“Some the biggest variances are made when people are asked about their feelings about hypothetically losing something - like their life’s saving - and actually losing every penny they’ve saved over 40 years of work. We actually see physical and mental reactions so profound in their differences they could literally be as vital as life or death in their outcomes.” - Dr. William Hunnicutt
“Mishaps are like knives, that either serve us or cut us, as we grasp them by the blade or the handle." - James Russell Lowell
My mistakes of 2019
Sometimes I think my investing career is a lifelong venture in showing future investors what not to do. Whether it be too hasty in making decisions to being slothful in my investment process, it seems the sheer number of mistakes never decreases. Like Mr. Lowell’s knife, I seemingly nearly always catch it by the blade.
As I look back at each year, I have a tendency to outline my mistakes and discuss what I’ve learned from them. Let’s face it – making the same mistake over and over – and not learning anything isn’t anything to boast about. But there it is. A seemingly never-ending amount of mishaps, do-overs and outright conscious catastrophes that lead to some real doozies over my career.
I’m happy to say there were no real bone-headed moves this year. Over time, you realize mistakes can fall into certain buckets. There are some that lead to permanent loss of capital, which are the hardest to explain away. These types of mistakes call into question your judgment. The next are those which clearly violate the client’s risk or guidelines. These types of mistakes call into your ability to listen and meet the fiduciary needs of your client. The last type of mistake is making a transaction when you don’t really need to. These are unforced errors.
I can confess this year we had several of the latter type, but none of the first two. While consoling in some ways, I’m pretty sure our investment partners would like to see none of the three I outlined. Here are three mistakes I made this year as well as the general characteristics of each.
The markets can remain positive longer than you can remain negative
Maynard Keynes once said the markets can remain solvent longer than you can. This is a corollary to Keynes’ theory. I’ve remained convinced - since at least 2015 – the markets are overvalued and prices will eventually reflect this overvaluation and drop dramatically. I’ve never shorted a stock in my life (and this is more relevant to Keynes’ comment), but I have held a significant amount of cash in my investment partners’ portfolios. This has certainly cost them significant gains over the past four or five years as they’ve missed considerable market gains. The only positive I can see that comes from this mistake is that cash anchors as much on a downside as it does on the upside. I’d like to think that when the inevitable downdraft arrives, my portfolio partners will be far less impacted than others that were fully invested in overpriced markets.
Cash is a lifesaver in down markets, a boa constrictor in up markets
The first lesson is to always understand that cash can be a tremendous lifesaver in a market crash (cash doesn’t lose a thing on the downside), but it can hamstring any possible gains (cash doesn’t gain a thing on the upside) during long bull markets. The past 10 years have been a pretty long stretch for those who have held a significant amount of cash awaiting a market correction. In the past three years, we’ve seen cash go from 10% of total assets under management to nearly 30% in some cases. In a time when markets have seen increases over 30% in a calendar year (like 2019), large cash positions can play old Harry with portfolio returns.
Selling too early is still a sin
Getting to such positions in cash usually entails selling positions because you believe they’ve run up in price where they now grossly exceed your estimated intrinsic value. A case in point is my selling FactSet Research (FDS, Financial) in 2015 to only see it continue to run up another 88% since your sale. If I’ve learned one thing in my investing career, selling based on price alone can lead to some significant opportunity gains lost in the long term. I’ve tightened up my sell criteria now to reflect both overvaluation combined with some significant change – such as new debt or an acquisition – where multiple changes can dramatically alter the future value of the holding.
Our biggest investment error was on this front in 2019. We sold – and then repurchased – Veeva (VEEV, Financial) based solely on valuation. Just mere weeks after selling my entire position, our full business case review showed we had undervalued its share price by roughly 25%. Combined with a 35% drop in price, we felt lucky to be given the opportunity to repurchase the shares. We will likely be holding them for a much longer period of time than our last investment period.
Conclusions
One the easiest ways to maximize your returns is to reduce the really stupid mistakes you make over your investment career. These include paying too much for an asset, trading far too often and paying too much in fees.
My first mistake of 2019 was being intellectually lazy and making the assumption that since Veeva was at an all-time high, it must be expensive and its price must far exceed its estimated intrinsic value. I simply was too indolent to rerun our numbers by taking into account its third-quarter earnings release. Our second mistake was not finding a way to test our investment partners real tolerance for risk and pain. Their answers on paper we found were very different than the reality of their physical and mental reactions to an actual 25% drop in their equity portfolio. Somehow we need to create a better simulation tool that makes a better or more realistic link between simulation and real-time activities.
As always, we look forward to your thought and comments.
Disclosure: Nintai has a long position in Veeva.
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