tag:blogger.com,1999:blog-1537902192385366572024-03-13T00:40:05.270-07:00Long Term Investment ManagementAlessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.comBlogger104125tag:blogger.com,1999:blog-153790219238536657.post-74198321630826732902015-02-12T12:54:00.001-08:002015-02-12T13:34:35.575-08:00AvangardcoReading the history of excellent value investors I find many started investing in statistical bargains. Securities of companies that are evidently cheap on multiples of earnings or net working capital. Working for a large institution that does not only deal with professional clients, many of these securities are out of my line of fire as they are neglected issues of small and illiquid companies - few buyers, less volume, hence more inefficient pricing (be it on the up or down side).
A few respected investment blogs have mentioned a stock by the name of AVANGARDCO, who currently trades at x1 its past earnings. What a bargain it seems. What must be going on for this offer to be in place - to be so left alone that its market price must reach such a low point. Well the risk factors are the following: Ukrainian company with almost all assets in Ukraine (and now some assets in Crimea, Russia), Expropriation of assets by Russian government, assets being deserted due to war conditions locally hence not being productive, debt in foreign hard currency such as Eur, USD, major shareholder controls company with approx. 77% stake, now lose making due to above conditions. One could fear the company could be restructured to survive under such draconian conditions so current shareholders are diluted to an insignificant stake. But who would take it up today - perhaps the major sharholder only to control his grip. The major shareholder has a holding company which controls his stake in Avangardco. This was due to be listed in mid 2014 but was postponed due to the Ukranian crisis. This company is even more interesting due to their agricultural assets - indeed Cargill recently bought a stake giving an indication what it could be worth. It has been suggested Avangardco shares can be converted to that holding company when it becomes public. Shares in Avangardco, as they currently trade under distressed conditions - and the holding company will not be floated under distressed conditions - could offer an attractive entry point in that business.
Note the biggest risk is 200 million USD of debt maturing in Oct 2015. Cash flow going negative mens even the large cashload they have cant rfinance the debt. Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com2tag:blogger.com,1999:blog-153790219238536657.post-58259039862315554892015-01-16T07:59:00.002-08:002015-01-16T07:59:39.230-08:00Risk run off modeIn this environment of ever decreasing bond yields, decreasing commodity prices and increasing margins and equity multiples I find myself in a <b>clear risk run off mode as the risk - reward for many equity securities I look at just aren't attractive enough </b>to make me deploy capital. Sectors such as energy are currently being investigated and small investments are being made here.
I continue to buy bonds, recently adding to a healthcare businesses senior bond whose junk rating hides its excellent cash generative ability. A 4% yield in USD for a 6 year bond is attractive for me - as I feel the large debt burden of many developed markets will not allow them to raise rates significantly, if they do. Meanwhile commentators argue if rates will rise in Q2 or Q3.....
The way I see it interest rates in USD are not likley to average more than 2.5% over the next 6 years. Hence a 4% yield over that period is an attractive premium if I am satisfied with the credit risk of the issuer and feel inflation is likely to average below 2.5%. I think this is likely at the moment. Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com1tag:blogger.com,1999:blog-153790219238536657.post-4348036405485906002014-12-18T04:23:00.000-08:002014-12-18T04:32:50.490-08:00US Macro policy - the theory and the practiceWe follow the macro situation to be aware of potential big problems and to guide us on asset allocation. US macro policy can be defined as follows in the last few years:-
(1) Keep rates low, this will encourage capex spending
(2)Buy bonds to reduce the rate, this will force the market to take on more risk, increasing asset prices and increasing wealth, this will increase consumer spending
(3) Growth will reduce the debt/GDP ratio. If GDP growth is greater than the cost of debt the country can deleverage
It sounds great on paper. However, QE by itself does not improve the economy. Its aim is to increase <blockquote>animal spirits</blockquote> - so demand is created by businesses willing to take risks by investing and consumers willing to spend. However, we have found the following happen:-
(1) Low rates have decreased the income from cash deposits. With a growing elderly population who have reduced their risk profile this may mute demand.
(2) Capacity utilisation has been below average why should businesses invest? Especially if consumer spending has been affected by low real wage growth, little credit availablility, and low deposit rates. The demand has not been there. So why should companies borrow to invest in capex. Better to borrow and buy back stock where earnings yields are lower than borrowing costs. However, higher asset prices only benefit those who are shareholders. This is often those with excess savings, hence the wealthy. Hence QE exacerbates the difference between the haves and have nots which can create social tension.
(3) Total debt has not decreased. It has shifted from the problem of a few companies or consumers, to a problem of the whole country (i.e. the government).
However, it maybe possible that a critical point is being reached in the US. Employment may be reaching a critical mass where real wages may start increasing. This will boost consumer confidence which can increase consumer spending, this may explain what seems to be the strong start to the Christmas retail season. Credit is becoming more available as US banks are now well capitalised. If this increases spending in the economy and GDP growth increases such that the US economy can start deleveraging, the economy will be improving in almost all metrics. This could even start a slow and gradual increase in rates increasing the income of low risk investors. This would be a virtuos cycle indeed and would be an important moment for central bank policyholders - who would deserve to be congratulated. However, due to the success so far relative to other countries the USD has started to appreciate. Though the trade defecit is shrinking as foreign oil demand is weakening due to large energy reserves found inhouse, it may affect the export market. For the Americans however this may be benefited by weaker commodity prices, which often have a strong correlation to the USD as they are transacted in USD. Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com1tag:blogger.com,1999:blog-153790219238536657.post-1537228649398385992014-12-18T03:59:00.004-08:002014-12-18T03:59:32.101-08:00Technical investing and risk managementI must admit a certain innocence in the use of technical investing. A close friend and respectable investor continuosly highlights its usefulness in investing. For example, this individual would buy into a stock weighting the size of the investments on the volatility of the stock. More volatility, lower initial position. I find this approach incomplete. For example, why not size positions comparing volatility of the stock price on volatility of cash flows. If cash flows are volatile and the stock price is volatile this merits a smaller initial position than a company whose cash flows are quite stable historically, and we believe they should not become considerably more volatile in the future. This way we connect market prices to company value generation.
