I’m going to try something new here by writing a diary-like entry in real-time money management. (Please excuse any typos). Maybe this is a mistake and I won’t do it anymore. But what’s a blog if not for experimentation? So, let’s see how the following is received...
I’m going to talk about how I manage one of my biggest positions. Plus I want to share a way to evaluate money managers. And, finally, I’ll ask the rather existential question: What makes a great investor? What does it mean to say someone is a great investor?
All of these thoughts were inspired by Topicus and the trading action this morning. (As I write, the stock is down ~5%).
Topicus is a spin-off from Constellation and is one of my biggest positions. I bought a bunch more after the spinoff and my average cost basis is C$64. I bought it with the intention of owning it for a decade (maybe longer!). I think the stock has a good shot of being a 5-10 bagger over the next decade.
But… the stock has run quickly. At its 52-week high, I was up ~125%. It zoomed to the top of my portfolio stack. Keep in mind, the stock started trading in February. (February!) That’s a lot in a short amount of time. And it seemed the shares maybe got ahead of the fundamentals, as people like to say.
So, trim or not?
I chose not to trim. As a general rule, I don’t trim. I let the portfolio get undiversified and unbalanced, which is a natural outcome of a healthy long-term orientation, in my view. Over time, certain positions are just going to get big. I think this is one of the paths to generating great overall returns in a portfolio. It’s the path I’ve chosen to follow. (I should note there is a limit. In my case, my fund documents preclude me from having a single position bigger than 25% of the fund’s assets. So, I would be forced to trim in such circumstances. Also, I never start a position at more than 10%, and even that would be very rare. More likely is a 7-8% type full position and then I let it grow into a bigger position).
But this strategy has its pain points when a big position draws down. Naturally, to lessen the pain, people like to trim when a position gets large.
Trimming, or trading around positions, can look smart and feel good. But here’s what I ask myself: If I think Topicus has a good shot at being C$300-C$400 per share in ten years, why trim now at C$140, even if I think the stock is ahead of itself, so to speak? If I trim:
I pay taxes - a significant drag on performance over time. People don’t realize how much better your replacement idea has to be to make a swap worth it.
I also have reinvestment risk. What to do with the cash? When? And will that do better than if I had just left it in Topicus?
Finally, I have execution risk if I decide to trade around Topicus. Again, would I have been better off just leaving it alone? In my long experience, I find I am often better off just leaving it alone. Don’t sell good businesses is the general rule, if you have a long-term horizon. As Marty Whitman used to say, “you make more money sitting on your ass.”
If I were worried about quarterly performance and focused on preserving my good returns for Q4 and a nice payday at year-end, I would’ve sold… But is that what you, as an investor in my fund, want me to focus on?
In a way, this is a good test to see if I do what I have been saying I’m going to do. Am I really focused on owning businesses that will create tremendous value for us long-term? Or am I playing the performance game by trying to trade stocks and outwit the market?
This brings me to the question “How to evaluate a money manager?” It is a tricky thing. Track records can deceive. They can be difficult to parse. What sort of risks did said manager take in generating returns? What kind of luck factor was involved? Or put another way, how repeatable does it seem? How to benchmark what they did?
For me, one of the simplest ways to evaluate managers is to see if they did what they said they were going to do. In my own case, I make a big deal out of investing with management teams that have “skin in the game.” I talk about it all the time in my letters and to my investors. If I go off and buy a company where the insiders own 1% of the shares, you might reasonably ask what is going on -- regardless of whether that particular position worked out or not.
Another promise I make to my investors is to invest in companies with strong balance sheets. If I go off the rails here and buy a heavily indebted firm, you should question such a move. Again, regardless of how the idea is performing or has performed.
There can be gray areas. For example perhaps, on the insider example, I come back and say that while there isn’t a lot of skin in the game percentage-wise, the insiders have a great deal of their personal net worth at stake and the incentives are well aligned due to a novel compensation plan. (I have made no such exception so far, I’m just using this as an example to make a point).
