In Seth Klarman’s 2010 letter to shareholders, he noted something about investing that I found particularly interesting (when Seth Klarman says ANYTHING about investing, you should probably listen): “As in football, you are well-advised to take advantage of what your opponents give you: If they are defending the run, passing is probably your best option, even if you have a star running back.”
For most investors, a company’s competitive advantage is a key part of what they look for in a potential holding. But you rarely hear people talk about their personal competitive advantage. What makes you different from the crowd? If there is nothing, you might as well invest in low-cost index funds, and avoid transaction expenses that will eat away at your returns. But if there is something, you should exploit this, and use it to your advantage.
A good starting point for answering this question is to figure out one simple thing: What can you do that the guys on Wall Street can’t? What is the advantage you hold as an individual investor? This article will look at three of the advantages that individual investors have over mutual funds, hedge funds and Wall Street firms:
LONG TERM HORIZON
As we know, Wall Street is notorious for having a short-term view; analysts are worried about next quarter’s EPS figures, not where the company will be in 2020. The same can be said for mutual fund managers, who face the possibility of huge cash outflows if they fail to deliver short-term results to clients. But for the guy sitting at home managing his retirement account, this is not an issue; you can buy companies with sustainable competitive advantages, regardless of short term-setbacks. A great example that everyone knows about is Johnson & Johnson (JNJ). While value investors like Buffett and Yacktman are buying, many people are stuck in a rut, worrying about short-term issues. Despite the current problems, you would be hard-pressed to find people who think JNJ, 10 years down the road, will still be struggling with recalls. Many people will wait for the surge in price as reassurance that things are back to normal at JNJ; don’t do that. With Wall Street stuck on 2011, prepare yourself for 2020 by loading up on great companies that will be successful long-term holdings.
ABILITY TO WAIT FOR THE RIGHT PITCH
As Warren Buffett noted at the 1999 Berkshire Hathaway (BRK.B) annual meeting, “The stock market is a no-called-strike game. You don't have to swing at everything—you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'” For individual investors, this is a HUGE advantage to have. I wrote an article yesterday about an active approach to dollar cost averaging, which essentially advocates this strategy (hold cash for rainy days). For fund managers, this wouldn’t work, because it would leave you holding cash on the sideline for months or years at a time; obviously, investors aren’t paying a management fee for what they could do with a free checking account. Another issue for managers is client withdrawals during market declines. Even if you are only 70% invested when March 2009 rolls around, you may find that 30% of your investors pull their capital from the fund when the market plunges; at the time when you are ecstatic about buying great companies for 8-10x earnings, you are left sucking your thumb and banging your head on the desk.
But for the individual investor, you can take advantage of these opportunities. No one is coming to grab cash out of your bank account, and you can sit back and wait for the right price as long as you want. In other words, you don’t have to swing; you can watch pitches come across the plate all day. As Ben Graham said, “He [the investor] should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored.” It is important to use this second option to our advantage, and to only swing at the fat pitches down the middle of the plate.
CONSTRAINTS BY SIZE AND STRATEGY
Finally, fund managers are forced to deal with constraints (usually from their size or the strategy of the fund) that limit the securities they can hold; for individual investors, our ability to search where we see fit provides us opportunities to profit from other investors’ limitations. One example that is frequently mentioned are small cap stocks, which are out of the view of managers with billions under management. In most cases, these companies are too small to move the needle, and would need to be acquired to have a meaningful impact on the fund (obviously, mutual funds aren’t in the business of buying up small companies). Another idea that fits within this category is limitations that constrain a firm’s holding based on their classification. For example, specialized fund managers (such as “small cap growth,” “dividend focus,” etc.) MUST follow the guidelines of their fund; if a holding in the dividend focus fund eliminates the dividend, you can bet that stock will be kicked to the curb ASAP at every fund implementing that strategy; this same argument can be made for stocks removed from major indices, or any situation that causes the stocks classification to be adjusted. As an individual investor with no limitations on where to invest, you can take advantage of these opportunities that are created by forced selling among institutional investors.