His second rule is he would buy once, buy twice, three out.
Another rule is setting a limit on how much lose you would take. This seems sensible and I try to ensure no single position can suffer a more than 1% loss on the portfolio in my worst case scenario (which of course can be wrong - and has been in the single case of Tesco so far). Indeed, this viewpoint is what finally deceides the position size of a stock.
However we must be careful. A long term investment philsophy based on understanding a business should not apply a trading risk management strategy - each process is built for a different strategy and combining them is likely to not be an optimal manner to manage assets.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com2tag:blogger.com,1999:blog-153790219238536657.post-65383778933138118252014-12-18T03:26:00.001-08:002014-12-18T03:26:18.843-08:00The market is always weighting different factors differently, this leads to volatility of stock pricesThe markets are a curious place because pricing at different points in time are dominated by different factors. Often macro factors dominate over sector and company specific issues. This results in higher correlation between stock prices in different sectors. Sometimes the market over emphasises quarterly results, meaning an up or down surprise can lead to violent changes in stock prices.
Some investors spend considerable time understanding the mood of the market and understanding quantitatively what factors it is focusing on. I dont do that because this takes considerable time and does not suggest a clear cut investment as an output. Instead we focus on businesses we understand, and appreciate in a qualitative manner when the market mood is different by the way it values the same businesses differently. This can provide opportunity.
We often find unlucky or lucky timing of events can pay a large role in market pricing. A large acquisition that perhaps was expensive can lead to the stock price of the company declining. A bad patch in the market can then exacerbate this decline followed by a bad sector issue can lead to carnage on the stock price of a company that was initially driven by a company specific event and then taken further down with market and sector issues. This can lead to mis pricing due to herd behaviour. It should be noted with ETFs taking greater market share of stock market volume this pricing momentum may increase.
Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-55043654461309966432013-08-04T13:19:00.002-07:002013-08-04T13:19:42.786-07:00Behind asset allocation decisions, lies inflationBuying bonds just to (1) reduce volatility in the portfolio (buy 5 year bonds of high quality company) and (2) generate an attractive income over cash, or to have (3) capital appreciation when interest rates fall, these sources of returns for bonds have been taken away. Only real source available now is the (4) credit profile of a company increases so the yield decreases, hence the price goes up. I guess this is why many investors are in high yield and high risk bond investments at the moment.
An increase in interest rates can create marked to market losses from a decline in prices. Yields are in absolute terms low. <i>There is little opportunity cost to cash and the risk/reward seems poor</i>. Risk of interest rates increasing, default, regulatory risk if have low capital structure securities of banks or telecom and utility companies, inflation risk, having equities being cheaper offering a higher return (but can always sell the bond with a 10% loss and buy the equity which would have dropped much more). Meanwhile if you dont know what is happening may be better to be invested in bonds and generating the income? The reward is 2 or 3%. I guess it is still 1.5% more than cash. But for how long will cash stay there. I guess that is the final question which will determine whether you buy bonds, or be underweight bonds and overweight cash. I have been the latter. So far it has been wrong as it has detracted from returns. The equities have done well, but the bonds should have helped more to contribute to returns. We are in a period where both bonds and equities are performing positively. This correlation will eventually break down. <i>Increasing inflation is usually the factor that makes this relationship break down</i>. Decreasing or steady inflation allows the conditions for there to be a positive correlation between bonds and equities. Inflation is the great unknown, and one should always try to hedge against it and have a minimal exposure to companies that can be hurt harshly by it.
Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-21177373757711524752013-08-04T12:55:00.002-07:002013-08-04T13:03:24.571-07:00Bonds: careful on how its role in many portfolios is changingWhen I started investing, my vision for the role of bonds in a portfolio was to help produce a steady source of income greater than the cash rate, whilst providing only a small increase in risk relative to the cash position (i.e. we did not see the risk of the issuer we bought being greater than the average bank that is holding your deposits! In fact, we would only buy the bond if we felt the bankruptcy risk was quite remote).
Hence a 40% allocation to bonds offering a 5 to 6% source of income (in those good old "normal" times) supported a 60% exposure to equities that were expected to generate around a 10% return per annum over the business cycle. This would allow a portfolio to credibly generate around 8% per annum over the business cycle with the bonds reducing the volatility in the portfolio, which many clients are so afriad of (at this moment I don´t chose my clients, but deal with clients from private banks, many who are lead to believe that volatility is risk in investing: a fact that would be ridiculous for them to consider if it was applied in there family/corporate businesses). However, today this role of bonds is quite limited. Rates are so low for the senior bonds of high quality corporates with duration less than 6 years that the small premium to cash rates today are substantially below the average cash rates for the currencies we deal with (for hard currencies you can assume the average cash rate over the last 100 years is around 4.5%). It is not silly to think that current cash rates will converge to the average over the next 6 years.