You may say, “okay, that makes sense” and agree with me. But if I am repeatedly making excuses for names in a portfolio that doesn’t seem to be what I have promised to create, then that would be a red flag and a reason to withdraw -- again, regardless of how I have performed.
Integrity is far more important than single year, or 3-year, or 5-year performance figures. And this is a lesson you will learn if you are in the game for a long time. Plenty of investors flame out after good streaks of performance -- for a variety of reasons. But certainly one of them is that the investor did not have a good process to begin with... or had one that was good, but did not stick to it (especially difficult when enduring a soft patch in performance).
It seems to me, long-term success in this business comes from finding something you do well and sticking to it. This doesn’t mean you don’t evolve and change. You do. And you should evolve and change as you gain new experiences. But you shouldn't let the market winds blow you around, changing your strategy to fit whatever is hot at the moment.
I suppose there are always exceptions; talented and bold individuals who frequently change their stripes, who turn over their portfolio every year, etc. and still deliver great returns. It’s one of the glorious things about investing -- there are so many ways to do it. In this sense, investing is truly an art.
My interest in investing, though, has always been more focused on what’s simpler and what’s repeatable and what has a very good chance of working over the long haul -- without doing anything risky. That’s why I started my book 100 Baggers with tales of ordinary people making a lot of money doing something simple -- buying good businesses and holding on to them.
Some people (not many, but some) have mocked that insight as being obvious, or not worthy of book-length treatment, or somehow just not good enough. It is as if the people who nabbed those 100 baggers were just lucky puttering grandmothers. But I could not disagree more. The power of holding on is the most important lesson for most everyone.
The ability to hold on is, in the parlance of our times, a superpower. It’s much harder than it sounds, as anyone who invests for any length of time will find out. Sitting through 30%, 50% drawdowns is not fun. Hanging on when people are telling you what you own is no good -- and when they keep telling you to buy a different shiny new toy -- is even tougher.
And this brings me to the existential question: What makes a great investor? What does it mean to say someone is a great investor?
I remember sitting on a plane one year, headed to Berkshire’s event in Omaha. I was in the first row after business class and there was an empty seat next to me. An elderly woman got bumped from first class for some reason or other. An apologetic flight attendant led her to sit next to me.
Well, we got to chatting. Turns out, she was an investor in the original Buffett partnerships. This predates Buffett’s taking control of Berkshire. And then she invested in Berkshire from the start. She told me stories about the early Berkshire meetings (she’s been to every one) and how, back in the early days, the annual meeting consisted of only a handful of people who met for dinner. She is quite rich today, as you might imagine, and lives in Nantucket. (Side note: Thomas Phelps, the author of 100 to 1 in the Stock Market, also retired in Nantucket after a successful investing career). She told me she gives a little bit of Berkshire stock away to her grandchildren every year.
I remember thinking: This woman’s track record as an investor is fantastic. She made one big move: buying Berkshire. And then she left it there for a long time. Is she a great investor? What does it mean to be a great investor? Is a great investor someone who can take apart a financial statement? Build great spreadsheets? Wears vests and lives in New York? Or is a great investor simply someone who saw a great opportunity, bought it and held it?
That woman who owns Berkshire and lives in Nantucket couldn’t care less about quarterly performance, what the Fed is doing, or whether the S&P is in a flag-and-pennant chart formation, or a long list of other trivial things people obsess over.
Again, you have to decide how you want to play the game. And as I have said, there are many paths up the mountain. You have to decide which one is for you. You have to get to know yourself, first of all. That is no easy task either. (“Know thyself” is the ancient wisdom). It takes time. And there will probably be some pain as you stumble around early.
In fact, the process never ends, because you always learn new things about yourself -- tendencies, weaknesses, strengths -- as you accumulate new experiences. That’s part of the fun of it, just learning and trying to get better.
Anyway, that’s my sermon for today. I’m hanging on to Topicus. Look me up in a decade and let’s see how it panned out.
Thanks for reading.
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Published November 4, 2021
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