The View From Burgundy: Unforced Errors In Investing – Winning By Not Losing

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Before I became an investor, I was a tennis player. I played competitively as a junior and became pretty good at the game. It took me a long time to learn the lesson that, many more times than not, winning is the result of not losing. Neither striking great shots nor having a better game is a prerequisite to winning; making your opponent hit another shot is what really matters!

Wimbledon is the most prestigious Grand Slam tournament in tennis. I thought it would be fitting to illustrate this point by looking at what became known as one of the best matches ever played: the 2008 Wimbledon final between Roger Federer and Rafael Nadal.

Roger Federer played a terrific match. He served more aces, hit a faster serve, played more aggressively by going to the net more often and hit 50 per cent more winners than his opponent. On most metrics, he did better or at least as well as his opponent.

So why did Federer lose? Rafael Nadal played better on one key metric: unforced errors. An unforced error is when you lose a point by hitting the ball into the net or hitting it out of bounds without being under duress from your opponent. In other words, you missed a ball you shouldn’t have missed. Nadal hit only 27 unforced errors against Federer’s 52. Even though he was outplayed on winners, Nadal won because he played more within himself, within his comfort zone. He didn’t play as aggressively and didn’t hit as hard, but won by making fewer errors. On a subtler metric, break point conversions, we can also see that his mental energy was well directed, winning the right points and converting more opportunities into games.


Now the catch is that “winning by not losing” is not nearly as appealing to our psyche as a “winning by winning” strategy. It just feels a lot better to win by hitting great shots, or in investing terms, to pick stocks that turn into multi-baggers. Telling the story, “I won because I played some amazing shots, hitting my favourite forehand winner,” is much more appealing than the alternative, “I won because I played with a margin of safety that allowed me to make few mistakes.” But if we go with the appealing strategy, we may find ourselves, as Federer did, making more unforced errors.

Unforced Errors in Investing

So what are the common unforced errors in investing?

Unforced Error #1: Chasing Winners

It is much more exciting to tell a story about hitting great winners than simply getting the ball back in the court, and nowhere in investing is storytelling more prevalent than in emerging markets. Great narratives get spun that capture the imagination of emerging market investors. Rewind a few years and the story on Brazil went something like this:

China’s torrid growth requires ever larger tonnage of raw materials from Brazil. Massive new oil discoveries will permanently alter the country’s terms of trade. This will spur an investment boom and require substantial new infrastructure to be built. Oil sector privatizations will open the gates for private capital and entrepreneurs to prosper.

At the height of the stronger-for-longer commodity boom, it was standing-room-only when the CEO of the Brazilian mining giant Vale hosted an investor luncheon in Toronto. The Global Financial Crisis inflicted severe pain in 2008-09, but the market recovered swiftly on “decoupling” and stimulus, and in late 2010 hit new highs (see Figure 2). At an event hosted by The Economist in Mexico around this time, the audience was asked to cast a vote on, “Is God Brazilian?”

Unforced Errors

Inevitably the boom turned to bust. Growth faltered and went into reverse on exceptionally poor policies, and the economy slid into the worst rot in living memory. The unveiling of staggering corruption took the country from an economic to a political crisis, which is where we are today. In January 2016, the market revisited 2008 lows, valuing Brazil’s Bovespa Index at only a little more than US$300 billion, 70% below its highs. In other words, the entire Brazilian market was being valued at just over half of Apple’s total market capitalization.

The perceived biggest winner, the oil industry, ended up being the biggest unforced error (see Figure 3 on the following page). From the peak in 2010, investors lost 90% of their money in Petrobras stock when measured in U.S. dollars. From peak to trough, US$220 billion dollars vanished in Petrobras stock and another US$80 billion dollars in Eike Batista’s oil and gas business, OGX. Not to mention the US$330 billion dollars spent in Petrobras’ capital budget over the past 10 years – it is difficult to determine future returns on those capital expenditure dollars.

In May 2016, Petrobras named Pedro Parente as the company’s new CEO; he is an experienced leader dating back to the Cardoso administration and I suspect his reign will bring important improvements to the company.

Nevertheless, Petrobras remains a government-run and -controlled company, and serves as a stark reminder of the perils of investing alongside government. Governments are not attractive business partners for minority investors. There are many government businesses listed on emerging markets exchanges. We find them especially in sectors considered strategic by the state: oil and gas, and financials. The problem for minority investors, like us, is that they are managed to achieve a broad array of priorities. They serve many objectives: social, political, power and security. They are run for the good of the state and rarely on sound business principles.

Article by Anne-Mette de Place Filippini, Burgundy Blog

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