So to generate that 5 to 6% in bonds today one must buy fixed income securities that are lower in the capital structure. This introduces the world of subordinated and perpetual bonds, as well as preferred shares, contingent convertible securities and the like. In a sentence: you are forced to increase risk to generate the same income. However, since in your portfolio statement all these securities fall under the BONDS section, many still assume it to be near risk free, or at least considerably less risky than equities.
Again, as is often the case, the problem is how we define risk. The word risk without an adjective is <i>meaningless</i>. Are you afraid of the size of price risk (i.e. volatility), duration risk (the affect interest rates may have on the price of your investment security), bankruptcy risk, lack of income being generated in your portfolio etc. <i>Depending on what your objective is, it will affect which risks you will be willing to take</i>.
For me, my view of bonds has changed, at least for the moment. When I look at great investors I see many don`t buy high quality bonds, but buy junk bonds. I guess if you focus on high quality companies to buy their equity, their is some logic to take advantage of the seniority of debt and focus on the average companies. When you buy a quality stock you often ask <i>will the company prosper</i>. But when you buy a bond, since you do not share in the profits, you only need to ask the question, <i>will they survive</i>. Indeed, I compare this strategy to buying net nets. These are companies that often have deteriorating operating results, but often have no debt on their balance sheet. Hence buying the equity is effectively equivalent to buying the bond. However, in this case you have the potential of a strong capital appreciation as well as any income that may be offered to shareholders. The question would be, is it more fruitful to invest in net nets of poor companies, or the senior debt of poor companies; which historically offers the more attractive return. Note should your analysis be wrong and the company goes through chaper 11 (in the US), as a bond holder you then become the shareholder of effectively a net net company (so you get a second chance!). With a net net unexpected costs may accrue leading to a lower return of capital than expected (book value is often much less in bankruptcy than it is stated on the balance sheet).
However, junk bonds role in the portfolio will not be to reduce volatility! But will be there because the risk/reward is attractive and merits its position over cash. This is the only way I think it makes sense to build portfolios. Not to assume what correlations between asset classes may be, or make macro assumptions the pillar of your asset or security selection. You focus on the risk/reward of each investment. If the potential risk adjusted return is offering a satisfactory return greater than cash, it should be considered a worthy investment. Unfortunately client facing institutions rarely think like this. Instead their aim is to make money every year, every quarter, every day. Indeed, it is for this reason value investing continues to make above average returns. The vital ingrediant of patience is simply lacking from our important financial institutions.
As a side note, if it was up to me I would focus on working with clients that (1) define risk as the potential of permenantly losing capital, (2) are keen on buying the securities of good companies at good prices, and (3) assess the performance of there investments over a three year period (over apprx. half the business cycle). A client who understands and agrees with the investment philosophy of their investment manager is more likely to have a fruitful relationship in terms of results, and to be more aware when the situation requires patience, or if their manager is sub par. If you cannot explain an idea to a client in a few minutes, it is not worth investing in their portfolio. Transparency and understanding leads to loyalty, and the best possibility of generating good results.
Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com2tag:blogger.com,1999:blog-153790219238536657.post-71197537389190319582012-11-04T02:04:00.002-08:002012-11-04T02:04:58.951-08:00The role of inflation in valuationOur simple approach to valuation was described in a recent blog.
However, though simple, we find it to be effective in focusing on what really matters: long term corporate profitability - rather than terminal values, theoritical discount rates or the volatility of stock prices.
We would like to show the power of this model by focusing on how high inflation can affect the pricing of the stock market.
Many readers are aware that during the 70s inflation rates increased and the stock market reached a valuation close to x7 earnings, a large displacement from its historical average of x16 earnings.
When the value of money is perceived to decrease over time, it is rational that investors want to pay less for future cash flows, hence the multiple of the market contracts.
However, focusing on those companies that have more manageable costs (consider their cost structure, its operational efficiency to competitors and the margin of the business) and pricing power, inflation over the long term will cause little permenant damage. If anything, it can increase their market share as competitors have a more difficult time, allowing the strong to become stronger.
Focusing on these companies means we do not need to alter our x15 multiple on free cash flow generated. We do not adjust our multiple on macro fears: because these class of companies have suffered a number of macro issues over their many decades of existence. Their flexible management team often handle the event better than competitors, and they have the resources, balance sheet and cash flow to overcome it.
Hence when we see x7 multiples as market continue to go down, we have a lens to generate the strength to buy.
Of course macro environments can change our margin of safety: rather than 35% in a high inflationary environment it will be 45%: but if our approach suggests a buy, we must be ready to fight our stomachs, the biggest problem of an investor.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-12509888451536165352012-11-03T15:39:00.000-07:002012-11-03T15:39:41.096-07:00How we can lose moneyThere are several situations we try to avoid where we think the probability of loss is too high for us to find the return interesting, irrespective of how large it may be potentially.
(1) High leverage, non consistent free cash flow and/or non liquid high quality assets combined
(2) No revenue growth and declining margins, yet high FCF yield
(3) Small FCF yield (overpaying)
(4) Capex heavy cost base creating problems in an inflationary environment from high spending and high borrowing costs to fund the maintenance capex
(5) Decreasing demand (i.e. product substitution)
(6) Increasing supply (including changing market structure)
(7) Quality of business model declining
Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-18467691999740240292012-11-03T15:05:00.001-07:002012-11-03T15:05:09.996-07:00Current updateThe year has been dynamic.
