he hasn’t properly considered his pension which is already a large position in bonds. His friend’s recommendation of 30% equities is probably not a bad overall allocation, but Joe’s true portfolio is now more like 90% in bonds, more conservative than what he was trying to achieve.

At the heart of this is an issue known as mental accounting bias, segmenting your assets and then treating them like they were somehow different from one another.

It’s far from an optimal approach to investing. Whilst different goals may have different levels of importance, it’s better to consider your goals collectively and then decide how to use all your wealth to meet these goals.

Unlike VaR, there’s an insight here that is worth keeping.

Posted on 01 Jun 2011 by Forager

Patience: Easier Acknowledged Than Exercised

Patience: Easier Acknowledged Than Exercised

On a Comrades race bib, it tells you how many Comrades the runner has completed. Inexperienced runners, like myself, seek out those with double digits on their bib for advice. There’s a consistent theme from every single one of them: ‘take the first half easy’;  ‘give the climbs the respect they deserve or you’ll pay for it at the back end’; ‘make sure you take more than half your target time to reach half way’.

 I’d heard and read the same advice dozens of times and told everyone that my plan was to do exactly that. Take it very slow to the 70km mark, and see what’s left in the tank.

‘What am I doing here?’ I thought to myself as I arrived at Drummond, half way in the 2011 Comrades Marathon, 20 minutes ahead of schedule. I had slowed down every time my watch beeped a km that was too fast, I had walked some of the hills, I had told people mid race how I was sticking to my plan. And here I was through 44km having averaged 30 seconds per km faster than I wanted to. That’s not a bit ahead of schedule, it is literally miles ahead.

I paid the price, of course. The first half took me four hours and two minutes. The second half five hours 20 minutes.

Patience is one of those psychological attributes that is easier to acknowledge than it is to execute. We all know that Warren Buffett’s punch card is a wonderful idea – that you would be much more successful as an investor if you limited yourself to 20 investments throughout your lifetime. But how many of us can exercise such restraint? Fear of missing out, the thrill of successful stock selection and the desire to ‘do something’ all conspire against us.

Every single marathon runner plans on pacing themselves appropriately but very few manage to pull it off. The adrenalin and excitement of the day makes you feel like you are running slow, no matter how often your watch tells you your are not.

I was somewhat philosophical as I struggled to overcome cramps, watched my average pace rise and saw the old-timers cruise on past. Some lessons just have to be learned the hard way.

My total time was a still respectable 9 hours 20 minutes, which placed me 2672nd out of approximately 14,000 starters. Many thanks for the generous donations. We’ve raised almost $8,000, which is enough to put 25 girls through a Camfed education program.

Posted on 03 Sep 2010 by Forager

The ‘What the Hell’ Effect

If, by chance, you are served an unusually large slice of pizza, compared with what others appear to be getting, would that experience incline you, some minutes later, to eat more cookies or fewer when platefuls came your way? That depends, it turns out, on whether you are on a diet. Those who are not eat fewer cookies, whereas those who are see the excessive pizza as a licence to pig out. It is a demonstration of what Janet Polivy, a psychologist at the University of Toronto, refers to as the “what the hell” effect—a phenomenon familiar from real life to which Dr Polivy has given scientific respectability, most recently in a paper published in the latest edition of Appetite.

That’s an extract from this piece in The Economist. It got me thinking about the impact of the ‘what the hell’ effect on investors. Many investors work hard to establish a framework, system or set of principles which they believe will serve them well in the investing world. Then, when something goes wrong, or the market crashes, or they slip up just once, the discipline and hard work get thrown out the window. It’s so easy to fall back into the habits of old, and before you know it one slip-up turns into a series of compounding errors.

I do have my doubts about the results of the study. People on a diet might be more susceptible to pigging out on cookies to start with – that’s why they need the diet. Perhaps it’s the same with investing.

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