Big Mistakes – The Best investors and their worst Investments
Big Mistakes – The Best investors and their worst Investments
One of the best books I recently read about investing is from Michael Batnick, which writes in his blog https://theirrelevantinvestor.com/ .One common problem for investors is that they commonly fall into the authority bias, and hero worship <The Greats>, or any new upcoming charismatic personality that is been promoted on CNBC Twitter and Bloomberg, instead of vetting their long term performance or their flaws. I personally find the story of Bill Ackman particularly fascinating and will follow up with a separate post on his hits and misses. This book provides a good reminder that even the best investors are merely human and makes the same mistakes as any other, and the wise learn from other’s costly mistakes than to make one themselves. There is a great quote from this book which I take it to heart.
<The difference between the normal investors and the great investors, is that the normal ones are setback by their mistakes, while the great investors learn and grow from them>
Most useful takeaways based on my interpretation
1) Michael Steinhart, Stanley Druckenmiller, Jesse Livermore
Importance of understanding the limits of your circle of competence and NOT step beyond it.
Trading in commodities and cyclicals required specialised skills and knowledge. Some industries / asset classes can simply be too hard to analyse and move too fast.
Importance of selling your losers and keeping your winners. Important to set your own trading rules and not breach it even if you are on a winning /losing streak. Importance of Risk management.
2) Benjamin Graham
Leveraging up on bull market and hit by the great depression. Catastrophic losses leading to the publication of the Intelligent Investor. Chapter 8 and Chapter 20 <Margin of safety and Mr Market> still relevant regardless of market conditions.
Graham’s portfolio consist of cigar butt companies that are worth more dead than alive, with a focus on working capital, and utilise activist shareholder approach to liquidate the company to unlock value. But his best investment is the anti-thesis GEICO which has huge runways to grow and requires heavy reinvestment at the on start. There is more than one route to investing success.
In his 1976 Interview, Graham lamented on the obsoletion of his deep value formula and is almost a believer of the Efficient market Hypothesis. What worked in the past may not continue to work.
3) Warren Buffett
I believe Buffett is a way better investor than me as he has an internal mechanism to weigh the probabilistic risk-reward and the payoff to strike into a deal like underwriting an insurance contract. However, this also leads to occasional blow-ups when he did not adequately size the moat and the quality of the business before buying it. For example, even though he had bad prior experiences with the airlines industry, he invested into it when the competitive landscape is stabilised and achieving operational leverage pre-covid. That did not turn out well when Covid hit.
Moats of the businesses will eventually erode over time. Investing is a huge mix of luck and skill and extrapolating past success in an industry too far out does not always work. In the book, the success of HH Brown and Lowell Shoe did not extend to Dexter shoes. In the more modern context, he also invested in Precision Castparts and Kraft Heinz which has significant goodwill write-offs when he misgauged the future cash flows of the business.
Drawing lessons for concentrated investors like the original Sequoia fund and Charlie Munger, Buffett has the tendency to bet big on his high conviction investments. Despite his prodigious ability and intuition, errors in valuation are inevitable. Better investors than me using this approach has blown up and dissipated in the annals of financial history and reputational ruin. I do not think I am as good as Buffett and seek to limit my investible universe to higher quality business and be more diversified with position sizing limits in my portfolio.
Although disciplined in his circle of competence, it is hard for him to pick up new tricks <Alphabet Apple> although he understands the economics of the business well. When Larry and Sergey approached Warren Buffett post IPO to restructure Google to Alphabet in 2015. Buffett and Munger understood the business model and the quality of management but was too set in their old ways and missed out to invest in a business model they understand, works well and is immensely profitable. Apple was a prompt from Ted and Tod who assessed that Apple value is derived from its premium brand and customer stickiness rather than just an average electronics company which is highly vulnerable to technological obsolescence. This insight proved to be correct in hindsight.
4) Jack Bogle
Prior to Vanguard, Bogle was running the Wellington fund. Caught up with the Go-go hype, he had a strategy switch from a balanced fund to momentum fund. Bogle innovated with <innovative strategies> like the speculative growth fund <Ivest fund>, Technical analysis funds, which blew up when the hype died down. This led to the permanent impairment to the brand of the Wellington fund which went through 1966 – 1976 lost decade.
