A Little Background
Why would any individual investor, for example, a Fourth Quarter forum member, believe that his/her point of view on the subject of investing might be of value to others. Maybe these reasons might apply. First, the value exists because the investor has taken the journey, perhaps with a great deal of capital, or perhaps with enough capital to sustain a comfortable retirement. Taking the journey as a consumer of investment advice, rather than a seller of such, is worth a lot. Second, the value exists because the investor’s journey has covered a fairly wide space, having studied and been exposed to a wide range of options. Third, and importantly, the value exists because some investors are also serious business analysts and understand how to look at things, examine outcomes and interpret what they mean. Finally, life and experience, including mistakes as well as successes, yields a sense of sophistication about such things that can be very useful to other people.
A Start Position: A Set of Beliefs
Many, many people want your capital. They all have great stories to tell, and the stories never have unhappy endings. The stories average out risk, which is why the endings are generally happy. But true risk is not an average of anything; it is more like a moment in time. If you are present with the wrong positioning, at the wrong moment, you lose. Quality investing requires what Howard Marks, one of Warren Buffet’s favorite thinkers, calls “second level thinking – deep, complex, and convoluted.” Current asset allocation programs mask true risk.
Many propose to align their risks with yours, thereby creating shared risk exposure. But, I would observe that there is no perfect alignment, and maybe not even a good one, between those who sell investment products or advice on capital deployment and those who buy it. The only true alignment is equally shared risk.
We live during a period when the term conflict of interest has become a legal construct. It used to be an ethical construct. Bad behavior with respect to business ethics is endemic, particularly in the Financial Services Industry. You must never relax your due diligence with respect to what is going on because your capital demands your over sight.
No investment is immune forever from the Black Swan. Even cash is not immune. Consequently, spreading your capital over a wide range of differentiated opportunities – intangible and tangible assets, passive and active investments – is not a bad way to go even though it may cost you short term return. You never ever know where the bullet is going to come from and what it is going to hit.
Diversification within the intangible asset class (equities) is difficult because technology and electronic transactions has caused much greater correlation among all such asset classes.
Beware of those who claim they can predict the future. The future is unknowable. There are quite a few people who have made a correct call about the future – they forecasted the Internet bubble or the housing bubble and acted on their beliefs – but that singular outcome does not qualify them as prophets, even though their advertising claims that it does. As Marks says, “In the investing world, one can live for years off of one great coup or one extreme but eventually accurate forecast.”
Never forget that economics is a behavioral science, not a physical science. The numbers describe history or they describe a point in time, but they can be used to only model the future. The important point for capital allocation is to intelligently assess how the investment world is going to react to the number. Everything else is a trend line, which represents not just an economic forecast but a behavioral one as well. For example, the U.S. Deficit issue is such a lesson. The only thing of which you can be certain is that it is profoundly unlikely that the deficits projected over the next ten to fifteen years will occur because such deficits are fundamentally unthinkable for the United States, an incompatible with its culture. The uncertainty rests in precisely how the issue will be resolved. “You can’t predict. You can prepare.” Investing is also a behavioral science. It starts that way. Marks says, good investing is “intuitive and adaptive rather than fixed and mechanistic.” Further, “the biggest investment errors come not from the factors that are informational but from those that are psychological. Greed, fear, conformity, envy, ego, suspension of disbelief are the impediments to informed decision making.”
the ostentatious displayof wealth or power, influence and positioning, forthcoming from many firms and individuals who want your capital, has little relationship to what they will help you achieve. Only the display of rigorous due diligence and second level thinking is relevant. The two qualities don’t frequently go hand in hand. If we have learned nothing else from the 2008-2011 economic debacle, it must be this.
Being an intelligent and successful person in your trade (business, government, academic, NGO, etc) does not necessarily make you an intelligent investor. Emotion is frequently a material asset in business. While emotion cannot be cut out of investing, or any other reasoned choice, it must be very carefully controlled, particularly as your capital is allocated to assets that are further and further away from actual businesses. With intangible assets, what you want to happen has very little relationship with what is going to happen.
