I always try to read everything that Jeremy Grantham’s GMO publishes, but I somehow missed this one until it was republished on Meb Faber’s Idea Farm. Good stuff: Don’t Act Like Stalin.
Lot’s of good takeaways (as always). GMO’s main point was that chasing recent performance is a game you can’t win. All good strategies (and good managers) have periods of outperformance and underperformance.
But while chasing performance is a terrible move, so is sticking with a bad strategy or a strategy that is likely to be a lousy fit in a given macro environment (i.e. owning bonds in an inflationary environment or owning gold and commodities in a severe disinflationary environment).
This is where communication is important. Talk to your manager and ask them to explain their strategy. If it’s outperforming, ask them why. If they can’t explain it (or if they get excessively cocky about it), I’d question how sustainable the performance is. You might want to bank your profits and move on.
Likewise, if they’re having a bad year, ask them why. If they can’t explain it, they get overly defensive or their answer just doesn’t make sense, don’t hesitate to cut them loose. But if their strategy makes intuitive sense to you and it offers diversification alongside other strategies you’re running (that great alchemy of uncorrelated returns!), then give the manager a little leeway.
Not for the manager’s benefit, of course. His or her wellbeing is not your concern. But if you employed them for a reason (i.e. their strategy tends to zig while the rest of your portfolio zags) then you should hang on long enough to get the expected benefit.
As a case in point, Grantham and his team lost half their assets under management in the late 1990s when value lagged growth. But Gratham absolutely killed it in the years following the tech crash… and his former clients that bailed on him missed out.
Prospect Capital’s (PSEC) latest earnings release didn’t do much to improve investor sentiment toward the stock. It remains mired in trading range and sits are barely 70% of book value.
PSEC has long been accused of being a little more aggressive than its peers in valuing its assets. But even so, at these levels it is safe to say that Prospect is trading at a deep discount to the value of its underlying portfolio.
We all know it’s a tough market for business development companies. Funding costs are rising at a time when yields on investment are falling due an glut of capital in the space.
So, here’s a novel idea for management: Halt all new investment and instead plow the proceeds into share repurchases.
I’m not joking. Prospect shares yield 11% at current prices, which is about in line with its new originations. But it also trades at a 28% discount to book value and is diversified. So why accept the risk of a new origination if you can simply reinvest in your own shares and be done?
Stock buybacks get a bad reputation — and justifiably so. It seems that for most companaies, a share repurchase is little more than an expensive mop to soak up share dilution from executive stock options or other share-based compensation.
So, it’s refreshing to see a company like LyondellBasell Industries (LYB). When Lyondell announces a share buyback, they mean it. The company has reduced its share count by about 10% per year for the past three years while also raising its dividend by nearly 20% per year.
That’s a company that takes care of its shareholders.
With market volatility picking up this past week, now is as good a time as any to review why it’s important to take your losses early.
Gain Required to Break Even
If you lose 10%-20% in a trade, it’s not that hard to recover. It only takes 11% – 25% to get back to where you started.
But if you lose 50%, you need 100% returns to get back to break even. Or if you lose 97% — as Bill Ackman recently did in Valeant Pharmaceuticals — you’d need a ridiculous 3,233% on your next trade just to get back to zero.
I have a select few stocks in my portfolio that I’m truly willing to buy and hold, tolerating whatever volatility the market throws at me. As an example, I own some shares of Realty Income (O) that I will never sell. I’m reinvesting the dividends and letting them compound, and I’m willing to sit through a significant drawdown.
But for the lion’s share of my portfolio, I take my losses early. I’ve taken enough losses over the years to learn that lesson the hard way…
Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.