INVESTMENT PERFORMANCE, FEES AND MAKING MONEY

Investment Perspective – September 2017

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

Making real money is not that complicated – once you understand…

Understanding.  Well that is where things can become a little complex, but lets see… 

What we know is that if you want to make real money, being an investor rather than a speculator is a good place to start.  Some are confused about the difference.

Then, either invest in real assets, such as property or productive assets, such as small or large businesses and thereby grow your capital. 

Investing in the bank trying not to lose money is not how anyone can make money long term.  Especially once we take off income tax from the interest and then allow for the rising cost of goods and services that eventually overrun any interest returned on fixed interest or bank type investments. 

Sure, there are times during specific market cycles when investing in the bank is a wining investment – especially when these “complicated market linked type growth investments” are unpopular.  When anything is unpopular, its price usually declines.  However, as Value Investors, what do we know about declining prices…?

Making real money

So, to make real money, invest for growth or invest for growth and income – not just income only. 

Oh, by the way, be sure to use the value methodology, incorporating intrinsic value.  That way, you will be less inclined to run with the herd, chasing after rising prices or running away from falling prices.  More importantly, you will have a proper reference point to know whether a particular investment is worth engaging with or not. 

Intrinsic value is not based on the price/earnings ratio, the price to sales ratio or the book value.  These are common financials that are used by most investment analysts to work out the value of an investment.  Okay as a bit of a loose reference point but not reliable when it comes to actually understanding and engaging the underlying intrinsic value of a productive asset (stocks / shares). 

The discounted cashflow represents a good starting point, however, it is the value judgments, the methodology around valuing a business and the experience of the investor and / or the adviser, that can make the application of the discounted cashflow calculation useful or not. 

For example, share brokers and many investors tend to chase popular stocks and not only use a methodology that is at odds with value investing but will apply value judgments that align with the financial analysis that matches their approach to investing (e.g. “momemtum” for most sharebrokers). 

The point here is that momentum investing, practised by share brokers and other methodologies may not actually line up well with maximising capital growth and long term investment returns.  They can work OK while a specific set of conditions remain at play but when those conditions move, their method can at times undo some of the gains made in the past. 

For example, Momentum Investing is based on chasing market trends and rising share prices.  Those investors generally tend to buy as prices rise (or have already risen!) and sell when prices decline.  Value Investors usually hold back as prices rise and are happier buying when prices are low because that is where the value is found.  

So, investing for growth and using a value based methodology, is a good place to start, for those wanting to grow sustainable wealth long term.  That way investors are not relying on market conditions or successfully chasing trends and rising share prices to maximise returns long term – see what I mean? 

To be clear, there is more to successful investing than transactions and following the herd.

Fees, costs and charges – an investment or a cost?

Are fees, costs and charges an investment in your financial future or a cost that frustrates? 

In my experience, when markets are buoyant, prices generally rise and the cash up value increases, which means that the fees as a percentage of the gains made over say, that previous 12 month period are acceptable or of no consequence. 

However … for some, when they compare the fees with the portfolio when the cash up value is less than the last time they checked, low or slow to grow, those fees can appear significant. 

One valuable manoeuvre – stay the course

Experienced investors understand the wisdom of staying the course.  They are not inclined just to pay fees and not check what is going on and how those fees compare with long term returns.

They will also take into account other factors, such as their investment goals, the methodology being adopted, the skill set and experience of other stakeholders involved (eg the adviser, the analyst) and how the net cost of investing plays out over the long run. 

For novice investors, who perhaps may not totally understand the methodology and may lack some confidence when it comes to investing in things they do not fully understand, they can develop some trust issues around their investments, the methodology and the advice. 

This can be a tricky combination because they can find themselves in a situation where the sentiment or the emotion around investing and in particular fees, can override and basically overcrowd other important aspects of investing. 

When the portfolio is slow (compared to other possible investment options) or low (eg the cash up value has declined by, say, 5% or 10% over the last 12 months), the only thing that seems to matter becomes the fee paid along with those questions around the competence of any advice and whether or not they are making a big mistake investing this way. 

This can be as simplistic as the novice investor starting to feel that if managed funds, exchange traded funds or residential property grew more over say the last 12 months that those other investments are going to be better forever – no matter what. 

Not staying the course – we need to be very certain before moving from what works

For some (where impatience is the real driver rather than a well thought out strategy), they change direction and start looking at managed funds, exchange traded funds, bank term deposits or other investments, thinking that is where the solution lies. 

Others may cash up, put the money in the bank or buy a property because someone else they know did that. 

The point here is that in this situation, the important drivers of investment success are held hostage by the lack of confidence, lack of understanding, frustrations around returns and performance of investments not hitting the mark as expected and fees just making things worse. 

Successful investing

At WISEplanning, some of my clients have a total understanding about my methodology for investing, some have no idea whatsoever and a good many have, either some idea or a reasonable grasp of the concept at least. 

What that means is that those who do not understand it may feel the need to discuss the fees they pay, particularly when their portfolio is low or slow.  This brings us to one of the keys to investment success, sometimes forgotten by those looking at the wrong thing.

Successful investing can be achieved by focusing on the right things…

Long term success is based on strategy – not short term price movement and sentiment

Investing in quality assets at a favourable price is a different approach to investing in anything whose price is rising because of market driven popularity (Amazon comes to mind, for those who can remember (BIL) Brierly Investments Limited, Chase… !!!). 

The economics of Amazon actually look quite promising in my view, however, this business continues to burn cash.  The price by any measure looks expensive and relies on the ongoing popularity or the need for others to keep buying Amazon, for the price to keep rising.  Hardly a fundamental approach based around intrinsic value.  Because the price has been rising for quite some time, the market starts to believe it is normal.  Indeed, it is a set of specific circumstances that has driven the price to this level. 

Chasing rising share prices can work but is unreliable when we are serious about building sustainable wealth long term. 

Some of the best investments that you and I will ever make will be those businesses, who for one reason or another, are out of favour and whose prices are low. 

To get bargains, the price has to be low.  High priced investments are not usually bargains.  At the risk of repeating the obvious, bargain prices occur when prices are low.  Those low prices will contribute to making the portfolio look slow compared to other investments. 

Whilst making more money than other investors is not a bad idea, we really want to focus on that over the long run (not the short term).  We do not want to have success in the short term and then see that success reverse later. 

When prices are running high then bargains will be difficult to find.

Bargains are available when prices are low compared to the intrinsic value – not when they are rising fast. 

If the cash up value of our investment portfolio has gone up by 12% or 15% over the last 12 months, then it makes it quite difficult to add to existing holdings, in order to make more money in the long run. 

On the other hand, if the cash up value of our investment portfolio has declined by say 10%, serious investors know that this is the time to add to existing holdings – not the time to be unhappy or berate markets, advisers or question methodologies that are proven. 

When we are investing in assets that grow, it is important to be at least understanding (preferably happy) when prices decline and the portfolio is low or slow. 

Investing success is driven by positioning – not transactions

That is because investing is not a transaction.  It is not a series of transactions.  It is about positioning. 

As value investors, we have positioning and opportunity that others do not. 

That is because, with intrinsic value, we can invest confidently and with conviction, in good businesses that others do not like.  As you know, intrinsic value is about the performance of the underlying business – not the share price rising or falling.

So, the way to improve investment performance long term is to chase investments that are unpopular, which is likely to be at a time when a particular investment or your whole portfolio is low or slow. 

“You are neither right nor wrong because the crowd (agrees or) disagrees with you.  You are right because your data and reasoning are right.“

Benjamin Graham