New Sunday Times Feature - Diary of a Private Investor

Discussion in 'Investments' started by Brendan Burgess, 4 Sep 2015.

  1. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
    Last edited: 12 Sep 2015
    Colm Fagan is an active private investor and former President of the Society of Actuaries. He will be doing a monthly column in the Irish edition of the Sunday Times starting this Sunday "The Diary of a Private Investor". Although I am not a stock picker, I have discussed investment issues with Colm in the past and his approach is far more systematic, independent and critical than the stuff published by stockbrokers

    Brendan
     
    Last edited: 12 Sep 2015
  2. mtk

    mtk Frequent Poster

    Posts:
    447
    Article for me had just couple points worth noting
    Fads and fashion drive prices
    Beware Heroic assumptions
    Lottery approach
     
  3. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
    Here is a copy of his first article
    upload_2015-9-12_11-19-45.png
     
    Annie51 likes this.
  4. SBarrett

    SBarrett Frequent Poster

    Posts:
    2,888
    Good article. I hope people listen to what he is saying. Investing shouldn't be seat of the pants stuff.

    Had a meeting with a potential client who said he was looking for a return of 4.9%. Very specific return but not an overly ambitious return. While I can't promise anything, I could show him the kind of portfolio that has generated those levels of returns over the long run. Long run? He wanted 4.9% a month!! A meet 58.8% per annum
     
    PaddyW and rob oyle like this.
  5. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
    Here is his most recent article which deals with stock market volatility.


    Diary of a Private Investor Colm Fagan Sunday Times, January 17, 2016

    The purpose of this column is to demystify the world of stocks and shares by recounting one person’s adventures in this world. It does not purport to give advice.

    “Are you beating the professionals?” It’s a question I am regularly asked at this time of year, when the financial sections of the newspapers publish tables showing the past performance of various fund managers. My answer is that I am doing well, but I won’t claim any expertise until l have survived a severe downturn. Like most investors, I suffered badly in 2008; I don’t want to fall to a similar fate in the next recession.

    Guaranteeing no repeat of 2008 carries a hefty price tag. The most I can earn from genuinely risk-free investments is around 2% a year- if I’m lucky. I need to earn more than three times that to have a reasonable income in retirement: 6% per annum plus inflation is my target. For that reason, bonds and deposits don’t feature in my portfolio other than for short-term cash needs and the unexpected rainy day.

    I have put my faith in ordinary shares for around 90% of my portfolio, believing that they will deliver the required return in the long-term. Over the last seven years, returns have been comfortably ahead of target, but that has been a good period for stock markets; I don’t expect the good times to last forever. Indeed, recent market falls portend that the good times could end much sooner than we thought just a few short weeks ago.

    Temporary price dips don’t worry me: on the contrary, I see them as buying opportunities if the fundamentals of the business are unchanged. Temporary price dips would be a concern if investments had to be redeemed when prices were down but up to now dividend income and normal turnover of investments have been sufficient to meet voluntary and compulsory cash withdrawals. (Because of my age, Irish pension regulations compel me to take some money from my investments every year, whether I want to or not.)

    Permanent loss of value is a different matter. I try to reduce that risk by investing in companies that are strong enough to weather a severe recession. Often, that means choosing companies with little or no debt, even though that can be a drag on performance in good times: just as someone who borrows to invest in property can earn a higher return than one who risks only what they can afford, the same is true for companies that borrow to expand or to acquire other businesses. The danger with such companies is that, in a downturn, all the profits could be eaten up by borrowing costs; worse, if loan covenants are breached, shareholders could be wiped out. I am prepared to pay the price of lower returns in the good times in order to reduce that risk.

    Some of my worst investment decisions have come from buying shares recommended by others. As a consequence, I now only buy shares that I have studied myself. I don’t have much time for research, which means that there are only a small number of companies in my portfolio. That doesn’t worry me unduly. It creates concentration risk, but I believe that less than a dozen companies provides sufficient diversification if the companies chosen are financially and strategically resilient and if there is little overlap between them in terms of risk exposures – a tall order, I know.

    Nevertheless, I recognise that I am running extra risks with a concentrated portfolio and one of my New Year resolutions is to increase the spread of companies in which I am invested. That means disposing of some of my current holdings to make room for the new arrivals. In mulling over which stocks to sell, I discovered that I have a condition that psychologists and behavioural economists call the endowment effect. People with this condition ascribe more value to things merely because they own them. I recognise myself in that description: I am prone to believing that the stocks I own are worth more than others I could buy for the same price. Now that I know I have the condition, however, I hope to be better able to counter it.