Legacy positions in non cyclical, high quality companies such as Sanofi, Glaxo, Roche, Kraft etc have now been sold.
The current fad is high quality, non cyclical, hence the good prices we got several years ago are now fairly valued. Perhaps we should have held on to enjoy the full momentum of the movement of capital to this strategy as bond yields get so low all the best known and highest quality dividend payers are being bought by these clients.
Everyone now seems to say low beta stocks outperform, hence everyone buys them so no performance is left for the future. All great ideas are at best temporarily killed when it becomes the consensus strategy. The consensus cannot beat the average (i.e. the market).
We find cyclical companies are now considerably cheaper than non cyclical on average. Macro fears means few want to bet longer than 2013 estimates of EPS. Should these estimates drop, we find stock prices fall heavily. Recent victoms include BG, Burberry, Hewlett Packard etc.
We find European companies are cheaper than US equivalents.
We find large caps are well priced relative to small caps.
We find deep value large caps are most easily found in finacials and technology in the USA.
We continue to stay away from direct stocks in emerging markets for the moment. Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-70359520045455129062012-11-03T13:10:00.000-07:002012-11-03T13:21:30.570-07:00The Success of Hedge FundsIt seems to me that many average hedge funds have found much interest for their products because investors focus more on reducing volatility, rather than generating returns. No doubt a consequence of losing money in 2000/02 and 2007/08.
However, I could go long Apple and short the S&P 500, and over the last year I would have had less volatility than the S&P 500. However, would I have beat the S&P 500?
For us, our view on investing is different. We would rather make a manageable number of investments (30 - 40 securities) and deploy capital when we think we have found the right company at the right price, rather than lose any potential alpha and time from finding good ideas by offsetting our good ideas in case they become bad (i.e. volatile) in the short term.
<i>We are willing to accept above average volatility to attempt to make above average returns because we do not associate risk with volatility. For us risk is the probability of losing our money.
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Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-45116956659187645132012-11-03T12:52:00.004-07:002012-11-03T12:52:40.654-07:00The Business CycleSince we often discuss the idea of stable earning power over the business cycle, some have mentioned that the business cycle is non relevant concept at the moment due to interest rates continuously being kept low in many developed economies.
An interesting point. But one I disagree with.
Firstly, interest rates on paper are being kept constant. In relaity, the cost of borrowing for the same company over the last few years has not been constant.
Secondly, GDP has varied over the same time period, as has inflation.
Interest rates are just one component which can be used to indicate the business cycle. Many factors including investment, total activity, credit creation etc can be used to show the evolution of the business cycle. The business cycle evolves whether or not interest rates are manipulated on paper at being constant and extremely low.
<i>I would add that considering the current macro sitation for many developed economies, the business cycle is likely to be shorter and more volatile relative to the historic average. This will translate into the average position in the portfolios we manage being held for a shorter period of time than we would historically (or in the future). </i>Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-60541391425636377512012-11-03T12:36:00.002-07:002012-11-03T12:36:16.557-07:00Our valuation approachMuch emphasis is made in academic circles and from nieve investors (both extremes of the spectrum) on valuation methods used to determine if an investment security is attractively priced, or not...
We have little to add on this debate. Many of our clients know we use a simple, transparent process that places greater emphasis on understanding the business, rather than crunching the numbers. We have often mentioned our process requires the mathematical skills of an average 12 year old pupil, and tries to incorporate the most powerful tool humankind has developed: applying trial and error. A simple method that reduces the number of assumptions used helps achieve this more successfully, in our opinion.
Not all companies can be valued using the below mentioned process due to the assumptions we must make. All models are a detachment from reality, the best we can do is determine when the model is more useful, than dangerous...
1. For certain companies it is easier to determine their <b>stable, normalised earning power</b>. Such companies have a sustainable, competitive advantage that can render this number relevant throughout the business cycle.
We attack this number by understanding the companies market structure, demand and supply dynamics for their products/services, the source of competitive advantage, their cost structure, business model, and management behaviour, operational efficiency and capital allocation.
2. We apply a x15 multiple to this stable earning power
3. We ask ourselves if this company can increase their free cash flow generation in the next 3 - 6 years. Hence, if it deserves to trade at a premium to its current stable earning power
4. We consider to purchase the companies stock if it trades at a greater than 35% discount to our estimate of its fair business value
<i>For companies whose products are continuosly changing, as may be there market structure, this method can be useless</i>. Stable earning power is non existent in many technological companies as the products they would be selling in 5 years time are likely to be different. There customers may be the same, but the distribution model may have changed, hence how they interact with clients will have changed.
<i>Such businesses are outside our scope of competence as we are not close enough to such companies to feel comfortable with how their businesses may look in 10 years time</i>. Since we do not have the resources that compete with hedge funds, mutual funds etc that have an army of analysts doing continuous inventory checks, talking to well placed friends in these industries, may even hire detectives to get data etc, we are not foolish enough to compete with their network and capital resources to determine how a businesses results may evolve on a quarter to quarter basis.
