Investment Philosophy

Most investors start their investing journey either as value investors, who depends purely on fundamental analysis of companies, or fall at the other end of the spectrum as technical traders who make buy and sell decisions of a particular company’s shares purely on demand and supply considerations as each trading day evolves. Both methodologies if applied correctly can be profitable, but both have its advantages and draw backs as well.

Value investing comes off firstly as being highly logical and intellectual in its argument, since it focuses mainly on a company’s competitive and comparative advantages, and how sustainable they are in growing their profits over the long-term. This methodology can afford to ignore the boom and bust of the economic cycles and therefore the stock market cycles of bull and bear that comes with it, since the shares of the company can be held comfortably over the long term as it continues to grow its profits, assuming you don’t really care about the changes in its valuation. However, one cannot ignore the drawdowns each time we enter a bear market, and unless you are Warren Buffett, many lose confidence and patience, sometimes hope, let alone have the courage to double down to buy more shares after such severe drawdowns, and even if you had the courage and wisdom to do so, your personal cashflows become a concern especially during the down-cycles. 

Furthermore, unless you are Berkshire Hathaway or a big private equity fund, most investors end up being minority shareholders who hardly have any influence over the company’s management, let alone have any access to any proprietary information. Some other value investors like Bill Ackman go a step further and act as activist investors to unlock further value for his investors with great success. Still, most funds that focus on value investing face serious drawdowns and withdrawals during down-cycles and many do not survive through such times. 

The only way to prevent such serious drawdowns is stringent risk management ie. taking losses at appropriate times and not let the portfolio sink to the bottom with index during the down-cycle. But that would mean breaking the first principle of holding an investment for the long-term (maybe 10 years or more), which then beckons the question, are such value investors then timing the market, making them speculators instead? Therefore, to define one’s investment style in a neat manner becomes a rather futile endeavour.

How does that then make the self-professed value investors, the disciples of Benjamin Graham, different from market traders, especially traders who rely entirely on technical analysis, to make swing trades (positions that are held over a very short period of hours, days or weeks) or position traders who try to identify crucial breakout stages in an uptrend or downtrend and are willing to hold positions over weeks, months, or even years, as long as the momentum is in their favour. 

Position trading in my opinion highly resembles growth investing, a methodology popularized by William O’Neill, and epitomized most aptly by Cathie Wood of ARK Invest, where hyper growth companies could grow their sales revenue and earnings above 20%. In the absence of earnings, sales growth should be more than 40% etc to make it onto the watchlist. The locomotive of such hyper growth companies are mostly pinned on very disruptively technological advancement, which has worked very well in the last 20 to 30 years as “technology” companies continue to see multiple revolutionary advancements  in internet, software, communications and semi-con industries etc, giving us life-changing products from WINTEL, to mobile phones, smart phones, e-commerce, smart apps, cloud computing, and now AI. 

Indeed,  “tech” sector has delivered the highest returns amongst the 11 sectors (according to GICS' classification) in the last 10 to 20years. Of course, other promising industries such as the biotech and pharma industries have also seen great advancement but have always been harder to appraise due to regulatory risks during clinical trials. While such hyper growth companies produce stunning returns, it comes with equally stomach wrenching drawdowns, case in point ARK Invest suffered its a drawdown of 80% in its worst year while delivering a stunning return of 100% in its best year. It is these drawdowns that we all wish we could avoid.

Pure technical traders typically ignore the fundamental aspects of a company, preferring to take short-term positions, make buy and sell decisions purely on demand and supply of a company’s shares traded over each hour, or even minutes. If one takes such a short-term view in trading shares, it is still highly plausible to make profits without any indepth knowledge of a company’s financial performance, but one would have to be perpetually clued to the monitors to make this methodology work; not unless you are a quant genius like Jim Simons’ of Renaissance Technologies who relies on huge computing power, massive historical trading data, machine learning to trade in and out of markets in minutes or seconds. 

Such quant funds with their algos choose when to trade and how to trade with exceptional speed, without the burden of emotions, could potentially avoid serious drawdowns by diversification across many different markets and asset classes, selecting assets that might be inversely correlated, and using leverage at the right times, and with strict risk management, such portfolios can deliver superior sharpe ratios over many years of trading.  

Besides Jim Simons, Ray Dalio’s “All Weather” fund and Sweden’s Brummer and Partners use similar methodologies to deliver superior returns, in which purist value investors like Warren Buffett might baulk at, preferring instead to study a company’s ROE, rather than to calculate it’s correlation to other assets. But such portfolio construction methodologies do have their merits, especially during down-cycles when correlations across every market and every asset class increases concurrently, hence only by diversifying across inversely correlated assets could one optimize portfolio beta along the efficient frontier to cushion and limit the drawdowns.

So how does macroeconomics fit into investing? Hedge fund stars like George Soros and Stanley Druckenmiller study macroeconomic trends to make macro bets in currencies, commodities and interest rates etc. Typically, Stan Druckenmiller when he was managing Quantum and Duquesne Fund would maintain a portfolio of long and short positions in a core group of stocks, and then use leverage to trade S&P futures, bonds and currencies. His key principle is in ensuring capital preservation while striving for home runs, and is ready to take concentrated positions in trades with high convictions but is equally ready to exit a trade if it is not working out. He never uses valuation to time the markets but rather uses technical analysis and identifying other catalysts, like liquidity, and other factors that might move an asset favourably.     