On a positive note, his losses and his experiences led him to come out with an alternative <Index fund> approach which disrupted the investment industry. There is a certain irony that the unmanaged S&P 500 has trounced most professional fund managers over the past decade as it held the strongest growth companies, with minimal costs and turnover.
5) Jerry Tsai – Fidelity top <Momentum> fund manager => Manhattan fund
History often celebrate the winners and forgets its losers. Jerry Tsai was mentioned in Beat the Street and was the same generation as Peter Lynch. But unlike Peter Lynch which retired at the height of his performance, Jerry Tsai overstayed his welcome.
Attribution bias. Confusing a bull market run with his own investment ability. Momentum trading and supernatural market timing may not work in all market conditions.
Completely ignore valuations, quantitative metrics of its financials, in favour of the narrative. That did not turn our well when the <metagame> stitched from narrative to numbers.
6) John Meriwether – Long Term Capital Management
As LTCM proprietary arbitrage strategies massively outperformed the market, key employees are being poached by rival firms and was leaking alpha to them. The out-performance diminishes over time.
There are issues with scaling their investment strategy as the opportunity set decreases and AUM inflow massive spiked up. The manager refuse to cap the fund size / inflows in favour of fees.
As the strategy tends to be successful on most days, the trades are increasingly exposed to higher leverage limits and position sizing. There is over-reliance and overconfidence on mathematical models which cannot price in fail tail black swan events. As the opportunity set is limited, company began taking directional bets rather than arbitrage bets. This did not went well when commodities prices crashed and Russian government defaulted.
7) Keynes the macro-economist VS Keynes the investor
One of my earliest post led me to study John Maynard Keynes, a prominent thought leader in the history of economics. I never really understood the idea that retail investors like to pretend that they can predict macroeconomic trends and outcomes, when Alan Greenspan from the Federal reserve cannot predict interest rates and one of the best economists from the previous century failed in currency and commodities trading dismally despite his best efforts.
One important lesson from this <Keynesian beauty contest>, is that it does not matter whether you pick the most beautiful lady as your choice, but rather estimate the mass psychology of the participants, and the second derivative of the meta-game / meta strategies that the participants are playing. This means the stock price can deviate from fundamentals indefinately for penny stocks or companies not trading based on fundamentals. Occasionally, it does not matter whether the financials are sound or the management is right. Companies such as AMC going into certain bankruptcy, or Gamestop executing a turnaround, is just an excuse / rallying call for predatory traders to execute momentum strategies or <Mother of all short squeezes>. Stocks that have lousy fundamentals can simply run up indefinably prior to MSCI inclusion, and get sold off once the upside of this <institutional bag holder> is exploited. This influenced me to abandon Top down Macroeconomic analysis, and stay out of penny /meme stocks when I started my investing journey.
8) Author <Michael Batnick>
Although not one of the greats, Michael Batnick is true to the theme of his book and provided a brutal take-down of his personal mistakes. It is refreshing to see intellectual humility and honesty unlike most books which are thinly veiled puff pieces. As there are huge similarities between the path he has taken and mine, I personally find this part the most relatable.
Personal Life Lessons
Intellectual smart but too complacent and laid back in his early years. Entered into the school of hard knocks but got himself together eventually. Admission that luck and randomness can greatly affect the chances of securing opportunities in life.
Graduated at the onset of the Great Recession in 2008. Got into a wrong career choice of a financial planner <Insurance product pusher> and wasted the first part of his career. Failing to investigate the competitive landscape for entrants into wall street <lacklustre resume>, hoping the CFA alone can get him into investment decision roles. Should have done more to network after passing CFA level 1. Overconfident of his financial industry experience and expecting the CFA bell curve to reward him for <Real experience>. And failing his level 2 despite best effort basis.
The idea of becoming the next Paul Tudor Jones is much more appealing than an index investor. I admit this is a possible trap I may be falling into. I believe in the possibility of outperforming index funds via active investing but the market frequently finds opportunities to teach its participants about humility and how wrong their original ideas are.
Common investment mistakes
It is Better to learn mistakes fast from other people, then spending decades losing money trying to figure them out.
Illusion of control. Day trading too much and spending too much on commissions and capital gains taxes. Having the perception that trading more will affect the results directly.