Our aim is to pitch for those investments that have a recognisable stable earning power, the potential to grow their fair business value through investing their free cash flow generating satisfactory returns on capital whilst, not being in a capital intensive business or having an over leveraged balance sheet, whilst competing in a market that has a favourable market structure, stable demand for their products over the business cycle (an essential item) with a product that is hard to substitute via technological change, and a competitive advantage(s) that generate high barriers to entry to keep supply in check.
This may seem demanding. However, several events may create this opportunity:
A market crash
Recession & other macro fears
A publically recognised operational error (when history suggests this is an exception rather than the norm)
A recent bad investment (leading to writedowns and lossing faith in management)
Litigation
Poor management (leading to temporary poor usage of free cash flow generated)
An over leveraged balance sheet
Buying/selling an asset
A corporate event (i.e. rights offering, spin off)
Changing business model
An underperforming business in the company that is publically discussed
Technology change (whose impact is not fully understoof yet)
This is not an exhaustive list. But indicates certain catalysts that allow the stock to trade at a greater than 35% discount to our estimate of the companies fair business value.
Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-71032793195656260502012-05-08T13:50:00.000-07:002012-05-08T13:55:54.968-07:00Insurance - can play a larger role in portfoliosThe reality is we seem to be in an environment where macro influences are more dominant than they have been over the last few decades. This may be because the debt super cycle is undergoing a turning point in developed markets, using the language of Bridgewater associates.
As a result, we should consider having an insurance policy that protects against the negative influence of a change in the debt super cycle, the monetory cycle, or changes in productivity. These can influence the earnings of companies over different timing cycles.
We can insure against these changing trends by studying how different assets move in these changing cycles.
A percentage of the portfolio can then be allocated to insurance, say 5%. Using cheap insurance in securities that have a quasi correlation with a certain event occurring that may result in the equities generating negative returns - this is our offsetting element.
Since we wish to deploy only 5% of the portfolio to such securities, we need to have embedded leverage, hence the usage of derivatives such as options. We pay a price to have protection against an extreme event by buying a call or put option on a certain underlying for a period of time (in general we want this product to have a similar time length as the underlying securities we have invested in).Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-32174082502447908032012-05-08T13:23:00.001-07:002012-05-08T13:23:29.225-07:00Mr. Dalio, it´s good to think in risk, not assetsToday I must say Mr. Dalio hit me hard on the head.
"<b>Don´t think in terms of asset allocation, think in terms of risk allocation</b>", he says.
What is risk? How do you measure it?
As you know from the articles in this blog, we expect to generate a certain return from an investment or will not proceed - hence our focus on valution.
Our buy price is influenced by the cost of money (the risk free asset), and inflation expectations - as well as the return of other securities from that company, and the return of other companies securities. Hence our valuation is affected by our interpretation of the risks within the company, within the sector, and macro issues. If we do not see opportunities to buy securities of companies we will leave assets in cash, rather then guess what will happen everyday. We will wait for our fat pitch, the investment that we feel most comfortable with, hence we are less likely to loss money, and more likely to be successful in the investments we make. This is because we are not a large team, and because we have not built a large wealth of knowledge in macro economics, and how it affects the markets, and how macro events evolve.
However, our return on investment focus, our investment process having a feedback loop from macro influences, means we do not allocate capital with a starting point based on allocation to equities or in bonds: we do not start from an asset allocation model, as Dalio warns against. We are prepared to take on a certain amount of risk for a certain return - if we do not find that opportunity, we do not deploy capital.
Where Dalio differs is he incorporates in his investing that he will not know with precision what will happen. As a result he places off setting investments in case growth is not what he expects, or inflation is larger than he expects. We do this by security selection in portfolios, by having different companies in different businesses and sectors, with different catalysts and in different investment categories. <b>However, most securities are equities, and hence will have a large beta component to their return</b>. As a result, our instrument to fight against never really knowing everything - the margin of safety - will be of little use in the short term when markets fall - <i>whilst Dalio´s offsetting trades can help him generate less volatility from trying to hedge where he may be wrong</i>.
We can say we dont want to spend the same amount of time on the areas we dont understand as much as the areas we do. But here we dont need to find different companies to short, as opposed to go long. Perhaps we need to spend time to find securities that are likley to bloom if certain things go against us in an investment case (this should be resolved through research of the company, unless very unclear but cheap to go short one item and long the other, then worth the risk), or maybe can offset beta risk. But the cost of shorting may eat away any alpha we may generate - hence we introduce a timing issue. When would be want to be short. When we see real problems and real extreme valuations. I have always tried to walk away from the timing problem by focusing on being long with no leverage.
Each allocates capital to their skills. Business managers that dont short their sector in a recession are not poor managers - it is just they focus on the long term, rather than generating stable results on a monthly or quarterly basis. It is this preference that matters. Which depends on the skill of the manager, and the demands and expectations of the client. It is important this is well understood at the start of the relationship, or it will create problems just when their are enough problems already!Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-13428608993409763302012-05-08T12:55:00.001-07:002012-05-08T12:55:15.678-07:00Dont forget organisationInvesting is a difficult business.
The flux of information is large.
As a result, an important skill is categorising data for easy reference in the future.
To know what is likely to be useful, analysing this data, storing this interpretation for later reference to see how accurate the analysis was to assist in enhancing future understanding and knowledge, so past work helps to accumulate future understanding. To learn from others mistakes.
