On January 19, Matt McLennan, portfolio manager of the First Eagle Global, Overseas, and U.S. Value Funds, in addition to being the successor of famed investor Jean-Marie Eveillard, appeared on WealthTrack with Consuelo Mack (here). When Consuelo asked him about volatility in equity markets, Mr. McLennan responded with something that’s worth talking about:
“Within equities, the volatility of markets is enabling us margin of safety opportunities; ultimately, we build wealth by buying good businesses at good prices, and so paradoxically it’s the volatility of equity markets in these uncertain times that’s giving us wealth building opportunities... Among the stocks that we own in the portfolio, if we have windows of negative volatility, that obviously provides us with an opportunity to selectively commit more capital to businesses we know and like and understand…
Many of the companies are very resilient; they support strong embedded market positions (often with 40, 50, 60 percent market share), they have fortress like balance sheets with net cash, not net debt, they have management teams that are prudent and rational and incrementalist in their behavior (rather than expeditionary), and we understand them; and if you own businesses like that, then the volatility ought to be less distressing.”
What McLennan said brings up three things that I think are important to recognize; the first is the focus on protecting against risk (meaning permanent loss of capital), while welcoming the opportunity that market volatility provides. Compare this to the average retail investor, who is generally concerned solely with the potential upside of a security, yet cringes at the chance to add to their holding of that same business at a cheaper price. Value investors who follow Ben Graham’s teachings know that Mr. Market is your friend, not your enemy; for many investors, this relationship is flipped on its head due to illogical reasoning and the failure to see a stock for what it really is: partial ownership in a business and the cash it will generate in perpetuity.
Another thing that McLennan points out is that simply buying more of a company as it becomes cheaper isn’t a move for success; the focus is on companies with dominant market positions, with an additional layer of security in the form of a strong balance sheet and a prudent management team. Ironically, these companies are likely to be those that are the least volatile, and increasingly attractive for those investors who clamor for stability; but sense these companies aren’t high flyers with the potential to quadruple their earnings in the next couple of years, many retail investors pass on them and instead buy “lottery ticket” stocks (that over time tend to payout just as poorly as the real thing…).
The final point from McLennan’s remarks that I found instructive was his mention of buying businesses that you understand. Some readers will look at something like this and think “but of course”, yet find themselves considering an investment in the newest cloud computing or solar energy name next time CNBC touts its potential (again, the focus on reward instead of risk). Peter Lynch used to have an effective test for avoiding what he couldn’t understand: Never invest in any idea you can’t illustrate with a crayon.
All of these points are embodied in McLennan’s final comment: Doing these things will help you act rationally during periods of distressing volatility. Emotion-based investing, which is generally value destroying, tends to spring up during periods of euphoria and distress; for the intelligent investor, investing in understandable businesses surrounded by a strong moat is key to maintaining a focus on the long term goal and avoiding the diversions along the way.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "Patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.