Investors in 2015 may be forgiven if they feel like bobbleheads. The volatility of the markets, the speed with which opinionholders dispense information about any event (some of it even accurate) and the sheer volume of too much data can make our heads, and our thoughts, swing too rapidly hither and yon, leading us to trade wildly, making brokers richer and investors poorer.
Of course, there are investors who claim they do not care one whit where the markets are or at what price their securities are selling. They take pride in spending no time studying the ways of the market but, rather, seek only to match the long-term performance of the market in which they choose to invest and let the chips fall where they may when there are corrections. Many such investors are adherents of John Bogle’s approach to investing and delight in calling themselves Bogleheads. Whenever I disagree with the premise of that thinking, “the phones are sure to light up” and the comments section will be filled with righteous indignation or derision from these acolytes.
The idea of buy-and-hold passive investing and holding a broad brush of securities is hardly new — but its popularity waxes and wanes with the market itself. For instance, whenever the U.S. stock market is doing well as (until this year) it has since March 2009, people who invest with a rock-steady eye on the rear-view mirror will pound the drum for passive investing via the cheapest ETF.
But how many of these investors, or their predecessors, really did hold on to their portfolios from October 2007 to March 2009 — and if so, what in tarnation were they thinking? As you might recall seeing the chart below, that was a particularly terrifying slide of a minus 53.5% in less than a year and a half. Buying passive index ETFs and holding is popular yet again, looking at the rear-view mirror back only as far as 2009, but those looking backward in March 2009 abandoned this strategy in droves.
There has to be a better way of investing than either day trading between biting one’s fingernails to the nub or stubbornly clinging to the notion that it's OK to hold on during a 53.5% roller-coaster decline because, after all, “the market always comes back.” (It’s true that the market came back after 2009, but it took five years, four months and 15 days to break even, not allowing for inflation. Not very helpful if you plan to retire in five years!)
My strategy is different. While I would “like” to be able to buy ETFs that do all my thinking for me and spend my time skiing, diving, hiking and traveling, at my age I really can’t afford to see my portfolio decrease 53.5%. Can you?
That’s why my approach is an active one. I may tactically employ index ETFs, ETNs or mutual funds to realize my investing goals, particularly in areas in which I do not have the technical knowledge to differentiate among the contenders. In biotech, for example, I’m happy to own a basket of health care firms that includes pharmaceuticals, biotechs, hospitals, etc. I will also, at those times when I see a short-term opportunity for the entire market, use index funds because their greater liquidity allows us to be nimble without paying too much in bid/ask spread to do so.
So my overarching strategy, of necessity, is to be an active participant. I use far more actively managed mutual funds and closed-end funds to populate the foundation of my own investing pyramid, while selecting individual companies’ stocks that are sector leaders for the very top (and relatively smaller square footage!) of that pyramid.
With this approach my firm, and I as chief investment officer, has to be better at picking winning companies than those who merely mimic the averages. In doing so, we seek the best companies in the best sectors as measured by growth in revenue; growth in real (as opposed to merely per share) earnings; honest and capable management, preferably with skin in the game; companies that reinvest earnings in capex, research and development or other avenues of enhancing future value (versus, say, borrowing money to buy their own stock to goose earnings per share); a rate of return that exceeds its primary competitors within the sector, and, finally, companies that represent good value for the price we pay.
In my experience all sectors go through periods of price contraction. Assuming the above factors are met, if the sector encounters short-term headwinds, that’s the time we like to buy. Of course, this often means we might be early in our buying. This doesn’t bother any of us if our analysis of all the above suggest there is unlikely to be a better time to nibble or buy or buy in size.
An example today might be the energy sector, down a whopping 21% year to date. Another would be the content creators and distributors, down because the assumption made by many is that, with the Internet, entertainment and content will become more distributed, lessening the value of creative offerings by the best in the business. When the entire sector declines, that’s the time we like to pounce on the best of the best; companies with the strongest balance sheets will pick up the pieces of firms more highly leveraged and, in so doing, will concentrate even more talent under their roof.
Our goal is to pay a fair price for a good-to-great company, not a priced-for-infinite-growth price for a great company. There is no doubt that Amazon (AMZN, Financial) is a brilliant company. I respect the company, but it simply isn’t part of our strategy to pay a massive premium for assumed eternal growth. Sooner or later, success breeds competitors, some with very deep pockets. I remember when University Computing, Polaroid, Xerox and so many more were alleged to have first-mover advantage “unassailable” moats. The funny thing about moats is they can dry up or be forded. Somehow I don’t see deep-pocketed Walmart (WMT, Financial), Target (TGT, Financial) and others rolling over forever in the online world. Give me a solid company at a fair price any day,
I’ve written extensively about energy firms before and will again. For all the years I’ve been in this business, I’ve listened to people saying that oil and natural gas are done for. Never happened. Won’t in our lifetimes. If somebody wants to sell me Chevron (CVX, Financial) at $75 (it’s August low was $70), I’ll back the truck up. If someone wants to sell me their Exxon (XOM, Financial) at $72 (its August low was ~$69), I’ll back the truck up. Will I hold them forever? No, but I believe I’ll make a fine return until the next time investors panic out of a basic need like energy.
So, to answer the question I posed in the headline, “Should You Be a Passive Investor These Days?” my answer is: absolutely not. I am out of sync with the current black box, quant and robo-advisor thinking so much in vogue today, but I am in sync with the likes of Benjamin Graham, John Templeton, Warren Buffett (Trades, Portfolio) and Peter Lynch, all of whom sought the best companies at the best price and held them until they no longer offered exceptional value. I’d rather be in the company of such as these any day over the current “You can’t beat the market so don’t even try” crowd!
In my next article, I’ll answer the questions, “Who are the best entertainment and content providers?” and “Are any of them worth buying?”