After you have allocated your capital, you control less than you think. With most investments across the spectrum discussed below, you don’t even control when you can take back what remains of your capital. So, you must get in cheap and get out when everyone else thinks it is a bargain.
Timing is everything. When you get in is everything. Price to value is everything.
Good timing is based on quality information. All smart people have access to the same macro economic data, if they are willing to search wide enough for the data. But, with respect to the behavior of individual firms, and the projected value of individual stocks, everyone does not have equal access to information. This is the micro data. An individual is at an enormous disadvantage when compared to institutional buy-side investors. Smart investment managers, working full time with full time working staffs, regularly calling and visiting CEOs, have the capability to know the good and bads about any company of interest long before any individual investor. This is just the way it is. An individual strategy to buy and hold a stock will mitigate some of the disadvantage. Taking a contrarian approach may win. Occasionally, buying a stock that is in deep disfavor with the Street could turn out to be profitable. But, in the end, quality investing is still a moment in time, and first-rate investment managers, who are monitoring fifteen or twenty companies, should know far earlier than the individual investor, when it is time to take action (sell/buy) against one of their portfolio companies.
Advisors who come from the financial services industry preach asset allocation models that only address intangible financial assets because that is the world they represent. While a structured asset backed security, a CDO (collateralized debt obligation) may have once looked like a piece of real estate, it has been distanced from the tangible asset class long before the buyer sat through the sales pitch.
The best deployment of your capital is to put it into things you understand and avoid things that only the people advising you understand. This seems obvious, but it is not. Most of what is put before you, you will not understand, at least not fully. This is a hard rule to follow. The first question you might ask is am I betting on a company or a set of companies, am I betting on an industry, am I betting on a region of the world, or am I betting on a set of financial arrangements that are at least one degree removed from betting on firms. People who bet on CDOs before the 2008 financial crisis, in most cases, did not understand the assets that were in these packages and in too many cases the originators and sellers of these instruments, by lying about the true content, turned a conservative way to invest into a crapshoot. All the buyer understood was the modeled project return. They got greedy and caught in the bubble.
Don’t ever confuse family with investing, especially if the family member is directly involved in that which is being capitalized. Deploy capital to help family members realize their dreams, and deploy capital to make money. Never confuse these two events.
A quality financial advisor may or may not lead you to greater capital returns. But, almost for sure, you will learn a great deal about investment options from a good advisor, and that has intrinsic value on it’s own. Again, the goal is to avoid the Black Swan through second level thinking about managers and also firms. A quality advisor has the skill, the access, and the full time resources to do this.
Earned income (i.e., work related) can be remarkably under appreciated. $50,000 of cash is worth $1,000,000 conservatively invested.
Leverage is a good way to make a lot of money and a great way to lose a lot of money. When deliberating on such opportunities, the upside return frequently obscures the real risk on the downside. Leverage and meltdowns go hand in hand.
Luck, both good and bad, must not be allowed to obscure whether you are making intelligent investment decisions. Marks says, “the correctness of a decision can not be judged from outcomes.” Correct decisions can be unsuccessful. bad decisions can be successful. “A good decision is optimal at the time it is made, when the future is unknown.”
“Experience is what you get when you don’t get what you wanted.”
High-risk tolerance per se is fools gold.
If you believe that you can buy undervalued assets, or that you can select managers who are tenaciously dedicated to second level analysis that enables them to buy under valued assets, then, buying indexed funds makes no sense because such funds can only generate returns that are related to the market as opposed to the true behavior of individual firms.
An investor must distinguish between “good assets and bad buys…low price is the ultimate source of margin for error.”
Many propose to align their risks with yours, thereby creating shared risk exposure. But, I would observe that there is no perfect alignment, and maybe not even a good one, between those who sell investment products or advice on capital deployment and those who buy it. The only true alignment is equally shared risk.
We live during a period when the term conflict of interest has become a legal construct. It used to be an ethical construct. Bad behavior with respect to business ethics is endemic, particularly in the Financial Services Industry. You must never relax your due diligence with respect to what is going on because your capital demands your over sight.