Overall, the three items mentioned above all point in the same direction: The way to beat a manic-depressive market with an obsession on short-term results is to see the big picture and wait for the right pitch. Speculation in the market is met by the best and the brightest on Wall Street, along with transaction costs and sky-high tax rates (though I would argue to make them even higher). For intelligent investors, a long-term strategy that exploits the inefficiency created by incentive structures on Wall Street is an effective method for creating long-term wealth. Also check out:
For most investors, a company’s competitive advantage is a key part of what they look for in a potential holding. But you rarely hear people talk about their personal competitive advantage. What makes you different from the crowd? If there is nothing, you might as well invest in low-cost index funds, and avoid transaction expenses that will eat away at your returns. But if there is something, you should exploit this, and use it to your advantage.
A good starting point for answering this question is to figure out one simple thing: What can you do that the guys on Wall Street can’t? What is the advantage you hold as an individual investor? This article will look at three of the advantages that individual investors have over mutual funds, hedge funds and Wall Street firms:
LONG TERM HORIZON
As we know, Wall Street is notorious for having a short-term view; analysts are worried about next quarter’s EPS figures, not where the company will be in 2020. The same can be said for mutual fund managers, who face the possibility of huge cash outflows if they fail to deliver short-term results to clients. But for the guy sitting at home managing his retirement account, this is not an issue; you can buy companies with sustainable competitive advantages, regardless of short term-setbacks. A great example that everyone knows about is Johnson & Johnson (JNJ). While value investors like Buffett and Yacktman are buying, many people are stuck in a rut, worrying about short-term issues. Despite the current problems, you would be hard-pressed to find people who think JNJ, 10 years down the road, will still be struggling with recalls. Many people will wait for the surge in price as reassurance that things are back to normal at JNJ; don’t do that. With Wall Street stuck on 2011, prepare yourself for 2020 by loading up on great companies that will be successful long-term holdings.
ABILITY TO WAIT FOR THE RIGHT PITCH
As Warren Buffett noted at the 1999 Berkshire Hathaway (BRK.B) annual meeting, “The stock market is a no-called-strike game. You don't have to swing at everything—you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'” For individual investors, this is a HUGE advantage to have. I wrote an article yesterday about an active approach to dollar cost averaging, which essentially advocates this strategy (hold cash for rainy days). For fund managers, this wouldn’t work, because it would leave you holding cash on the sideline for months or years at a time; obviously, investors aren’t paying a management fee for what they could do with a free checking account. Another issue for managers is client withdrawals during market declines. Even if you are only 70% invested when March 2009 rolls around, you may find that 30% of your investors pull their capital from the fund when the market plunges; at the time when you are ecstatic about buying great companies for 8-10x earnings, you are left sucking your thumb and banging your head on the desk.
But for the individual investor, you can take advantage of these opportunities. No one is coming to grab cash out of your bank account, and you can sit back and wait for the right price as long as you want. In other words, you don’t have to swing; you can watch pitches come across the plate all day. As Ben Graham said, “He [the investor] should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored.” It is important to use this second option to our advantage, and to only swing at the fat pitches down the middle of the plate.
CONSTRAINTS BY SIZE AND STRATEGY
Finally, fund managers are forced to deal with constraints (usually from their size or the strategy of the fund) that limit the securities they can hold; for individual investors, our ability to search where we see fit provides us opportunities to profit from other investors’ limitations. One example that is frequently mentioned are small cap stocks, which are out of the view of managers with billions under management. In most cases, these companies are too small to move the needle, and would need to be acquired to have a meaningful impact on the fund (obviously, mutual funds aren’t in the business of buying up small companies). Another idea that fits within this category is limitations that constrain a firm’s holding based on their classification. For example, specialized fund managers (such as “small cap growth,” “dividend focus,” etc.) MUST follow the guidelines of their fund; if a holding in the dividend focus fund eliminates the dividend, you can bet that stock will be kicked to the curb ASAP at every fund implementing that strategy; this same argument can be made for stocks removed from major indices, or any situation that causes the stocks classification to be adjusted. As an individual investor with no limitations on where to invest, you can take advantage of these opportunities that are created by forced selling among institutional investors.
Overall, the three items mentioned above all point in the same direction: The way to beat a manic-depressive market with an obsession on short-term results is to see the big picture and wait for the right pitch. Speculation in the market is met by the best and the brightest on Wall Street, along with transaction costs and sky-high tax rates (though I would argue to make them even higher). For intelligent investors, a long-term strategy that exploits the inefficiency created by incentive structures on Wall Street is an effective method for creating long-term wealth. Also check out:
