I have the majority of my liquid net worth in our AWSM Fund, so I feel the underperformance of this Fund during 2017 very acutely.
Running a concentrated portfolio (15 to 20 stocks) in the small and mid cap space on the JSE was always going to be a wild ride, but our focus on only trying to invest in quality businesses aimed to partially mitigate this risk.
In the short-term, nothing can really mitigate volatility, but in the long-term one hopes that good, growing fundamental earnings and cash flows are rewarded by the market. Hence, our focus on “quality” businesses.
Firstly, this year proved that at least one of our investments was not quality (Note on CIL & Why We Sold) and, secondly, despite the rest of our portfolio growing its earnings by an average of c.15% y/y, our share prices fell c.20%. (AWSM Fund is currently on a 9.6x PE, which means that it can literally double right now and still be cheaper than the AllShare Index’s PE of 20.4x!)
Why did the de-rating of our stocks happen?
For any combination of reasons with the short version being: local political risk has thrown our domestic economy and, thus, domestic equity market into a bear market that has been felt most severely by the least liquid, most domestic stocks: small caps.
And then our market has had Steinhoff! Next, we have the ANC NEC and whatever outcome it brings with it…
Wow. What a disaster of a year (so far).
I keep trying to stand back and see what the ‘big picture’ lessons are. What could we have done differently? What could we have done better? What did we do wrong?
I think our methodology of a high conviction, concentrated portfolio of high quality, fast growing and undervalued small caps is the correct methodology (albeit, a brave one). I also think that, although we are going (guaranteed!) to get investments wrong from time to time, we have actually gotten the majority of our investments right (the market should reward us in time here).
Hence, I don’t think our lessons are in changing our methodology nor how we are executing it. Rather, I think the real lessons here are universal. These lessons are always applicable and not very exciting to write about.
And everyone already knows these lessons.
That said, let me remind you the ‘big picture’ lessons here:
- Diversify: This one is obvious, but I remind you here again. No matter how good an investment looks, it always comes with risk. Hence, diversify across investments, geographies and asset classes. (Note, though, that I do not do this as the majority of my liquid net worth residing in AWSM Fund aligns with the interest of co-investors. I just believe this is more ethical than spreading myself outside of the Fund. This is an exercise in the alignment of interests.)
- Don’t invest in what you don’t understand: How many times did we hear that people did not understand Steinhoff (SNH) and its balance sheet, yet they still held it? Screw your benchmark or what your mates are buying. Only buy what you understand. Likewise, there are plenty of people who confess to not understanding Bitcoin, yet still hold it? Not that you cannot make a good investment based on luck (however improbable), but you cannot make a logical assessment of risks if you do not understand what you are actually investing into. Golden Rule: Don’t touch it till you understand it.
- Admit when you are wrong, & do so quickly: Nothing is more expensive than ‘ego’. If you can admit that your investment case is wrong, then you can act quickly to minimise downside (i.e. sell). Perhaps we can be accused of doing this with CIL? Perhaps it is a fair accusation. Likewise, I think Steinhoff might prove this way for many others… The point is, good investment decisions start with self-honesty about the potential fallibility of your own intellectual prowess.
I can summarize these three lessons:
Know (2) what you are holdings, (3) why you are holding it, and hold a bunch of (1) different things.
That said, 2017 is not over yet. The Vaal just got hit with a random tornado. We still have the ANC NEC next week. Trump and North Korea could still start a nuclear war. And Naspers could still wake up one morning and China has nationalised Tencent…
What a year!