• Chris Mayer

Volatility Takes a Bite

This morning, with another strong day for the fund in the offing, I was reflecting on the recent volatility and thought I’d share these thoughts below.

A heads-up: I’m trying out the diary blog format again – which means I wrote this quickly and posted it shortly thereafter. Please excuse any typos. And, as with all my writings, I adopt the humble intent of Descartes, from his Discourse on Method: “My present aim is not to teach the method which everyone must follow in order to direct his reason correctly, but only to reveal how I have tried to direct my own.”

To start: I don’t like to follow the returns of my fund’s portfolio too closely. For example, I try not to actually log in to the account unless I know I want to do something. I don’t want the daily blow-by-blow on prices. It’s bad for the investing psyche; it makes you impatient and lose perspective.

Those prices flashing before your eyes cry out for action. Feeding that into your brain every day (or worse, multiples times a day) invariably compresses timeframes and makes every day seem important. Then before you know it, you are one of those people who go around with explanations for why such-and-such stock was up (or down) that day. Seems a recipe for madness. (As Gandalf said in Lord of the Rings: "Tell me, friend, when did Saruman The Wise abandon reason for madness?" I don’t know if this quote really applies here, but I felt like sticking it in).

I prefer to cultivate a general awareness of where prices are. But I couldn’t help myself after we closed the books on the month of November because it was an interesting and unusual month. Also because, frankly, it meted out some unusual pain.

Well, much as I train myself to see price declines in my holdings as not necessarily bad, there is a part of me that frets over them. After all, I do run money where I have to report to investors. I’d rather not have my biggest position drop 20% in a month, know-whatta-mean? Even though, time and time again, such drops turn out to be opportunities – and I know this! – it’s never so easy when you go through it.

Further, as a practical matter, no one buys into every decline. At some point you are full, or you run out of money. Which reminds me of this meme I saw that cracked me up:

Anyway, November was unusual, as I say. The S&P 500, for example, was barely down. But most stocks were down quite a bit more. Smaller cap stocks outside the S&P 500 fared even worse. A friend tipped me to something LRT Capital Management put out, which I think does a good job showing this:

"Through December 1 , the S&P 500 index is down only -4.07% from it's all-time high, while the small-cap index, Russell 2000, is down -12.08%. However, these numbers do not give the full picture of the market decline that has occurred over the past several weeks. A small group of stocks, primarily mega-cap tech shares have supported the market, while most stocks have been declining for several weeks now. The disproportionately large impact that mega-cap companies can have on market capitalization weighted indexes has effectively hidden this fact, so while the S&P500 has only declined by approximately 4%, the average stock in the index is down -15.5% through December 1.

"To put some numbers around this phenomenon, we looked at all the stocks in the S&P 500 – there actually 505 stocks today in the index – and here is what we found:

"More than half of all stocks in the S&P 500 are down more than double the decline of the index itself. In addition, the percentage of S&P 500 stocks at one-year lows is at its highest level since April 2020."

Thank you, LRT. You made us all feel a bit better.

Charlie Biello, who puts out interesting lists on his twitter account, shared this one on the last day of November:

Whew. I don’t own anything on this list, but clearly some speculative air went out of the tires in November.

Drawdowns are part of investing, as you know. But it helps to review this point. Even great stocks have nasty, gut-wrenching declines. I think of the Bessembinder study, which reviewed the top 100 firms that created the most value and found this about their paths:

Again, those were the best.

I’ve had to suffer through a couple of November drawdowns. You could probably guess the names. One I wrote about in my last blog post. And the other is Evolution (EVO), which many people have asked me about. Evolution fell as the result of a short report alleging nefarious and illegal gambling was taking place on its platform.

I went through the report, most of which I found sensationalist and not quite right. Some of the points it raised, though, I wasn’t so sure about. After an hour-long call with the company and other conversations with fellow investors and experts in this space, I am perfectly comfortable with Evolution and bought more at just under 1,000 SEK per share. We’ll see how it goes, but I think EVO is primed for outperformance in 2022 (and beyond) as these fears recede. The stock is quite a good value now, especially given its strong return on capital and growth rate.

Long-term, this whole event may prove a good thing. The management team, which has limited experience in public markets, now has some good experience under its belt and won’t repeat the mistakes it made in responding to this challenge. Also, there may be some additional disclosures coming, which will ease investor concerns. And the company is using the decline to buy back shares, which I love to see. Finally, I deepened my understanding of the business, which is always a good thing.

Otherwise, I dribbled in some cash on a few other positions, but nothing major. That’s as it should be because… nothing major happened. This month will soon fade in memory like the many months before it. They’ll blur together and become part of the tapestry of your returns.

As I wrote up top, this is the way I do it, but other people navigate these things differently. For example, I read a thoughtful interview with Gavin Baker of Atreides Management in the latest Graham & Doddsville newsletter. You can read it here.

In this interview, he says:

“You sit in an ivory tower and think, ‘Oh, all I care about are returns over 5 to 10 years and I don't care about the path to get there. I don't care about volatility.’ That is true in an idealistic sense – the most important risk is always going to be permanent loss of capital. But your clients care about volatility…”

Well, I’m not going to say “I don’t care about volatility.” I’d rather have a smooth ride! Who wouldn’t? But that’s not realistic. I will say that I don’t actively manage volatility.

What I found most interesting about this interview was its blunt talk about the difference between running a portfolio as a professional and running your own personal portfolio. (I don’t have a personal portfolio anymore. It’s in the fund). At one point he says, “maximize your Sharpe and your Sortino ratios because that is your job as a professional investor. As an individual investor, you should not care at all about those ratios.”

Hmm! I don’t know. Shoot, I don’t even know what my Sharpe and Sortino ratios are. Do Buffett and Munger? Baker chides people who are “idealists” and “philosophers.” As people say nowadays, “I feel seen!”

There are different ways to climb the mountain. However, I like to think I’m doing what is best in the long run for my capital and my partners’ capital, and that I’m not making undue concessions just because I’m a professional investor.

Of course, I don’t manage billions of dollars and I’m not as rich as Baker. So there’s that. I do have a great set of partners and a structure that allows me to take the long view. For us, November was just one more month. I think this approach makes a better life and I am confident my returns will be good.

Thanks for reading. In case I don’t write anything between now and the end of the year, let me wish you and yours the best this holiday season! I appreciate your support of the blog and your encouragement to keep at it. I will try! It’s hard sometimes, because I feel like I repeat myself. I also try hard to share what I think are useful ideas to help you on your own investing journey.

May you find a 100 bagger (or two).




Published on December 7, 2021

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