No investment is immune forever from the Black Swan. Even cash is not immune. Consequently, spreading your capital over a wide range of differentiated opportunities – intangible and tangible assets, passive and active investments – is not a bad way to go even though it may cost you short term return. You never ever know where the bullet is going to come from and what it is going to hit.
Diversification within the intangible asset class (equities) is difficult because technology and electronic transactions has caused much greater correlation among all such asset classes.
Beware of those who claim they can predict the future. The future is unknowable. There are quite a few people who have made a correct call about the future – they forecasted the Internet bubble or the housing bubble and acted on their beliefs – but that singular outcome does not qualify them as prophets, even though their advertising claims that it does. As Marks says, “In the investing world, one can live for years off of one great coup or one extreme but eventually accurate forecast.”
Never forget that economics is a behavioral science, not a physical science. The numbers describe history or they describe a point in time, but they can be used to only model the future. The important point for capital allocation is to intelligently assess how the investment world is going to react to the number. Everything else is a trend line, which represents not just an economic forecast but a behavioral one as well. For example, the U.S. Deficit issue is such a lesson. The only thing of which you can be certain is that it is profoundly unlikely that the deficits projected over the next ten to fifteen years will occur because such deficits are fundamentally unthinkable for the United States, an incompatible with its culture. The uncertainty rests in precisely how the issue will be resolved. “You can’t predict. You can prepare.” Investing is also a behavioral science. It starts that way. Marks says, good investing is “intuitive and adaptive rather than fixed and mechanistic.” Further, “the biggest investment errors come not from the factors that are informational but from those that are psychological. Greed, fear, conformity, envy, ego, suspension of disbelief are the impediments to informed decision making.”
the ostentatious displayof wealth or power, influence and positioning, forthcoming from many firms and individuals who want your capital, has little relationship to what they will help you achieve. Only the display of rigorous due diligence and second level thinking is relevant. The two qualities don’t frequently go hand in hand. If we have learned nothing else from the 2008-2011 economic debacle, it must be this.
Being an intelligent and successful person in your trade (business, government, academic, NGO, etc) does not necessarily make you an intelligent investor. Emotion is frequently a material asset in business. While emotion cannot be cut out of investing, or any other reasoned choice, it must be very carefully controlled, particularly as your capital is allocated to assets that are further and further away from actual businesses. With intangible assets, what you want to happen has very little relationship with what is going to happen.
After you have allocated your capital, you control less than you think. With most investments across the spectrum discussed below, you don’t even control when you can take back what remains of your capital. So, you must get in cheap and get out when everyone else thinks it is a bargain.
Timing is everything. When you get in is everything. Price to value is everything.
Good timing is based on quality information. All smart people have access to the same macro economic data, if they are willing to search wide enough for the data. But, with respect to the behavior of individual firms, and the projected value of individual stocks, everyone does not have equal access to information. This is the micro data. An individual is at an enormous disadvantage when compared to institutional buy-side investors. Smart investment managers, working full time with full time working staffs, regularly calling and visiting CEOs, have the capability to know the good and bads about any company of interest long before any individual investor. This is just the way it is. An individual strategy to buy and hold a stock will mitigate some of the disadvantage. Taking a contrarian approach may win. Occasionally, buying a stock that is in deep disfavor with the Street could turn out to be profitable. But, in the end, quality investing is still a moment in time, and first-rate investment managers, who are monitoring fifteen or twenty companies, should know far earlier than the individual investor, when it is time to take action (sell/buy) against one of their portfolio companies.
Advisors who come from the financial services industry preach asset allocation models that only address intangible financial assets because that is the world they represent. While a structured asset backed security, a CDO (collateralized debt obligation) may have once looked like a piece of real estate, it has been distanced from the tangible asset class long before the buyer sat through the sales pitch.
The best deployment of your capital is to put it into things you understand and avoid things that only the people advising you understand. This seems obvious, but it is not. Most of what is put before you, you will not understand, at least not fully. This is a hard rule to follow. The first question you might ask is am I betting on a company or a set of companies, am I betting on an industry, am I betting on a region of the world, or am I betting on a set of financial arrangements that are at least one degree removed from betting on firms. People who bet on CDOs before the 2008 financial crisis, in most cases, did not understand the assets that were in these packages and in too many cases the originators and sellers of these instruments, by lying about the true content, turned a conservative way to invest into a crapshoot. All the buyer understood was the modeled project return. They got greedy and caught in the bubble.
