Investment articles

The Russian army’s invasion of Ukraine is the latest macro event that has investors concerned about equity markets. It is also the latest macro event that most investors would do well to ignore.  We worry about specific, prominent issues because we want to protect against the losses that may occur if our worst fears are realised. The irony is the most sure-fire way for investors to make consistent and substantial losses is by jumping from one high profile risk to the next, making consistently poor decisions along the way.

We have all seen the charts depicting the benefits of taking a long-term approach to equity investing.  They show how markets have produced strong returns in-spite of wars, recessions, and pandemics. They are a great illustration of the benefits of a long-term approach, but they don’t tell us everything. What they fail to show is all those critical issues that worried investors but never came to pass. We are always wondering about the next great risk to markets; the key to successful investing is finding ways of drowning out this noise.

Even though we can be certain that there are some events that will cause dramatic (short-term) losses for risky assets; ignoring them is absolutely the best course of action for most long-term investors. This is for a host of reasons:

We cannot predict future events: Pre-emptively acting to deal with prominent risks that pose a threat to our portfolios requires us to make accurate forecasts about the future. Something that humans are notoriously terrible at.

We don’t know how markets will respond: We don’t only need to forecast a particular event; we also need to understand how markets will react to it. What is in the price? How will investors in aggregate react? Even if we get lucky on point one, there is no guarantee we will accurately anticipate the financial market consequences. It is worth pausing to reflect on these first two reasons. Forecasting events and their impact on markets is an unfathomably complex problem to solve. We are incredibly unlikely to succeed in it.

We are poor at assessing high profile risks: We tend to judge risks not by how likely they are to come to pass, but how salient they are. This a real problem for macro events because the attention they receive makes them inescapable, so we greatly overweight their importance in our thinking and decision making..

We need to be consistently right: Even if we strike lucky and are correct in adjusting our portfolio for a particular event, that’s not enough – we need to keep being right. Over the long-run being right about any individual prominent macro event is probably more dangerous than being wrong, because it will urge us to do it again.

If we find ourselves consistently worried about the next major risk that threatens markets, there are four steps we should take:

1) Reset our expectations: Investing in risky assets means that we will experience periods of severe losses. These are not something we can avoid. They are the reason why the returns of higher risk assets should be superior over time. We cannot have the long-term rewards without bearing the short-term costs.

2) Check we are holding the right investments: The caveat to ignoring the risks of major macro events is that we are sensibly invested in a manner that is consistent with our long-term objectives

3) Engage less with financial markets and news: There is no better way to insulate ourselves from short-term market noise and become a better long-term investor than to stay away from financial markets. Stop checking our portfolio so frequently and switch off the financial news.

4) Educate ourselves about behaviour, not macro and markets: What really matters to investors is not the latest macro event or recent markets moves, but the quality of our behaviour and decision making.

Source: Most Investors Should Ignore the Risk of Major Macro Events By Joe Wiggins

Asset Multiplier Comments:

• Macro Events are a recurring feature of the markets, trying to anticipate when they will occur, rather than accepting them as an expected feature of long-term investing, will inevitably lead to worse outcomes.
• Provided we are appropriately diversified, the real investment risk stemming from major macro events is not the issue itself but our behavioural response to it – the hasty decisions we are likely to make because of the fears we hold.
• Long Term Investors are better off not being bothered by macro events and it’d serve them well to not check their Portfolio Performance daily to avoid unwise decisions.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

The vast majority of people have no edge over others in the stock market. Even professional fund managers who have demonstrated skill in picking stocks in the past struggle to beat the market once their high costs are taken into account.

The way of the Rational Investor– Keeping costs low is vital to being a Rational Investor. Since you are not going to outperform the market, it makes no sense to pay a penny more than you have to in order to achieve as close to the market’s return as you can. By keeping costs low, you can end up richer than those who pay a high price to try to beat the market and fail.

Active management comes at a cost– Fees are always important in finance, but even more so for the Rational Investor.  Paying initial fees just to get into an active fund is becoming a thing of the past, but you might still save another 2% a year by investing in an index tracking fund, compared to an active one. If a 2% annual saving does not seem like a lot to you, then you’re forgetting the power of compounding returns. If you think you have great edge in the market and you could easily make up this 1.5% to 2% annual cost difference by picking stocks or choosing superior active fund managers or timing the markets or whatever other approach you take, then good luck to you. All the odds and evidence are against you. If you don’t have an edge, then the sooner you get out of the expensive investment approaches and into cheap index tracking products, the better off you will be.