Sometimes the size of this task hits you, and one must think not only about investments, but how data is organised and sorted. This helps effciency and will, no doubt, over time contribute to performance.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-17906953459644499002012-05-08T12:47:00.001-07:002012-05-08T13:30:17.303-07:00The Turnaround Investment StrategyBuying a mature company whose stock price, and business fundamentals, in recent years have deteriorated is a high risk strategy. We are speculating that either (1) The business will improve more than the market believes, (2) that the deterioration has been exagerrated by the market and that the remaining earning power is being undervalued (i.e. that we better understand the business economics of the company than the market in general). We have a preference for category 2, as here we don´t have to fight the old adage, "turnarounds often don´t turn".
However, in this strategy downside risks may be larger than other investment categories. We may under estimate the loss of earning power from poor management, changing market structure or obsolescence of the companies products, services and skills. As a result, venturing into this area must result in a potentially very satisfying reward - we would expect to at least double our investment in the next 5 years (approx. 15% per annum).
We currently have two turnaround investments in portfolios. A defense company and an "old technology" company. Neither have significant leverage, hence have the ability to survive a financial shock in the short term should funding become difficult (i.e. less general liquidity as well as problems from their negative market label at the moment).
Turnarounds also have advantages. There stock price performance can be less correlated to the market as its fortunes are often more greatly influenced by internal changes rather than external changes (i.e. less influenced by the macro environment, especially if a non cyclical revenue generator).
Turnaround strategies must be followed more closely than other investment categories, i.e. relative to an asset play. We must be confident we are not seeing more deterioration than we expected - that the earning power we envisioned is still there and producing, that any changes to capital allocation are adding to sales and cash flow in a satisfactory manner. As a result, for such companies we closely follow quarterly earnings and the general news flow.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-11889412774440286292011-11-28T11:35:00.000-08:002011-11-28T11:44:07.781-08:00when are stocks mispriced?There are four principal reasons, using our inhouse language, why stocks are mispriced in the market.<br /><br />1. The accouting causes confusion to investors that won´t dig into the gory details<br />2. A risk factor is over or under discounted (i.e. fear of government expropriation)<br />3. Not understanding the business economies, hence the stability in the companies earnings, hence its quality of earnings<br />4. Growth potential is over or under priced into the stock<br /><br />Regarding point 2, we look and try to understand the following risk factors for a company:-<br /><br />Market risk<br />Real profits<br />Inflation<br />Economic cycle<br />Government<br />Technology<br />Regulation<br />Product substitution<br />Obsolescence<br />New competitor<br />Market structure<br />Currency <br />Non recurring affects (i.e. litigation, restructuring, accidents)<br />Final market demand<br />Insider actions<br />EPS relative to analyst expectations<br />Management record<br />Capital allocation<br />Business economics<br />Fraud<br />Stigma<br />AccountingAlessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-8640281417706187312011-11-28T10:31:00.000-08:002011-11-28T10:39:19.869-08:00Classify and categorise risks and portfolio structureOur database of interesting companies that seem to trade below fair business value is not what we currently spend most time on.<br /><br />Now that we have defined explicitily the risks we look for in every investment, and keep our eyes open for new ones, we determine what our exposure to different risks are.<br /><br />Be it government or barriers to entry in a business. <br /><br />We align this with the asset allocation of the portfolio in terms of exposure to investment strategies and different risks, as well as asset allocation.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-77267364990435528372011-11-19T00:03:00.000-08:002011-11-19T00:26:22.409-08:00Is 100% in cash safe?I hear many individual say the world is so uncertain at the moment it is best to be 100% in cash.<br /><br />Two main points.<br /><br /><span style="font-weight:bold;">Uncertainty always exists</span>. Sometimes people pay attention to it, sometimes they don´t. <br /><br />Often the media is the trigger that determines how much investors are concerned by uncertainty. When the media continuously talks about cancer you may be more fearful about getting cancer, but your probability of catching cancer has not changed by much (it may change a little after your reading if you change your lifestyle, i.e. stop smoking or put sun cream on at the beach). The same is true with investing. There is little you can do to stop uncertainty - hence it is uncertain.<br /><br />The way we fight uncertainty (the only sensible way uncertainty can be fought in our opinion) is by buying securities with a large margin of safety, i.e. buy cheap. If we don´t pay for growth in a company we think can grow nicely, we don´t get harshly punished if the growth rate the market expected is not achieved due to some unexpected factor!<br /><br />However, back to cash.<br /><br />We must remember, as we have discussed in past blogs, <span style="font-style:italic;">we are in a capital destruction environmen</span>t. Too much capital was created, lots of it was unproductive, it must diseappear to encourage new investment - hence it must be destroyed. The capitalist system allows this to occur.<br /><br />Depending on the path the capital destruction takes, different asset classes will perform differently.<br /><br />Debt destruction via haircuts would merit having a large cash position in the portfolio, whilst excessive money printing to keep economies from paying their debt would be a catalyst for equities.<br /><br />Capital is like water. eventually it will reach its targeted goal. Capital must be destroyed and if governments are against the idea of writing down sovereign debt it will happen via other means including currency devaluation, reduction in wages, reduction in asset values etc.