Don’t ever confuse family with investing, especially if the family member is directly involved in that which is being capitalized. Deploy capital to help family members realize their dreams, and deploy capital to make money. Never confuse these two events.
A quality financial advisor may or may not lead you to greater capital returns. But, almost for sure, you will learn a great deal about investment options from a good advisor, and that has intrinsic value on it’s own. Again, the goal is to avoid the Black Swan through second level thinking about managers and also firms. A quality advisor has the skill, the access, and the full time resources to do this.
Earned income (i.e., work related) can be remarkably under appreciated. $50,000 of cash is worth $1,000,000 conservatively invested.
Leverage is a good way to make a lot of money and a great way to lose a lot of money. When deliberating on such opportunities, the upside return frequently obscures the real risk on the downside. Leverage and meltdowns go hand in hand.
Luck, both good and bad, must not be allowed to obscure whether you are making intelligent investment decisions. Marks says, “the correctness of a decision can not be judged from outcomes.” Correct decisions can be unsuccessful. bad decisions can be successful. “A good decision is optimal at the time it is made, when the future is unknown.”
“Experience is what you get when you don’t get what you wanted.”
High-risk tolerance per se is fools gold.
If you believe that you can buy undervalued assets, or that you can select managers who are tenaciously dedicated to second level analysis that enables them to buy under valued assets, then, buying indexed funds makes no sense because such funds can only generate returns that are related to the market as opposed to the true behavior of individual firms.
An investor must distinguish between “good assets and bad buys…low price is the ultimate source of margin for error.”
The Range of Choices
All of us who are deploying capital want the relative safety of cash and the return associated with invention. As you move from cash, the risk goes up, and so does the possible return. As Marks writes: “a great investor takes risks that are less than commensurate with the returns they earn.” In between cash and invention are things like:
Practically all of the people who want your capital most probably want to put your capital against something that is on this list. There is not much mystery about who wants your capital and where it goes. All the mystery is in the sales pitch and the projections. All of the mystery is in the future, which is what risk is all about. As Marks says, “you need to understand risk, to recognize when it is high, and to know how to control it.”
- cash
- money market mutual funds and treasuries
- indexed stock or bond funds or anything else that purports to help you buy the market average
- Investing with low cost/high volume fund managers like the Vanguards and Fidelities of the world
- Municipal Bonds
- Corporate Bonds
- Investing in a wide range of mutual funds, stocks or bonds
- High yield bond funds of both categories
- Instruments that invest in trades of some sort, and not really in the underlying assets
- Instruments like derivatives, CDOs, Credit default Swaps, etc.
- Investing in managed funds, acquired through institutional brokers, managed by named investment managers. With managed funds, you are betting on the wisdom and tenacity of the managers and their back-up staffs to select and monitor individual firms and to acquire second level knowledge.
- Investing in hedge funds, either through institutional brokers or by way of financial advisors who identify such opportunities and create access.
- Investing in a Fund of Funds, or a package of hedge funds
- Investing in MLPs (Managed Limited Partnerships), such as those put together in the oil and gas industries. MLPs are very specific to an industry, or even a piece of an industry
- Investing in PIPEs (Private Investment in Public Companies)
- Investing in Private Equity
- Buying Real Estate – single family, multi-family, commercial
- Buying land
- Buying other hard assets, such as precious metals, wine, etc.
- Investing in Venture Capital
- Investing directly into a business Partnership as a limited partner.
- Investing directly into a company
- Buying a company and going back to work.
- Inventing something that becomes a company
Practically all of the people who want your capital most probably want to put your capital against something that is on this list. There is not much mystery about who wants your capital and where it goes. All the mystery is in the sales pitch and the projections. All of the mystery is in the future, which is what risk is all about. As Marks says, “you need to understand risk, to recognize when it is high, and to know how to control it.”