To the average investor, the most important element of macroeconomics in investing is to study at which stage the economic cycle is in and what corresponding monetary policies would central banks’ make that might affect the credit cycle ie. interest rates and money supply, and in turn how that would affect each sector and its corresponding industries. Of course, economic cycles are also affected by geopolitical events (war, trade tariffs and sanctions etc) which typically can have long lasting effects as we now have witnessed in the standoff between China and USA. 

Major indices typically consist of the largest companies in each market, and macroeconomic events are instantly reflected in stock prices of the largest companies in the world, even if the impact to each company’s financial performance could be minimal. Such gyrations create buy and sell opportunities, and this is where most of the complexity is in investing. Most investors can analyse companies’ financial statements quite ably, but reading the economic cycle and broader market trend and how macroeconomic changes could affect each sector and the corresponding industries are always tricky.

Fidelity does a great service in offering their views on the business cycle (could be used interchangeably with economic cycle) of each major country, and Sam Stovall of S&P published the first in-depth book on sectoral investing, although they were many others before him who were proponents of sectoral investing as well, which provided a framework on sector rotations as the economic cycle matures. Certain sectors, especially those that are sensitive to high interest rates, like technology and financials, conform better to sector rotation methodology, while sectors like energy, materials conform less well due to the influence of other geopolitical factors affecting demand and supply. Nevertheless, the concept of sector rotation is a useful framework that allows the investor to catch signals better and position himself for peaks and troughs. In a paper published by S&P, in which it back-tested a portfolio consisting of only the top-3 sectors at all times had outperformed the S&P500 by 30% over a 20 year period.

Noriyuki Hayashi, a protégé of Jim Rogers at Quantum fund, who shared his methodology in great detail over 2 books is one fund manager who uses a fair mix of fundamental and technical analysis, to identify new sectoral winners at different phases of the economic cycle, preferring to focus on stocks hitting 52 week highs and having gone through a stable period of consolidation, then identifying the catalysts behind his stock picks.  He typically picks winners in hyper growth industries or companies in traditional industries breaking out from a successful restructuring or turnaround, and enforces strict risk management in taking his losses early. He also shared his “sell” rules which many investors frequently overlook. 

In a perfect world where all things are measured in a precise way, assuming a company could grow its earnings at an average pace of 10% a year, its stock price should correspondingly increase 10% per annum. However, in an imperfect world, where we live through wars, changes in governments, competitive forces, disruptive technologies, credit cycles, economic/ business cycles, which then impacts a company’s fortune, the role of a company’s management becomes crucial to navigate such vagaries. To ignore such ever on-going changes, one must not only have the ability to hold onto his investments over a very long period, but have a consistent supply of incoming cash to allow for cost averaging during the down-cycle. That is, one is assuming one has full faith in the companies he invests in can weather through such changes and come out of it as winners. As an illustration, the Dow Jones Industrial Average, an index consisting of 30 of the largest companies, has seen the deletion (and addition) of 67 companies since 1929. 

So why invest in the equities in the first place? What other asset classes are there that might offer inflation hedging properties, reasonable returns with less downside risks? Some might find investing in real estate the most palatable if one had the time to manage them, but other asset classes like commodities and forex are equally opaque and hard to appraise fundamentally, unless one has the resources to delve deep into the structure of the industry, understand the demand and supply of every commodity out there, or risk getting relegated to being a trader that relies on wave and cycle theories. The story is highly similar for forex traders who mostly rely on technical analysis, which is unlike skilled macro-event managers, like Soros-Druckenmiller, who broke the Sterling Pound by spotting the dichotomy that Bundesbank and Bank of England were facing in early 1990s. In short, Bundesbank was out to fight inflation due to the reunification of East-West Germany (which led to tremendous injection of capital from West Germany into East Germany to support the reunification), thereby forcing Bundesbank to raise interest rate, whilst UK was undergoing a recession and Bank of England had wanted very much to cut interest rate instead. The Sterling Pound at that time was pegged to the German Mark as part of the European Exchange Rate Mechanism (ERM), and this peg was no longer sustainable.  This rest is history.

Unless one has such great insights, equities remain the largest asset class with high amounts of public data and information available. Even if one gets it wrong more than half the time, with proper risk management, one’s portfolio could still be profitable by keeping losses to a minimum and maximizing the gains in the positive bets. Regardless of whatever one’s investment style is, risk management across all styles is one and the same.

Lastly, my investment style is highly similar to Noriyuki’s methodology. Increasingly, I focus on macroeconomic factors and money supply in each market, where the economic cycle is at for each market and which sectors are showing signs of resilience. Afterall, according to William O’neil’s research,   37% of a stock's price performance is tied to the industry group that it's in and an additional 12% from the industry sector's performance. Stock selection flows more naturally after that without having to review the financials of an excessive number of companies. Depending on where the economic cycle is at, I alternate between growth and value stocks, which might help to boost returns in uptrends and minimize drawdowns in the down cycle.

I hope you might have found this useful in helping you to define your own investment style better. And thank you for reading.

But let's stay in touch. ct@simply.sg