In the first episode of “The World According to Boyar,” host Jonathan Boyar sat down with Chris Mayer, the chief investment strategist of Bonner & Partners. During the podcast, Mayer discussed “The Coffee Can Portfolio,” an article by Robert Kirby that appeared in The Journal of Portfolio Management more than 30 years ago. Here’s the key anecdote from Kirby’s article:
“The Coffee Can idea first occurred to me in the middle 1950s when I worked for a large, investment counsel organization, most of whose clients were individuals. We always told our clients that we were in the business of preserving capital, not creating capital. If you wanted to get a lot richer than you already were, then you should hire someone else. We were there to preserve, in real terms, the client’s estate and the standard of living that it provided.
And, indeed, we were. The investment counsel business, as it is traditionally practiced, and probably as it should be practiced, is a simple process of making sure that clients never have so much risk exposure that their capital or standard of living can be impaired by some specific negative surprise. In other words, as your most successful investments grow in value, you make partial sales and transfer the capital involved to your less successful investments that have gotten cheaper. The process results in a stream of capital being transferred from the most dynamic companies, which usually appear somewhat overvalued, to the least dynamic companies, which usually appear somewhat undervalued.
The potential impact of this process was brought home to me dramatically as the result of an experience with one woman client. Her husband, a lawyer, handled her financial affairs and was our primary contact. I had worked with the client for about ten years, when her husband suddenly died. She inherited his estate and called us to say that she would be adding his securities to the portfolio under our management. When we received the list of assets, I was amused to find that he had secretly been piggybacking our recommendations for his wife‘s portfolio. Then, when I looked at the total value of the estate, I was also shocked. The husband had applied a small twist of his own to our advice: He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it.
Needless to say, he had an odd-looking portfolio. He owned a number of small holdings with values of less than $2,000. He had several large holdings with values in excess of $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio and came from a small commitment in a company called Haloid; this later turned out to be a zillion shares of Xerox.”
Those numbers are quite impressive. Over the course of 10 or 15 years, some of the positions ended with a 20-fold increase in value. And one was even a 100-bagger (in case you’re curious, turning $5,000 to $800,000 over 15 years is a 40% CAGR). Assuming a 20-stock portfolio (starting at $5,000 per stock) where three went up 20x, one went up to $800,000, 11 doubled to $10,000, and the remaining five lost half their value, that’s good for $1.2 million – an increase of 12x over 15 years.
The practical problem for investors is that to achieve those outcomes, you have to actually wait fifteen years for those returns to materialize (and obviously you don’t know the outcome in advance). That would probably include multiple periods where your largest holdings are down 20% or more, all while your spouse, clients, or some guy on TV is telling you that you should be doing something. It’s a lot easier to live with two or three major drawdowns in theory than it is in practice. The same goes for a quick “paper gain” of 50% that you don’t want to see disappear.
Volatility, which is a necessary condition for the creation of investment opportunities, is a blessing and a curse. That's the reality of being a human being (as opposed that elusive “rational man”). And research has shown that applies regardless of how smart you are.
What can we do about it? Once thing I’ve noticed is that many of the investors I respect tend to set fairly strict rules that dictate how they react to short-term market movements. Clearly they recognize that we’re all tempted by short-term market volatility. Here’s an example from Geoff Gannon:
“Selling is something I struggle with. But, it’s something I’ve gotten better with over time to the extent I decided on three things… One, never sell a stock within the first year of buying it… The guiding principle is: Don’t sell a stock before you let the original thesis play out. The ironclad rule is: Don’t sell a stock within a year of buying it.”
The rebuttal is clear: “But what if it doubles in six months and it’s trading at a huge premium to my fair value estimate?” That can happen – and I think Gannon would say that’s a price he’s willing to pay. What the “ironclad rule” prevents you from doing is selling in the much more likely scenario where you buy a stock and you’re suddenly looking at a 10-20% gain after a lucky couple of weeks. His rule gets you out of the trader mentality. There’s no asking, “Should I at least take some off the table?” Committing yourself to at least a one-year holding period keeps you firmly focused on the long term (what Geoff calls an “investing mindset”).
That same idea is what draws me to the “Coffee Can Portfolio.” It’s an approach that gets you out of the trading mindset and into the investing mindset. In today’s world, I think that’s often easier said than done (even when we don’t want to admit it). Instead of worrying about precise estimates of price-to-value or 10-20% moves in the stock price, do whatever you can to focus on the long-term prospects for the business. Focus on finding great businesses at reasonable prices that you can stick with for years (and through inevitable bouts of market volatility).
Kirby hits the nail on the head when discussing the value of the “Coffee Can Portfolio:"
“The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the coffee can to begin with.”
That’s an interesting way of framing the decision. When you can’t sell, it really matters what you buy. It’s a variation of Warren Buffett (Trades, Portfolio)’s 20-hole punchcard. The point is that thoughtful decision-making, especially when you’re making a long-term commitment to that decision at the outset, is likely to produce high-quality outcomes over the long run.
Conclusion
Today’s investor lives in a paradise of endless access to information and near-zero transaction costs. But I think these benefits have their limits. For example, it was much easier to stay away from the endless stream of noise when you only received information (or a stock price) once a day in the newspaper. In addition, low-cost online trading lends itself to increased portfolio turnover (especially tinkering with position sizes after big moves); I think it’s a safe bet that this activity, over an investment lifetime, will detract from the results of the average investor.
As with most things in the world of investing, this isn’t black or white. I don’t think the “Coffee Can Portfolio” is flawless (think about how that huge position in Xerox would’ve performed over the ensuing decades – the type of “negative surprise” Kirby referred to). But I think there are a number of positives in this approach that may be helpful for investors.
Specifically, I think the long-term, buy and hold nature of the “Coffee Can Portfolio” is likely to be beneficial for most investors; take Gannon’s “ironclad rule,” but extend it out over a longer time horizon. I view this a hybrid of active and passive investing that forces you to think differently than most market participants. Concerns about a short-term unexpected increase in cost of goods sold fade away as you focus on the question that truly matters: Where will this company be five, 10 and 20 years from now? If you can correctly answer that question, everything else is just noise.
Disclosure: None.