Lessons Learned...(some, the hard way)
- Let’s start with one of the most unsophisticated investments I have made, but one that has been remarkably stable. It is a Vanguard High Net Worth Corporate bond fund. For almost ten years the fund has thrown off about 7% a year, sent me a monthly check that is constant, while its principle value has gone up and down through the economic circumstances of this time period. At one time, the principle value was 60% of my invested amount (guess when), but the monthly check continued, for the same amount, as the posted return simply went up. Today, the principle value is slightly more than my initial investment, while I have taken back in cash close to 100% of my initial capital. (Only about 20% of bonds are junk bonds and, during the crisis, a lot of good stuff was rated junk.) Clearly Vanguard has done a good job.
- If you want to work, the best return on invested time and money is probably starting a business. In one case, a partner and I formed a personal services business, put a small amount of cash into it (less than $50,000 total) and two years later sold it for several million dollars. (It was not our first rodeo.) Now that was a nice return. We also collected salary from the concern for two years, and then collected even more salary from the buyer for several years. Of course, when you build a company, that asset class forces you to go back to work.
- Every once in a while you can find yourself in a completely legal preferential position with respect to an individual stock. i have had this experience twice, and in both cases they were companies with which I was deeply involved, once as an official insider – and traded only during the allowable window under allowable circumstances – and the other as just a smart observer, under contract with the company. In both cases, each company’s stock tumbled to deep, deep lows and I simply disagreed with the market’s judgment. In one case, the market’s judgement was zeroed in on the company. In the other, the company traded at a deep discount during the worst of the financial crisis. In one case I made 4X (in about 4 years), and in the other, about the same (in about two years). These cases are really not examples of stock picking because my positioning with the companies put me in a preferential position to make judgement. I had second level knowledge. I had convinced myself that both companies were selling below their intrinsic value.
- I have found that investing directly into a private company run by someone else is dangerous, even if you are partially inside. In one case where I made a serious investment, I also went on the Board. This was during the height of the Internet bubble. From the board spot, I was able to positively influence a decision to be acquired by a public company. The big cat investment advisors from Wall Street wanted us to go public. They would get fees and we would get risk. I was scared and thought their idea foolish and self-serving, and I vociferously opposed this and won. I won and we sold out. As it developed, the Internet bubble hit within weeks of finalizing the deal to be acquired. The public company, which was four times our size, and positioned differently in the market, barely survived, but eight years later sold 5X of my initial investment. If I had been a silent investor, the investment bankers would have convinced the owners to do an IPO and, I have no doubt, I would have lost my full investment.
- In the above case, I kept my shares for a number of years, during which time the stock traded very low, materially below my investment. But, I had a story. I believed that they had carved out a unique space in the payments system and would eventually be acquired by a big player essentially as a function of their market penetration. They were, and for 5X or 6X of my investment.
- My worst investment was in a trade.It was a highly leveraged bond deal that was taking advantage of anomalies in the returns associated with various forms of long and short-term bond debt. It took me a year to decide to make the investment, during which time of course, the trade threw off 10% a quarter like clock work. The big lesson here was that I never fully understood the risk. The second was that it was a trade, and safety of quality assets, high-grade bonds in this case, was compromised by leverage. The quality assets were just a necessary part of the trade, so to speak. The third lesson is that the deal only worked with high leverage, about 7:1. I was sure that the guys running the trade knew what they were doing, but I did not. But, eventually, I bought the sales argument and went into the deal. The 10-12% return, mostly non taxable, seduced me, and I enjoyed that return for a couple of years and even took some of my money off of the table. However, the ending was not pretty. The early period of the financial crisis, when even the highest-grade bonds dramatically and quickly dropped in value, cratered the deal. All of the bonds were high grade. But, the collateral crisis emerging in debt and leverage with junk investments (like CDOs) infected quality investments in bonds. In 2007, the shit started hitting the fan in specific areas, as desperate people sold off quality assets to meet margin or debt requirements. As the real estate market started to crater and the bond market cratered, my deal cratered, as my guys were forced to sell quality bonds to meet their leverage ratios. By the time it ran its course, I had lost 70% of what I still had on the table. The problem in a leveraged play that goes bad is that the underlying quality of your assets is of no help. When market value drops, ratios and borrowing terms need to be met. There is no holding in place. I bought this deal at the wrong moment in time. I had no real concept of leverage. In the end, it was “an improbable disaster”, an “investment that was susceptible to a particularly serious risk that will occur infrequently, if at all.” This was when I began to understand risk.
