This post is different (although I’d like to think that they all are) and is the first of a series of posts I will be writing about what I call simply the Investment Decision System and even more simply “IDS”. This is my humble attempt at writing down and systemizing my investment activities. While I am doing this to share with you how I allocate capital, my more profound purpose is to use this medium as a way to record, question and organise more thoroughly my IDS to come up with more and better investment ideas and decisions.
David Einhorn's Greenlight Capital funds were up 11.9% for 2021, compared to the S&P 500's 28.7% return. Since its inception in May 1996, Greenlight has returned 1,882.6% cumulatively and 12.3% net on an annualized basis. Q4 2021 hedge fund letters, conferences and more The fund was up 18.6% for the fourth quarter, with almost all Read More
It’s important to note that what I will present is MY way of investing, at this specific point in time. There should be as many IDSs as there are investors out there. Although investing should not involve emotions or personal biases, the process of investing successfully is highly linked to your personality and it is important to find a way which fits intrinsically with who you truly are. If you try to apply an IDS which doesn’t stick with your personality (tolerance to risk, attention to details, etc.) you’re bound to fail. And if you’re going to do this for years on end, you better do it in a way that you like. Most IDSs will simply be variations of similar models, however some investors take a radically different approach to investing, think Ray Dalio vs. Warren Buffett. They have both been extremely successful over a long period of time using very dissimilar approaches. Investors can find success by focusing on macro factors, fundamental analysis, using the private markets, being activists, shorting stocks, using a combination of these, etc. You get the idea.
IDSs are not all equal. Some are clearly superior and this translates into higher investment returns over long periods of time – easy enough. Some investors (especially large money managers) are just lazy and uninterested in performing exceptionally well. In general, for large firms, as long as they get their management fee, they won’t budge much. This leads to less than average Investment Decision Systems applied less than rigorously resulting in below average returns. Another phenomenon leading to poor performance which is quite common in a market like Asia, is when investors start chasing after what they think might work next, instead of discovering what works for them and improving on it. One day they do macro, another they do value, then they think that private equity is great and that they need to get involved because their friend told them this is the next big thing and that the government is keen on this or that specific industry. You will rarely find the same firm adopting very different investment approaches simultaneously and successfully. Mastering one investment approach is hard enough, thinking you can be great at a few of those is just insanity.
An IDS, besides being tailored for and by a specific investor, should also be flexible and evolve over time. Although this evolution can be quite dramatic, the IDS will normally retain the same fundamental principles over time, as initially developed by the investor. Many factors will influence an IDS over time. One major factor is experience and more specifically mistakes and what you learn from them. We make mistakes every day. The difference is how one deals with mistakes. People usually think a lot about the future and how to become successful, but we spend a lot less time thinking about our mistakes and what we can learn from them. I am not talking about ruminating sadly in a dark corner about past errors. I am talking about having a constructive and positive approach to our mistakes. A systematic way to do this, is to keep an error log. Simple idea but very few people actually do it. We tend to try and forget our mistakes as soon as possible, but that won’t help in the future and as our memory is far from perfect, keeping an error log will help you not only remembering what you’ve done but also make you think and reflect on what led to this error. Other than experience and mistakes, factors such as new industries, new financial instruments, and the sum of money managed will all influence your IDS over time.
In summary, there are two important aspects to keep in mind as I go through my IDS: 1) An IDS is unique and needs to be developed or at least refined by the investor himself and 2) an IDS should be flexible and improve over time. It’s a personal continuously evolving machine.
With this in mind, the first step in the elaboration (or recording) of your IDS is to define what’s your personal investment focus. Your personal investment focus will influence every step you take in selecting and ultimately taking a position in an investment. It is the basis for everything you’ll do next. So, spend some time on it and try to get it right as much as possible. Ask yourself questions such as: do I like to spend hours and hours looking into everything I can find on a company? Do I like to look at macro factors? Do I mind a focused portfolio? Do I mind investing in tiny, crappy companies but which are deeply undervalued? Do I like special situations? Do I prefer excellent companies compounding over time? At this stage, we’re simply trying to figure out what will suit the investor, and asking specific questions will be helpful in coming up with a general statement of preference in order to focus our efforts going forward. It’s nothing fancy, it’s simply what you prefer to invest in.
So, what is it for me (if you care to know)? A recurring theme for me is quality, i.e. a strong business with great potential. I love finding good or even great businesses and to be able to do that, I don’t mind digging deep into the financials of a company, its business, its management, etc. – as always, simple but not easy. Poor and highly undervalued companies, investing solely for what’s on the balance sheet of a company, macroeconomic factors, or momentum investing all generate little enthusiasm from my side. You might like it, others might, but I don’t, so I can simply forget about those things and better focus. Although valuation is critical (as I’ll talk about further in a later post), it doesn’t define my investment style by itself. There are tens of reasons why the stock of a good or great company can be undervalued. This is important in my system because it allows me to build a database of great companies which Mr. Market might not be offering at a deep enough discount to intrinsic value as of today but one day (for whatever reason) their stock price might become attractive enough to take a position. Finding a great target is hard, so when I find one I certainly want to keep track of it, regardless of its valuation. It might just not be as high a priority at this point in time if its share price is through the roof.
Once you know yourself and find out what you like to invest in (which might take some time if you’re just starting), then what do you do? Well, it’s time to start sourcing ideas and I’ll tell you practically how I do it in my next post. But again, this second step will have to be tailored based on your answer to the first question above. So think about it twice!