<br /><br />Note how your cash would perform if:-<br /><br />The currency was excessively printed?<br />Your economy was to leave the eurozone?<br />Inflation kept rising whilst interest rates were kept artifically low?<br />Your bank went bankrupt?<br /><br />There are a number of extreme scenarios for normal times that are becoming more common in the capital destruction era we find ourselves in. In this era cash is by no means a risk free investments that allows you to maintain your quality of life. You must be aware of this.<br /><br />The value contained in being a 100% cash holder is being tapped by the authorities and distributed elsewhere. This is what money printing effectively does. Being 100% in cash is partially equivalent to being 100% invested in the authorities. <br /><br />Though we are ourselves large holders of cash in a number of currencies (on average 20-25% of portfolios due to our belief that debt writedowns are required in a number of economies) we hold the other 75 - 80% of assets in the securities of companies that are off bank balance sheets. <br /><br />Note cash can also be held off the bank balance sheet via money market or short term government bond funds (we hold some with an average duration of less than 1 month holding maninly German, Swiss and Dutch debt).Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-86882301828426440532011-11-18T23:53:00.000-08:002011-11-19T00:03:04.774-08:00The winners of globalisationIn an economy there are three main economic participants.<br /><br />Governments<br />Corporates<br />Households<br /><br />One can see by viewing the publically available GDP numbers of an economy how each economic participants is doing. For example, by looking at the income view of GDP data we can see the tax receipts of the government, the wages received by households and the profits generated by corporates are evolving.<br /><br />However, as we have stated in the past, we see many developments in economies, and hence GDP structure of economies, be significantly affected by the role of globalisation.<br /><br />Globalisation is a word so commonly used that the majority of the value contained within it has been destroyed. We simply see it as the reduction in barriers to move capital outside your home country to wherever you decide to spend/invest that capital. There are many consequences to this becoming easier and easier.<br /><br />However corporates are the economic participants that most enjoy the fruits of globalisation.<br /><br />Governments by definition are local, hence cannot invest capital abroad.<br /><br />Households are stubborn and don´t move easily to where the best paid jobs are for their particular skill set. Hence in Spain unemployments is over 20% whilst in China wages are increasing by 20% per annum.<br /><br />Corporates can choose to invest in any region of the world determined only by how profitable the venture is expected to be. Hence they are the winners of globalisation. It is no surprise they are generating record profits with record margins whilst unemployment is at record highs in developed markets and wages are increasing significantly in many emerging markets.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-8204995278021063982011-11-13T02:39:00.000-08:002011-11-13T02:55:08.050-08:00Current asset allocationCash <br /><br />In different currencies to offer diversifiaction and spread the economic risk and "government reaction" risk<br />We hold EUR, USD, GBP, JPY, HKD, CAD<br /><br />Bonds<br /><br />Little exposure to a few investment grade short term positions (<3 years)and a few perpetuals (tier 1, some have a few lower tier 2)<br /><br />Equity<br /><br />Most of our capital is allocated here. If currencies weaken (our cash) the equities will rise. If equities fall our cash will be worth more. Mainly non cyclical high quality stock paying dividends at least x3 current cash rate<br /><br />We also hold the equity of companies involved in the oil and timber business to have indirect exposure to commodities<br /><br />We classify portfolio by strategies and asset classes<br /><br />Cash (base currency)<br /><span style="font-weight:bold;">Cash non base currency</span> Currently very popular<br />Bonds<br />Cyclical equity<br />Non cyclical equity<br /><span style="font-weight:bold;">Commodities</span> Currently very popular<br />Macro strategies<br /><br />Net nets<br />Asset plays<br />Cheap defined free cash flows<br />High quality<br />Cheap normalised earning power<br />Cheap earning power (a reason the company is disliked which is not permenant)<br />Turnaround<br />Growth<br /><br />On a simple cyclical view of the DM economies. This is a time to have at least 50% in equities. People fear debt destruction can cause a deep panic. It will. It will create losses and slow down the economy. The destruction of capital in debt will also destory capital in equity for the economy. You need to make sure it is not your equity that gets destroyed.<br /><br />Cash/equities we are 40/60<br /><br />If governments print money this allocation will be enjoyed. If there is a serious of debt destruction events than we will suffer heavily in the short and maybe even the medium term.<br /><br />But we will have cash in hand to make it workAlessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-74577115578942780902011-11-13T01:35:00.000-08:002011-11-13T02:36:30.318-08:00The basic role of macroeconomics in investingThere are three main macroeconomic variables that really matter to any serious investor (almost irrespective of investment style).<br /><br />1. The growth of the economy (GDP)<br />2. The purchasing power of the currency of that economy (inflation)<br />3. The cost of borrowing/lending money in that currency (interest rates)<br /><br />Usually economic growth is very cyclical, where the cost of borrowing plays an important role in influencing the growth rate, as does the inflation rate (which often determines the cost of money). We tabulate this simple statement below and create 6 simple stages to a normal cyclical economy:-<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfdftSYM0W7S2FtfGbH6LsmZpwyrS8NcQsSFWmzJo3zZ0WyEjciA-o1ziNg-3MM62To9i6NBAJWVNr4gqyCuSqKLEKvG_buBXcgjuQaVqhLC3-chhda2DpjNjkeG8Q4SSt2WcKy-Cb8BUa/s1600/Macro+stages.jpg"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 194px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgfdftSYM0W7S2FtfGbH6LsmZpwyrS8NcQsSFWmzJo3zZ0WyEjciA-o1ziNg-3MM62To9i6NBAJWVNr4gqyCuSqKLEKvG_buBXcgjuQaVqhLC3-chhda2DpjNjkeG8Q4SSt2WcKy-Cb8BUa/s400/Macro+stages.jpg" border="0" alt=""id="BLOGGER_PHOTO_ID_5674413524594074386" /></a><br />We note that currently many developed economies are stuck in stage 5.