Winning is about ensuring the upside return potential is significantly greater than the downside potential loss. Lee Freeman-Shor
As I’m spending some time taking in some winter sunshine this week, I thought it would be a nice chance to do my first book review. One of the key things I’ve learned from my investment journey is that listening to and reading the works of the greatest investors can be beneficial. Reassuringly the lessons are relatively consistent between them. Do your research, buy good companies and manage them in a way that your gains materially outperform your losses.
Every so often a classic comes along. Even though it was published less than 5 years ago, it is one of the best books you can read on how to approach investing.
Freeman-Shor was by 2012 ranked as one of the world’s best fund managers. He was in his thirties. He wrote the book just as he had turned forty in 2015. Despite his relative youth, the book is a model of clarity and could be read in a day or two. This contrasts admirably with a number of books on investment that lay unfinished on my shelf, due to the layers of complexity which the authors allow themselves to be drawn into. The Art of Execution is the antithesis of this scourge.
The book is also backed by decent empirical research. The author gave a group of the world’s leading fund managers between $25m and $150m to invest in their ten best ideas. He then observed their performance and was able to rank them into categories. It is the categories that create all of the interest in the book and make it so memorable. These categories are as follows:
1. Rabbits (very bad)
2. Assasins (good)
3. Hunters (quite good)
5. Connoisseurs (the best)
In categorising the performances in this way, the author is able to show that even the best fund managers fall into the traps that we ordinary investors fall into. For example, the Rabbits (who habitually jumped into positions and then hung on to losers for way too long) were guilty of all the common psychological errors that we as human beings make. I particularly enjoyed the endowment effect by which we tend to place a higher value on what we own over what we do not own. By the same token the Raiders tend to snatch at “treasure” (or profits if you will) too quickly and gave up the much longer term gains that could have been had if they had just stayed patient. As Freeman-Shore comments “Big winners are rare and I am yet to see a successful investor who has not ‘hung around’ with big winners”.
By contrast, much can be learned from the approach of the others. Assassins were ruthless and very good indeed at killing losses when they had reached a certain threshold. They always had a plan and worked to it. Hunters were classic contrarians and (having invested a lower sum initially)were prepared to increase positions in losing stocks which they had the conviction of being undervalued. Again this was always based on a pre-determined plan. Eventually when the price began to rise they had the opportunity to sell and take profit on a much lower average price that they had acquired for. This is not an approach for the faint-hearted. I have usually found that averaging down is a strategy that backfires unless you have really deep knowledge about the stock (which is often beyond the reach of the ordinary investor).
However the very best investors were the Conoisseurs. These were people who bought a few high conviction companies with stable growing revenues. In many ways classic Warren Buffett companies, under the mantra that the favourite holding period was forever. They would often add to their positions even after share price falls. The key to their success was being greedy and buying a lot of their high conviction plays and then selling a little at a time as the price rode up. They would never extract every last drop from the share that way, but would often secure triple digit returns. Interestingly these investors had a lower than 50% strike rate, but when they won big they won really big.
The book concludes with some really valuable advice for investors, drawn from the lessons set out above. As an ordinary investor, it is difficult to emulate the investment style of the Conossieur or be as brave as the Hunter, however a lot of the themes ring true. I have had a few big winners in my eight years of investment, but have not made nearly enough out of them, by not owning enough of the share or (most commonly) selling out too early. At the same time I have not been ruthless enough with my losers, usually waiting too long to sell them. This has very occasionally permitted a few to recover, however I then made the mistake of not going back and reassessing the investment case when they were being rerated and buying some more.
What makes the book so readable is the simple way in which the author explains concepts which can be easily identified by the reader. It is reassuring to know that even the greatest fund managers are susceptible to the same foibles as us ordinary folk. Equally we are unconstrained by many of the rules that govern such professionals as the only person we usually have to please is ourself. We can do very well by prudent selection of stocks, reaction when we need to and by patiently running our best ideas.
I can thoroughly recommend this book to the amateur investor.