Not understanding the underlying product and trading 3x leveraged ETFs, which is a product with significant leverage expense ratios and prone to wipe-outs in severe price corrections. Not having a consistent core process and strategy but borrowing too many ideas from vastly different investment styles. Mixing Macroeconomic analysis and bottom-up analysis.
Misinterpreting the hype generator in CNBC and Bloomberg as ideas generation, instead of a rumour mongering hub that generates portfolio churn. Going into twitter and social media for <Established traders and tips> and not recognising the amount of fraud and charlatans there. This is compounded by the loose accounting and misrepresentation of their investment performance, their track record of success and failures, and the way they live in pretence and self-denial.
Price anchoring and missing multi-baggers. Cutting the flowers and watering the weeds.
Overconfidence bias. Taking short term trading success <shorting Netflix via weekly options> and earning huge amounts of money in a short time as a measure of skill. Failing to understand time decay of options and short-term unpredictable nature of markets, and 76% of options expire worthless.
It does not matter whether you believe you can predict macroeconomic events. You still need to be able to gauge market sentiment and predict future prices based on that event.
Not having a sufficient Warchest / lockup account to allocate cash for short term immediate needs <Preparing for wedding and housing>. The market does not care about your plans and can crash at any time without your approval.
9) Review on my Potential Mistakes
1) Value investing is naturally contrarian. I am a Natural Sceptic and try to avoid overcrowded areas and trades. I dare to be great but also run the risk of ruin. Just because you are contrarian does not mean you must bet against the horde, unless you have strong evidence and thesis that the market is underappreciating the growth story / overreacting to negative news.
On hindsight, I had some successes in Singapore by buying undervalued infrastructure assets trading at net cash and properties during the interest rate hike in 2016 <Ascendas REIT>, and benefited from the huge offshoring megatrends despite the perceived forex risk at 2017 <Ascendas India Trust>. My best performing region is HK/CN as I ventured into HK/CN market when the narratives is at its worst between 2019 and 2021. Ironically, Singapore is my worst performing region despite being my home market.
I had bad experiences investing in Singapore Blue-Black Chips like Hyflux and Singtel and STI ETF when they were cheap but continue to deteriorate over time. The conclusion I derived from my results is to diversify away from Singapore as there is lack of strong and unique business models with huge runways to growth. There are limits to Fundamental analysis and the diminishing returns associated with deep dives, and the underlying business can be crummy no matter how hard you look into it. To compensate for my limited visibility in foreign markets, I make a conscious choice to hold ETFs as broad <Hunting ground> exposure.
2) I have a tendency to take too much time on long term decisions, and mentally short the idea or try to debunk it. However, once I did a sufficient level of fundamental analysis and scuttlebutt and believe my reasoning is right and the core thesis is still sound, I tend to stick to it through thick and thin. When I make a trade, I try to prolong the holding period for as long as I can unless the core thesis is breached <Diamond Hands syndrome> . This makes me naturally suited for index investing and Buy and hold, and I had successful picks which unlocked value over time.
However, When the market metagame / narrative shifts rapidly, I might not be as adaptable as momentum traders to adapt to the narrative. This makes me a potential bag-holder for lousy assets / stocks that changes from market darlings to out of favour . This also makes me unsuited for cyclicals and fast-moving industries / asset classes / commodities and cryptos.
I may jump onto a good investment idea late when that idea has been priced in by the market. This characteristic makes me unlikely to chance upon severely undervalued compounder stocks as I may wait for a number of quarters / years for the numbers to prove the narrative, and the lindy effect to kick in.
3) Commitment bias that was practiced by Mark Twain. Once I like the stock or a particular idea, I tend to speak positively of it and promote the merits of it. However, I can love the stock, but the stock will not love me back. I am susceptible to errors of judgement like many other. If I do not rely on market prices as a reliable feedback mechanism, I could be stuck with value traps indefinitely with none the wiser.
The Internet and Google is also not helpful as it reinforces the closed feedback loop system instead of presenting 100% objective data. Analyst reports are inherently bullish and there is significant anchoring bias if I look at narratives, investor presentation reports and Seeking Alpha articles rather than the numbers first. My current approach is to use an investment forum with seasoned and credible investors to get feedback on why others might not like the stock and mentally short them without my bias at play.