<br /><br />It is as if the cycle will not turn anymore.<br /><br />The high debt burden these economies have accumulated have muted the role of interest rates to stimulate growth. The debt load itself is now the key variable!<br /><br />This is not a normal cycle. Structural change is required.<br /><br />This means changes to variables that determine GDP, interest rates and inflation.<br /><br />1. Such as the structure of economies (i.e. the role of imports and exports) <br /><br />2. How various economic participants allocate capital (i.e. households save more, governments spend less, corporates invest more in their country of origin if they become more competitive)<br /><br />3. Floating currency exchange rates to incentivise the flow of capital internationally<br /><br />4. Increasing productivity by increasing the knowledge of workers to help generate innovative soutions that can be sold internationally<br /><br />5. Compensating workers for their productivity not their existence<br /><br /><br />Reactions to the halt of the economic cycle have included massive money printing by DM authorities. However, much of these funds channel their way to regions that experience strong growth and have low debt burdens - emerging markets. <br /><br />As a result these countries are experiencing strong inflation which may be exported to DM. Hence DM may experience no growth, no change in interest rates but increasing inflation. This reduces the demand to hold the cash and bonds of these economies. Hence we see weakness in currencies such as the USD and GBP. This is positive for the equity markets of these regions.<br /><br />However such action is increasing the need for CURRENCY DIVERSIFICATION (especially for simple cash holdings) and exposure to REAL ASSETS. <br /><br />Hence more investors are becoming MACRO ECONOMIC INVESTORS.<br /><br />It is normal. There are big macroeconomimc problems and they cannot be ignored.<br /><br />This is made all the more difficult because in DM interest rates are zero. Hence bonds offer very little. It is cash or equities. <br /><br />Since cash could be diluted by imported inflation and many investors are worried by growth (hence worried by equities)- FX and COMMODITY investments are becoming ever more popular.<br /><br />I understand.<br /><br />In the end, by investing in FX and COMMODITY products you are investing in an area where the cyclical properties still seem exist (hence you feel it is more predictable), so feel more comfortable than being somewhere where the cycle seems to have stopped and you don´t know what could happen (the great uncertainty we keep hearing about).<br /><br />Many also invest in EM because they do not see a structural change there but a simple cyclical one, which again they feel more comfortable with.<br /><br />However one needs to be very careful with price when buying anything cyclical.<br /><br />This is made all the more difficult when commodities do not generate any cash output, it is simple attempting to guess what it is worth tomorrow. Many assume the dilution of cash from money printing and the belief that demand in the future will not be less than today will protect them against a capital loss. A bout of deflation from debt destruction by a number of economies to reduce their debt load would destory that idea and lead to many an unhappy customer. Furthermore, in this scenario demand in the future would then be more likely to be less, not more than today for quite some time.<br /><br />FX. I don´t know. I just dont have enough knowledge in every economy in the world to make judgements about them.<br /><br />But, don´t forget that high quality companies in the right market structure with a mis priced valuation and a strong management team also offer a good opportunity for investing - and are more stable in the long term, unlike FX or commoodity investments. Managements can react, a piece of metal can´t.<br /><br />One more point.<br /><br />Oil is the key to globalisation.<br /><br />Items are connected to different regions by transporting them there.<br /><br />Oil is mainly used to transport physical items.<br /><br />If you think globalisation will continue, be long OIL in the long run.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-89996575985725888382011-10-06T13:56:00.000-07:002011-10-06T13:59:57.446-07:00Macro, market structure the business: factors that determine returnsStock prices are primarily determined by <br /><br />Inflation. Affects costs as well as ccy. Need to ask if ccy looks expensive<br /><br />Real gdp growth. Which determines ernings growth if sales are in the that country (or the countries they do business in)<br /><br />Multiple, ie the price you pay<br /><br />If sell abroad to economies that are growing strongly<br />Have costs in a weak growth economy where wage growth is slack<br />And your performance is measured in a weakening ccy<br />Then you have an interesting combination<br /><br />This is what GE has!<br /><br />The above are the macro factors<br /><br />Then add on the market structure factors particular to a certain industry (i.e. may have a stable structure which gives more visibility on future free cash flow generation)<br /><br />Add on individual company factors such as management, the price, allocation of capital, the business model, cost management, pricing power, sales forceAlessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0tag:blogger.com,1999:blog-153790219238536657.post-54467188855932242722011-09-17T08:39:00.001-07:002011-09-17T08:44:45.915-07:00Comparing potential cash outflow in 5 years to current market capI noted in a recent article published by Bestinver that they place importance on comparing the market cap of the company relative to the cash and cash equivalent assets of the company a number of years in the future (2012 in this example).<br /><br />We like this approach.<br /><br />If we take a companies net assets and modify their value to current valuations (conservatively), and then add the free cash flow we feel can be achieved over the next 5 years, we can compare this sum to the market cap at the moment.<br /><br />For example a company that achieves a 20% return on equity consistently that has a conservatively valued balance sheet and can be bought for x2 book would be good value under this approach. If they held hidden assets on their balance sheet it could be an exceptional investment.Alessandro Sajwanihttp://www.blogger.com/profile/18366574639899654814noreply@blogger.com0