Dilma Rousseff. Putin. Filipino Hard Man.
Brexit. Trump’s in. Usain Bolt wins again.
If Billy Joel rewrites his 1989 classic We Didn’t Start the Fire, 2016 will surely get its own verse. From January’s China meltdown worries through to a US president elect pursuing government policy via Twitter, hardly a month went past without something extraordinary happening.
Truth be told, we didn’t predict any of it. We didn’t know who was going to win what and we didn’t place any huge bets on the outcomes of elections, referendums or currency movements. And yet 2016 was one of our best ever years of relative performance. Despite some disappointing developments in the last three months of the year, the Australian Fund added 16% of performance for the year, 4% ahead of the All Ordinaries Accumulation Index. Despite being down 5% in the first month of the year, the International Fund finished up 24%, versus 9% for its MSCI global index.
Perhaps it was a year where knowing nothing was an advantage. Perhaps lady luck blessed us with good fortune throughout the year. But 2016 provides a few useful insights into the Forager investment approach.
Value investing lessons on the chess board
I am at best a mediocre chess player. But I enjoy the game and enjoy observing those who are good at it. One of the insights that helped me as an investor was recognising that the best chess players aren’t as visionary as most people think. The idea has been perpetuated that you need to be able to see 20 moves into the future to be a grand master. Yet ask the good players why they made a particular move and, most of the time, they will tell you they are simply trying to occupy a strategic part of the board. They want to get their pieces into positions where they are, firstly, protected and, secondly, can make as many future moves as possible.
Towards the end of a game they might force their opponent to make certain moves and therefore can think several moves ahead. But in the early and middle parts of the game, there is no knowing what the opposition will do. The key is to get into a position where all potential moves can be countered, and poor ones can be punished.
This philosophy underpins our entire investing approach. We don’t know what is going to happen in the world. We don’t know how the market will react. So we prepare our portfolios such that they are robust to a wide range of potential outcomes. This means holding appropriate amounts of cash and ensuring we don’t have too much exposure to any one company, industry, sector or country.
Then, as events unfold and opportunities arise, we capitalise on them. Oaktree’s Howard Marks explained a similar process when he joined a Sky Business panel I was on late last year:
I am not someone who invests on the basis of expectations for the future … When you react to what actually happens rather than guess about what might happen, I think you make less mistakes.
Lots of events, then, means lots of things to react to. Which goes some way towards explaining why 2016 was such a good year. A healthy chunk of the returns in both portfolios came from stocks we didn’t own at the start of the year or ones where we added to the investment as share prices tumbled. By the end of the year miner South32 had tripled from its January lows (held by both portfolios). We only began purchasing international holding El.En in January but it more than doubled. And a post-Brexit addition, London listed JRP Group (reviewed in the upcoming quarterly), had rebounded 40% by Christmas. It was our reactions that generated profits, not our predictions.
No end game in investing
The big difference to chess is that the investing game never ends. The board is like a slow moving treadmill that is going to roll on forever. You occasionally get opportunities to make big, game changing moves but you never achieve a checkmate. Each win is followed by a period of consolidation, where we go back to occupying those strategic positions on the board.
As we roll into 2017, it feels like such a time. Surveying the investing landscape, there are not a lot of opportunities for bold and decisive investing decisions. We think there is still plenty of money to be made in the oil sector. There are a number of individual stocks which look attractively priced. But most sectors and asset classes look somewhere between fair value and expensive.
We have no more idea what is going to happen this year than we did last. Marine le Pen may win the French Presidential election. The Italian banking system might collapse. Donald Trump might spark a global trade war. He may well start a human one.
Or none of these things might happen. Where other investors fear “uncertainty”, however, you should welcome it. In uncertainty lies our opportunity. The more of it, the better.
This blog post is an extract from our December quarterly report which will be released in the coming days. Email [email protected] if you would like to be added to the distribution list.
Past performance is not a reliable indicator of future performance. The Trust Company (RE Services), Fundhost and Forager Funds Management do not guarantee investment performance or distributions, and the value of your investment may rise or fall. Total returns and estimated valuations have been calculated using the mid-point of unit prices, before taxation, after ongoing fees, and assuming reinvestment of distributions. We encourage you to think of investing as a long-term pursuit.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.