In his recent speech at Peking University, Li Lu dispensed timeless and worldly wisdom. Among his wonderful pieces of advice, one resonated with me strongly – less is more. Li said that a common mistake for investors is to keep adding more companies to the research list because of the distorted incentive system and the fear of missing out, but there comes a time when investors should be doing subtractions, not additions.
The reason why I bring this up is because I have personally gone through a few distinct stages in my investment career, and the more I experience, the more I agree with Li that less is more.
I started my value investing journey in 2011. Back then, as a non-professional investor with a busy full time job, I only had time to read the 10ks during my limited spare time. Therefore, my research list was very short. I was heavily concentrated with 3-5 investments. Because I didn’t have time to do much research, my investment decisions relied very much on balance sheet based margin of safety analysis. There weren’t many decisions and the results were good. Granted it was an easier time for the stock market.
In January 2014, I became a full-time professional investment analyst. All of a sudden, I could spend all my time researching companies, which felt great. For the next four years, my research list kept growing and growing. There were both personal and business reasons for the exponential grow of my research list. On the business side, the fund I worked at had a diverse portfolio and most positions were small positions. Believe it or not, a 3% position was considered a large position. Like most value funds, the research department advocated a generalist approach. Therefore, each analyst had to cover multiple companies across different industries. I covered quite a few companies which were only 1-2% positions in the fund.
On the personal side, I was eager to learn as many businesses as I could. One of the first projects I worked on was to go through the entire coverage of Value Line and compare across industries. It was a great project because in some industries, even the worst players have favorable economics, while in other industries, even the best players earn low ROIC. After going through all the Value Line reports, I picked many companies to do further research on across a few industries. The tag line was “go wide and then go deep.” By the time I resigned from that job, my coverage list was so long that even the focus list had more than 20 names.
Unfortunately, looking back, I kept going wide but didn’t go deep enough. I often relied on management guidance. This resulted in multiple mistakes.
Being a professional analyst allowed me to spend all my time on research and to gain access to more research resources and information. At the same time, I made the mistake of letting my intellectual curiosity run too far. Most companies have something interesting about them, but not many are worth the time and effort of further research.
One important unintended consequence of having a long research list is that it subconsciously made me want to act more. This is consistent with Munger’s "consistent and commitment" bias. Once I’ve committed the time and effort to research a company, of course I’d like to reap the benefits.
Fast forward to the end of 2017 and I followed Munger’s advice of “fish where are fish are” by making the decision to focus on China’s market. At first, I carried my “institutional bad habits” with me and made a big list of companies I needed to do research on. The idea was to build the “actionable ideas” database. There were pressures and anxieties to learn more about more businesses. It was far from ideal. I knew something was very wrong.
A few events happened during 2018 and 2019 which made me hit the pause and refresh button. First of all, Charlie Munger (Trades, Portfolio) again preached the idea of focus and concentration at the 2018 and 2019 Daily Journal shareholder meeting. During my years as a professional analyst, I’ve attended the Daily Journal annual meetings. Each year Munger would remind us to concentrate on our best ideas. but I thought it was not practical to practice Munger’s idea for someone working for an institutional fund. My previous job required me to come up with multiple ideas, each representing 1-5% of the portfolio, not put 25% of my best idea in one position.
Then I had the pleasure to speak to a few truly extraordinary investors, both individual and professional fund managers, who have compounded at extraordinary rate over many years. One common trait among them is heavy concentration – most of them have 3-10 positions. When I asked them why they concentrate on their best ideas, they asked me the reverse question – why can’t you concentrate on your best ideas? It suddenly dawned on me that my standards were too low in terms of margin of safety, depth of research, quality of company, expected rate of return and the combination of many other factors. Since coming back from the Daily Journal meeting this year, I have been doing a lot subtractions. I spent months focusing most of my time on one business. There’s less pressure and anxiety that way, and I feel much more peaceful.
As you can tell, I went from “less is more” to “more is less” and am now back to “less is more.” Li was absolutely right in pointing out that the fear of missing out and the distorted incentive system often result in hyperactivity. I was a perfect victim.
Conclusion:
Towards the end of his lecture, Li brought about an idea from the second law of thermodynamics. He said that investing, if done right, is a process of reducing entropy in life. What he meant, in my opinion, is that there are a lot of impurities in investing, such as the diversification theory and the distorted incentive system. If we start with a strategy that keeps introducing chaos into the system, chaos will compound and someday the system will become unsustainable. However, if we start with a system that has an entropy-reducing mechanism, the system is much more sustainable.
Simple but not easy.
Read more here:
- Notes From Li Lu's Latest Speech at Peking University, Part 2
- Notes From Li Lu's Latest Speech at Peking University
- Case Study: Buffett's 50% Edge Against the Dow in the 1950s
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