    A significant proportion of my investments are in UK companies, probably because the Financial Times is my investment bible. In the last two years, UK exposure has delivered windfall profits: sterling rose by over 7% against the euro in 2014 and by over 5% in 2015. In mid-2015, partly in anticipation of Brexit risk, I decided to hedge some of my sterling exposure. I have locked in a fixed euro/ sterling exchange rate until mid-2016 and the present intention is to renew the lock when the current one expires. I have not hedged my exposure to UK companies that have significant international operations, on the grounds that the underlying businesses are already multicurrency.

    I discovered the hard way that I know very little about commodities: I incurred significant losses on Tullow Oil and Barrick Gold (a Canadian mining company), believing about two years ago – wrongly as it transpired – that oil and gold had hit rock bottom. I cut my losses on both stocks in 2015. I have resolved to stick to stock-picking in future and not try to predict macro trends, whether in commodities, currencies, or in the overall level of the market.

    As we enter a new year, I look forward to continuing to share with you the ups and downs of life as a private investor. I also hope that 2016 will not be the year that will test the quality of my defences against another 2008-style collapse.

    Colm Fagan is an active private investor. He is a retired actuary and a non-executive director of a number of financial institutions.
     
  6. cremeegg

    cremeegg Frequent Poster

    Posts:
    2,674
    There is also a condition akin to hypochondria whereby people believe that they must be experiencing every passing fad among behavioural economists.

    You are a stock picker. You should believe that the stocks you own are worth more than others you could buy for the same price. Why else would you have bought them.
     
  7. mtk

    mtk Frequent Poster

    Posts:
    447
    Diary of a rational investor

    I throw 20 numbered darts at a list of randomly sorted global large cap stocks ( top 200 ) as at 1 January. Choosing 200 is a judgement call . 20 is a judgement call based on size of portfolio relatively to dealing costs / currency costs etc .
    I blindfold myself in order to avoid bias
    I rebalance as follows .I rethrow the darts on each 1st January
    I then buy/sell each of the 20 every 365/20 so every 18/19 days selling them in same order I bought them and so holding each for 1 year .
    Repeat
     
  8. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
    Hi mtk

    Not sure what your point is?

    I am a long-term buy and hold investor. I have about 10 stocks and only rebalance when one of them gains so much that I become overweight.

    Colm has roughly the same strategy except that he believes he can pick winners (and losers), while I don't think I can.

    Both of us should do well compared to the market, because we have very low dealing costs.

    You would see most of your gains going in transaction costs and stamp duty, not to mention the cost of the damage caused by throwing darts while blindfolded.
     
  9. mtk

    mtk Frequent Poster

    Posts:
    447
    fair point brendan although i find the massive volatiliy in last few years mean dealing costs are not as big in relative terms ( to gains /losses) as you may expect.
    i throw darts from close range with door locked
     
  10. Colm Fagan

    Colm Fagan Frequent Poster

    Posts:
    214
    Hi Cremeegg. First of all, it was I, not Brendan, who mentioned the endowment effect, and I think you misunderstand what I was saying. Of course I believed in the stocks when I bought them, but the point relates to how I feel about them afterwards, when their value will have changed from when I bought them. That's where the endowment effect comes in. The illustration of the effect that I particularly liked was when two groups were given objects of approximately equal value, one group getting a coffee mug and the other a chocolate bar. When offered an exchange, something like 80% of the people who were given the coffee mug said that they would prefer to keep the mug rather than exchange it for a chocolate bar, whilst around the same percentage of the people who had been given the chocolate bar said that they would prefer to keep it rather than exchange it for a coffee mug.
     
  11. Sarenco

    Sarenco Frequent Poster

    Posts:
    5,269
    Hi Brendan

    I am attaching a link to a recent Irish Times article on the size of an ideal stock portfolio.

    In a nutshell, the article suggests the sweet spot for an active investor that is trying to beat the market is around 30 stocks and anybody trying to simply match a market return should simply buy that market through index funds.

    An ultra-concentrated portfolio of only 10 stocks, almost by definition, cannot produce average market returns. It will either beat or under-perform the wider market (the later being a much more likely outcome). An ultra-concentrated portfolio of only 10 holdings could never be considered a passive investment approach.

    Holding individual stocks obviously avoids fund management charges but commissions on trading or re-investing dividends are significant for individual investors and stockbrokers commonly apply an account maintenance charge. For all but the largest of stock portfolios, these investment costs will typically exceed the TER and trading costs associated with holding a simple index fund.

    http://www.irishtimes.com/business/...e-size-of-the-ideal-stock-portfolio-1.2423050
     
  12. joe sod

    joe sod Frequent Poster

    Posts:
    601
    great irish times article you posted now.
    "The volatility of individual stocks has escalated sharply in recent decades, he says, causing him to change his mind on the idea of 20-stock portfolios."
    So volatility has been increasing.
    Also interesting when he says
    "Ironically, research suggests many fund managers are skilled stock-pickers, but they are undone by an insistence that they be diversified. According to a 2010 study, the top holdings of funds – likely to be high-conviction holdings – easily outperform the market."
     
  13. noproblem

    noproblem Frequent Poster

    Posts:
    1,472
    The IMF and ECB plus so called Economists change their minds several times a year as to what %'age growth we're going to have based on data that means very little as there's so much luck involved and things happen for no particular reason. Picking stocks is no different and it doesn't mean an awful lot having big blue chip companies or whatever. One is gambling, nothing else, although some would have us believe that research, price ratio to this that and the other and dividends, etc, etc, etc, will get you much profit or some other fancy name. Amazes me how so many of those genius's lost everything over the past few years
     
  14. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
    Last edited: 26 Jan 2016
    Hi Sarenco

    The wisdom of holding 10 stocks is considered in a Key Post elsewhere. The error in most of the discussion is that the researchers and commentators equate risk with volatility. This is primarily because they can measure volatility but they can't measure risk.

    The only part of that article which would cause me to review the strategy is this:
    "Bernstein’s says a handful of “superstocks” have historically accounted for the bulk of market returns."
    "Separate research conducted by Longboard Asset Management found that, between 1983 and 2006, 39 per cent of stocks were unprofitable and almost two-thirds underperformed the market. Again, a minority of stocks accounted for all the market gains."

    With 10 random blue-chip stocks, the risk that all would be loss makers is vanishingly small .39^10.
    The risk that I would pick 10 stocks which all underperform the market is around 1.5% .66^10. They might well underperform the market but the portfolio could still be profitable.
    The most likely outurn (based on the above figures) is that 4 of my stocks will be loss makers and 6 will make gains.
    And, of course, I might be lucky in that I pick more than 6 profitable stocks.

    I have not kept long-term historical records and maybe I will be able to reconstruct it from my files. My gut feeling is that the gains have far outweighed the losses. I have lost 80% on a couple of stocks e.g. AIB. But huge gains in other stocks e.g. Ryanair, Aryzta and DCC more than compensate for those losses. I need to check the records because it's quite possible that I have a selective memory, I might remember the gains and tend to forget the losses.

    I also wonder if there is a timing issue here? During certain periods nearly all stocks go down together and in other periods nearly all stocks go up together. Most people invest over time and so that is a form of diversification in itself.

    Actually, when I come to think of it, I did not lose 80% of my investment in AIB. I lost 80% from the peak to when I sold, but I built up my holding over many years and got a good dividend return during those years. So my actual loss was a lot less than 80%. Similarly my Aryzta shares are down 50% from their peak. But I bought them years ago when they were IAWS and so my gains on the share are still huge, although they feel like a loss maker to me now.

    The other diversification which virtually all of these studies ignore is that most people have other assets e.g. their home and their pension. There is absolutely nothing wrong with a 35 year old who has €100k equity in their home and a secure job investing their €10k of free cash in one share. Of course, they probably should pay down their mortgage instead.
     
    Last edited: 26 Jan 2016
  15. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
    Hi Colm

    That is a very interesting analysis.

    When it comes to stock picking it's important. Professional active investment managers keep switching from chocolate bars to coffee mugs and back again. They run up stamp duty and transaction costs in the meantime which wipe out their gains.

    So a passive fund is more likely to outperform by buying a few coffee mugs and a few chocolate bars and sticking with them.

    Brendan
     
  16. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
  17. Sarenco

    Sarenco Frequent Poster

    Posts:
    5,269
    Hi Brendan

    The fact that the majority of stock market gains come from a relatively small number of stocks is actually pretty consistent across time.

    From 1926 through 2009, US stocks produced a total annualised return (with all dividends reinvested) of around 9.7% per year. However, if you exclude the top 10% of performers, the return would only have been 6.2%. If you exclude the top 25%, the return becomes slightly negative at -0.6%. The top 25% of performers actually accounted for more than 100% of the returns.

    For the period 1983-2008, US stocks returned almost 10% a year. However, during this period, about 40% of stocks had a negative return and about 20% of stocks lost nearly all of their value. 64% of all stocks underperformed the broader market. Obviously a small number of stocks are responsible for the vast majority of the gains - about 10% of stocks recorded returns in excess of 500%.

    In 2015, the total S&P500 return was modestly positive. However, if you remove 9 outperforming stocks from the index (including Disney and Netflix), the return actually turns negative.

    Diversification is not simply about moderating volatility - it also helps to ensure that a portfolio has a reasonable number of winners and avoids having an oversized number of turkeys.

    There is obviously the possibility that some or all of a portfolio of 10 stocks chosen at random will feature amongst the top performers. However, there is a far greater probability that some or all of those 10 stocks will feature amongst the under-performers. The market does not compensate unsystematic risk.

    None of the above is to suggest that a skilled active manager cannot outperform the wider market with a high conviction portfolio of around 20-30 stocks. However, as the Setanta Focus fund adequately demonstrates, the problem is that it is extremely difficult to maintain any such outperformance over the medium to long term.

    Incidentally, an actively managed fund does not necessarily imply a high portfolio turn-over. There are plenty of active managers that make minimal changes to their portfolios from one year to the next.
     
  18. Brendan Burgess

    Brendan Burgess Founder

    Posts:
    36,806
    Hi Sarenco

    Thanks for that. Some very interesting data there.

    But presumably had I excluded the bottom 10%, the return would have been a lot higher?

    Is that argument not like me saying I have a 10% annualised return on my portfolio - if I exclude my stupid investment in AIB? (I have heard card players claim that they are consistent winners, if they exclude the times they played while drunk.)

    Interesting, but how typical is that?


    That is the bit I need to think more about. It's quite likely that one or maybe two of the shares I currently own will collapse completely. The problem is that I don't know whether it will be Ryanair, CRH, DCC etc. In the past, the collapses were more than compensated for by the stars. But maybe none of my portfolio will shine over the coming years.

    If Ryanair doubles, my portfolio increases by 5%. If I have 100 shares, my portfolio would increase by only 0.5%. So I would need a lot of winners in the 100 shares.

    It probably needs someone to run lots of models of portfolios of 10 shares to see how often they crashed completely and how often they did very well. I am sure that someone must have done this.
     
  19. cremeegg

    cremeegg Frequent Poster

    Posts:
    2,674
    I think that the chocolate bar and the mug are supposed to stand for two things which provide no points of comparison on which to base a decision. But shares do provide a basis of comparison. If you bought Share A because you thought it had greater growth potential than other similarly prices shares. You can at any later point revisit that question. There may well be such a thing as an endowment effect but where you have points of comparison that effect can be minimised by rational decision making

    In my experience much a greater threat to rational decision making is emotional investment in a share. You decided to buy Share A and you want it to do well to justify your decision. This may also lead you to keep a share irrationally but it is quite different from the endowment effect.
     
    Sarenco likes this.
  20. Sarenco

    Sarenco Frequent Poster

    Posts:
    5,269
    Yes, but excluding the bottom 10% does not have nearly as dramatic an effect on performance as missing out on the top 10%. The point is that the number of stocks that drive market returns actually represent a relatively small proportion of the overall market - if a portfolio does not contain any of a handful of "super performers" then the portfolio will inevitably lag the market return.

    Very. If you excluded the top 25% of performers from 1926 through 2009, then US stocks produced a negative return. On the other hand, including the top 25% gives an annualised return of close to 10%. That's a difference of over 8,000%!

    That's really my point in a nutshell.

    The more concentrated the portfolio, the greater the likelihood that the portfolio will outperform the market. But the reverse is also true - the more concentrated the portfolio, the greater the likelihood that the portfolio will underperform the market.

    Given the fact that the majority of stock market gains come from a relatively small number of stocks, you can see that the probability is far higher that a concentrated portfolio will underperform (as opposed to outperform) the market, simply because there is a greater probability that a concentrated portfolio will miss out on the "super performers".

    A randomly selected portfolio of 10 stocks is twice as likely to feature in the bottom 20% of stocks (whose value went to zero) than the top 10% of "super performers".