- When I started, I knew nothing about hedge funds and assumed that they were pretty risky. In time I came to believe that unleveraged hedge funds were not a bad investment. However, I did not invest in individiual hedge funds. Rather, I invested in several Fund of Funds, in effect funds that are comprised of perhaps twenty different hedge funds. I never had exciting returns in the funds I bought. But, my major fund went through the financial crisis with very little disturbance. It went down maybe single digit, and recovered nicely. It has turned out to be a decent capital preservation strategy with conventionally expected returns of mid single digit, a bit up or below. In effect, when done accordingly to principle, hedge funds are a “skillful defensive strategy.”
- My experience with private equity has been quite good. I do believe that private equity companies have a pretty good business model. Typically, they know about as much as you can know about a company prospect, without being inside, and their financial models, which guide their investments, are pretty conservative. They are true believers in second level analysis and they are not passive. They are able to put their knowledge to work if their properties get into trouble. The big issue I have with private equity is liquidity. Your capital is in the game forever and you control nothing. You never know when you are going to get a capital distribution. You are always uneasy about your exact return because these pools of capital play out over such a long period of time. In the end, I believe that my returns have been double digit over time (the firms clearly claim this outcome), but I am not sure I could ever prove it. However, I have re-invested in private equity firms, so I guess I concluded that they did a pretty good job with my capital.
- Like most investors, I have pools of funds with large institutional firms, under the guidance of account managers, who recommend specific fund managers. Each of these managers is attempting to execute this strategy or that, pointing toward various sizes of firms, regions of the world, and specific industry markets, against either short or long time periods. These relationships are expensive (pay the manager, pay the advisor’s firm) but as intimate as you want them to be. The main problem with this broad approach is that as technology and electronic trading have increased the correlation among all asset classes, there has been a decline in the protection obtained from this type of diversification.
- I have also invested with mass-market retailers, such as a company like Fidelity, to test the cheap and non-intimate model. In these cases, you spend some time on the phone with an advisor, discuss conventional investment criteria, and let them distribute your funds over a package of funds that, according to Fidelity’s magic, somehow meet conventional criteria. The cost for doing this is very low. The relationship is not intimate. Very little time is pent. You are about fully dependent on them. In the end, I have attempted to compare the returns forthcoming from my expensive major relationships with the returns from Fidelity and I notice that there doesn’t seem to be a major difference, net after cost. perhaps the explanation is that I am comparing unlike things. For example, there is more movement in and out of positions with my intimate relationships, making calculations a bit difficult. But, nonetheless, each time I have attempted to make the comparison, being careful to create models which seem fair, factoring in costs on both sides, I have yet to end up with a result that was strikingly different on one side or the other. This puzzles me. The other issue relates to the conflict of interest question raised earlier. Is every action taken based solely on how it affects my return, or do some actions benefit the investment house whether or not I have a positive return?
- I have been involved as a limited partner in material commercial real estate investments. This falls into the category of investing into someone else’s company. Two things help you succeed in real estate. True experience and knowledge of the behavioral conditions of the marketplace and good timing. I have never known a real estate developer who could perfect timing. But, I have known a few who were deeply experienced and knew how to survive a down market. I would observe that their people had great skill, which I do not possess. Some of the deals I was in did ok. Some didn’t. In all cases, in so far as my involvement was concerned, both outcomes were pure luck. I was depending on others to manage my capital. But, my adventures did result in real buildings being built and eventually being rented and sold. I am not out looking for real estate deals.