How to get an active manager’s sports car– Conversely, consider the 85-90% of investors who invest in active managers as opposed to index tracking funds, either directly or via their pension funds. Over the long run only a very small percentage of investors who take the active approach will be lucky enough to invest with managers that give better returns after fees. The rest have simply paid a staggering amount of money to the financial industry over their investment lives, and will have less money in retirement as a result.

Passive investing requires patience– The key to reaping the greatest savings is to have the patience for the compounding impact of the lower expenses to take effect. It is like making money while you sleep; lower fees make a little bit of money, all the time.In the early years you can barely see the difference between the active and index tracking investment approaches. In the later years the benefits are obvious – but they are only there for the investor who kept his or her discipline with lower fees.

Ignore the siren songs of sexy managers– you must remember it will take discipline to stick to this approach. The index tracker will perform slightly better over the long-term than the average active fund, and that outperformance will come from the cumulative advantage of lower fees. Meanwhile the many active funds out there will be all over the map, the best performers will try to scream the loudest about how their special angle or edge has ensured their amazing returns that year. We might even be tempted to believe these managers and abandon our boring and average index tracking strategy. But please stick to your index investing plans unless you can clearly explain to yourself why you have edge. The chances are you don’t, and you will be wealthier in the long run from acknowledging this.

Source: The cost of active fund management published on Monevator

Asset Multiplier comments:

• The most underutilised investment skill is patience, but it can be developed.
• Fund outperformance is unpredictable, and forecasting a successful mutual fund may be difficult. An additional savings of 2% (of management fees) put in a low-cost passive route may be a better decision for an investor.
• The gap between price and value, often known as the margin of safety, protects an investor from unanticipated occurrences and allows him or her to obtain extra profits in the absence of such events.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

Intelligent investing rests on three tenets- Anand Sridharan reminds investors that intrinsic business value, Margin of safety and Mr Market are three tenets that matter. If we truly understand the essence of Ben Graham’s three tenets, we’re done. There’s nothing else to sensible investing. View stock as a business. Roughly gauge what it’s worth. Since world is all messy, don’t cut it too fine. Keep some cushion. View nutty counterparties as entertainment, unless they offer something actionable based on the above.

Two tenets – intrinsic business value & margin of safety – are inseparable. It wouldn’t even occur to Mr Sridharan to ask the question “What’s the value of this business?”. The actual question that he asks is “Around what buy-price am I fairly sure that I’m getting a decent deal?”. The second question blends intrinsic business value and margin of safety to help me reach an actionable decision. My guesstimate of business value will have wide error bars. The range maybe 100 to 150. Whatever be that number, I never do an artificial separation of value and safety margin. At all times, prudent investors don’t fuss about intrinsic business value, apart from being cognizant of a broad range that’s reasonable for a particular business.

This is why simple works better than sophisticated. In any real-world, reliable sense, DCF is nonsense. It is a sophisticated tool for impostors to delude themselves and others. We suck at forecasting and have no way to reduce risk to a number. A mental model that integrates margin of safety and intrinsic business value nudges us to focus on being roughly right, not precisely wrong. It is why the best investors spend a lot of time ensuring that businesses are predictable, and little time making actual predictions. Simple valuation methods suffice for businesses where cashflows and risks are relatively knowable.

Ongoing charade is even more flawed than it seems – What’s helpful to practitioners is a buy-price that offers reasonable certainty of getting more than what we pay for. This goal is achieved through a mindset that views value and safety in unison. Investors get habituated to methods that yield neither value nor safety without such a mindset.

Source- Buggy Humans in a Messy world by Anand Sridharan

AM Comments: –

• It is tough to establish the true value of a firm. Each investor has their own method of estimating value, which may or may not be reliable. Because intrinsic worth is subjective, it should be assigned a range rather than a single figure. An approximate estimate, say within 10% of the actual value, should be enough. This gives the investor the opportunity to investigate the more subjective components of the valuation process.
• Investing is done after a thorough examination of the firm and its cashflows, assuring a healthy margin of safety and a reasonable return. Investors don’t have to aim for perfection all of the time. Because we cannot precisely forecast the worth of a firm in the future and discount it at a suitable discount rate, investors must be comfortable with their purchase price.
• Market frenzy is characterized by heightened emotions. Prices are at an all-time high. As a result, recalling Mr. Howard Marks, one should resist the temptation of participating in a market frenzy.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”