Value investing asset managers industry in Spain is in a great moment. New players are joining the club, for example, the former Bestinver partner and CIO Francisco García Paramés started his new company at the end of last year. This week two event happened: the Spanish regulatory approved Cobas Fund‘s new funds and the II Annual azValor Investor’s Conference took place in Madrid. azValor was created by García Paramés former partners at Bestinver.
For the last 4 years, I have been following the CIO of azValor, his wisdom, humility and knowledge have made him a key player to follow in the world of investment in value investing.
If you master Spanish I highly recommend you to watch this conference here.
Yesterday I read the report published by Michael Mauboussin called as this post title. Michael is Head of Global Strategy at Credit Suisse. I am fascinated with this report, all the common sense Michael share in it. Also, I would like to recommend the Alphaville podcast with the author.
Teaching imposes a discipline of understanding and communication that few other activities can—save perhaps writing. Inspirational teachers are also diligent students. So a commitment to teaching at a high level demands constant learning and consolidation of knowledge. There is the additional benefit of being around young people who are bright and challenging.
Actual time to be an investor:
As I like to tell my students, this is an exciting time to be an investor because much of what we teach in business schools is a work-in-progress.
I believe in economic value, the importance of constant learning and teaching, and that diverse input combined with rigor can lead to insight. This is all very consistent with what Charlie Munger, the vice chairman of Berkshire Hathaway, calls the “mental models” approach.
Michael divided his work into 10 attributes that great investors have.
- Be numerate (and understand accounting), Michael comments his favourites books:
Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, Creative Cash Flow Reporting: Uncovering Sustainable Financial Performance, The Financial Numbers Game: Detecting Creative Accounting Practices, The Art of Short Selling. Financial statements have two goals: 1) translate financial statements into free cash flow and 2) find the link between company’s strategy and how it creates value.
- Understand value (the present value of free cash flow). Try to understand the magnitude and sustainability of free cash flow.
- Properly assess strategy (or how a business makes money). Two dimensions:
- How the company makes money.
- The competitive advantage when it earns a return on investment above the opportunity cost of capital and earns a higher return than its competitors.
- Compare effectively (expectations versus fundamentals). Human are quick to compare but not very good at it. Here Michael explains the “variant perception” concept, I first here about this concept in a well-know twitter account called @PlanMaestro. Variant perception definition: “He develops perceptions (intellectually sound investment thesis) which are at variance with the general market view. In other words, a view that is at odds with the prevailing Wall Street view. He will play those variant perceptions until he feels they are no longer so.”. Fundamentals are how fast the horse will run, and expectations are the odds.
- Think probabilistically (there are few sure things). Here the point is that you need to earn more when you are right versus when you are wrong, even if you are wrong more times than right.
- Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected). Open-minded, period.
Beware of behavioural biases (minimizing constraints to good thinking). Here, Michael, presents Keith Stanovich’s idea between IQ (intelligence quotient) and RQ (rationality quotient). I save the name of the last book called The Rationality Quotient. IQ = “mental skills that are real and helpful in cognitive tasks” and RQ = “the ability to make good decisions”.
- Know the difference between information and influence.
- Position sizing (maximizing the payoff from edge).
- Read (and keep and open mind). Albert Einstein’s quote:”success comes from curiosity, concentration, perseverance and self-criticism”.
Multiples are not valuation but a shorthand for the valuation process. No thoughtful investor ever forgets that. Shorthands are useful because they save you time.
What I found more useful in this report is the following part. To peak performance as an investor, you need some factors. From left to right you can find it.
Both Keith Stanovich’s work on IQ and RQ and Phil Tetlock’s work on superforecasting strongly suggest that there’s more to good decision making than traditional smarts measured through IQ. Qualities such as active-open mindedness, thinking probabilistically, an ability to update views frequently and accurately, and persistence are not well captured in tests. Even proxies for intelligence, such as graduating from an elite university, do not do the job.
Done properly, deliberate practice is designed with a specific objective, requires timely and accurate feedback from a coach or teacher, entails substantial repetition, and is only viable for students who are motivated. Deliberate practice is not fun, but it is gratifying because the performance improvements are tangible.
I have access to the 2016 year-end letter that Seth Klarman has shared with Limited Partners and stuff.
How important is Trump’s presidency that Seth divided the year between “Before” (44 weeks) and “After” Trump to share his view of the year. The first one was dominated by tepid economic growth, low-interest rate, rich valuations and relatively low volatility. Also, quantitative easing, QE-infinity and negative rate (quite nonrational IMHO).
The election was an inflexion point, “after“, post-election rally, winners and losers (of course, those in most influence Trump’s point of view will win more that the others).
Seth quote the last summer article called “It’s Getting Scarily Quiet in the Stock Market”, this article warned the complacency about the central banking, Seth’s point of view is that the central banks, with their policies, have increased the financial assets. Examples such as The market and Methuselah, Saudis bonds and Austria. The debt expansion was huge in 2016, IMF said last October that world debt is a real thread for 2017. A really good point is that last 35 years the modern world has been living in a bull market, low-interest rates and right now inflation is going up and interest will raise and not much of active managers have experience in this type of market. Seth is critical with this topic:
- Whenever interest rates return to more normal levels, these bonds will trade below price
- Inflation, if this comeback, these instruments will sell off further.
Animal spirits drove US stocks, election benefited infrastructure companies. News highs, especially shares of those companies expected to benefit most from lower taxes, expanded infrastructure spending, and deregulation. Post-election, interest rates jumped and bonds slumped in anticipation of policy changes and an acceleration in economic growth. As Trump promised, tax cuts and fiscal stimulus will cause higher corporate profits. Also, a relaxation of regulations is expected to boost the banking industry.
“Goldman Sachs notes that the S&P 500, in aggregate, recently traded at 85th percentile of its historical valuation over the last 40 years, while the median company in the S&P 500 had reached the 98th percentile of valuation”
The main point about Trump economy is that “may be able to temporarily hold off the sweep of automation and globalization, keeping jobs at home, bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces[…] the U.S long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off”.
For businesses and investors predictability it really importance to make assumptions, model performance and finds decisions. Elections matter, Trump will create investment opportunities and high uncertainty.
“A value investing approach is defensive by nature, emphasising preservation of capital through the purchase of investments with a margin of safety”.
In my opinion, the best part of the letter is the last one, when Seth explain that the key approach is to maintain conservative in weak markets. In top-down approach, you need to be right in the magnitude, path and timing.
The market is in bull market mode as we can see below.