- I have never bought gold, silver or other precious metals. Obviously, you can make money on anything if you buy low and sell high. However, if you buy gold or silver with dollars, you are betting on macro economic events, not the managers and products of a firm, and you make money if you guessed right (dollar gets monetized) and you lose money if the dollar gains in value. For example, who would have thought in the fourth quarter of 2008 that the dollar would materially gain against the Euro, which I believe it did. The other point of concern for me is how do you time such buys. Wouldn’t you suppose that by the time the prophets of doom tell you to buy gold that the advantage might already be gone. In effect, you are buying straight into the bubble. Like all investing, if you are not an expert, be careful. I am also bothered that gold/silver feel more like a trade to me, than the purchase of a piece of an underlying business. If in the end, as the prophets of doom say, there is nothing much left with value other than gold and silver, I wonder: how do you monetize it, who’s going to buy it, and what shape is the world in at that point? On the other hand, if you view gold as just another investment in a hard asset, you better time it right, you better buy it when nobody wants it, and you better have some expertise. I do not have such expertise.
- Occasionally, an investor gets an opportunity to become an angel investor in a start up company. I think the bottom line here is simple. You better be very smart about the product/market point being attacked, that is, have real expertise equal to the entrepreneur; and you better be as smart as the CEO. This is a second level knowledge play at the extreme. Otherwise, I think it is a Las Vegas play. I have never met all of those requirements, so I have passed on such opportunities.
- An investor may be asked to invest in venture capital funds. In this case, you are betting that the leaders of the fund are precisely those people mentioned in the paragraph immediately above. This type of investing is very high risk chasing very high reward. I have never sought out these kinds of opportunities because I have never been in a position of strength with a venture fund. I have been in some private equity funds that foused on very early stage companies (no revenue or single digit million revenue). I have been quite satisfied with my major involvement but the differentiating factor was I knew the target industry very well, I knew well the management of the Fund, and I was co-investing with companies who were positioned to become customers for the products being developed or sold into the market. The business model has been quite successful over the past ten years in spite of the economic challenges.
Summary
Investing is all about understanding intrinsic value – which is itself not truly a mathematical computation – and buying assets, which are priced below intrinsic value. The cost to value opportunity exists because (1) the asset is not generally understood by the marketplace, (2) the under priced component of value has been derived through wise and penetrating due diligence, (3) the herd is running in the opposite direction, (4) the psychology of the market is working against the company, (5) the asset has true defects, and (6) the asset is unpopular and no one likes it. Price is everything. Even risky assets can make good investments if they are cheap enough. But, as Marks says, “you should like it less as its price rises.” High risk comes with high price.
Jack Nicklaus believes that in professional golf, particularly in the Majors, the victory goes to the one making the fewest mistakes, not the ones making the greatest shots. In Saturday morning golf it is the same. It is not the birdies that make your score, it is the absence of double bogeys. So it is with capital allocation. Marks says, “over the long run, most investor results will be determined more by how many losses the have, and how bad they are, then by the greatness of their winners.”
Life is cyclical. Investing is cyclical. I do not believe in the new normal. I do believe that the psychology of the market today (August 2011) has all but forgotten that most things are cyclical. This time it really isn’t different. Only the bubble was bigger. The pendulum swung further out and the time to rebound will take longer. But, when it does start to rebound, it will be swift. You will wonder how something that took so long to happen could have happened so quickly. Today may be a time for healthy skepticism, that is, “optimism when pessimism is excessive.”
Jack Nicklaus believes that in professional golf, particularly in the Majors, the victory goes to the one making the fewest mistakes, not the ones making the greatest shots. In Saturday morning golf it is the same. It is not the birdies that make your score, it is the absence of double bogeys. So it is with capital allocation. Marks says, “over the long run, most investor results will be determined more by how many losses the have, and how bad they are, then by the greatness of their winners.”
Life is cyclical. Investing is cyclical. I do not believe in the new normal. I do believe that the psychology of the market today (August 2011) has all but forgotten that most things are cyclical. This time it really isn’t different. Only the bubble was bigger. The pendulum swung further out and the time to rebound will take longer. But, when it does start to rebound, it will be swift. You will wonder how something that took so long to happen could have happened so quickly. Today may be a time for healthy skepticism, that is, “optimism when pessimism is excessive.”
