The New Year: A look back and a look ahead
About this time every year almost every investment blog tends to expound on how well their ‘picks’ did last year (assuming they did well), or how well their model portfolio performed against some appropriate benchmark. Sorry, readers, I’m not going that route. I will say that my own ‘value’ portfolio, mostly comprised of the stocks mentioned on this blog, was up about 20% last year, or slightly better than the S&P Total Return index, but I’m not proud of it; I should be doing better. So I’m going to dedicate my attention to what I’m doing wrong.
First, let’s review why I should be doing better than the indexes. I’m a relatively small private investor so I theoretically have a number of advantages over most of the professional portfolio managers out there. I have permanent capital, i.e. I don’t have to worry about maintaining liquidity for clients who want their money back at exactly the worst time. I can keep a large portion of my portfolio in cash without clients wondering why they are paying me to manage their money. I have a relatively small amount of assets under management and thus have minimal problems with entering and exiting a position, plus I have a larger potential universe of securities to invest in because I can create a meaningful position in all but the smallest microcaps. I have infinite flexibility to change my investment strategy on a dime, unconstrained by securities regulations or other concerns. And there are others. Of course there are also downsides to being a small private investor, such as higher transaction costs and limited research capabilities. All in all, however, I think the benefits far outweigh the downside. So I should, by all rights, be able to ‘beat the averages’ handily, however they be designated. The threshold is high, but it should be; after all its my own money I’m investing.
So with that perspective, my slight outperformance last year doesn’t seem so good does it? What’s wrong, then, with my selections or my methods? A quick look at my portfolio holdings brings an initial response. I’ve listed some of my advantages as a small private investor above. Those represent my edge over other portfolio managers. So am I making best use of my edge? Do all my positions reflect this edge? Unfortunately no. Look at my largest position, AIG; what’s my edge there? Yes, I know the company is still being shunned by many institutional investors because many of them were burned during the financial crisis of 2008 when the Treasury took a majority equity position during the bailout. Shares are still trading at less than 60% of book value, just the kind of investment I like. But I’ve got a lot of ‘company’ in the shares now. The Treasury sold its last equity interest in AIG last month (though they still own some warrants) so there are 1.5 billion shares in private hands. Hardly a narrowly held security. I don’t think my ‘size’ edge is very great here. The only thing I might be able to claim is I was in early (May 2011) when the stink factor was relatively high. But it seems to me that ‘stink factor’ is quickly wearing off and in the next six to twelve months it might be gone completely. I’m anticipating an exit sometime during that period, hopefully at 80% or 90% of book value. If the shares don’t respond as I’m predicting, I’ll be out anyway before my minimal edge completely disappears. My next largest position is Bank of America warrants. Bank of America is hardly a microcap. Yes, again I was in early (too early) when the stink factor was high, and at this juncture I have a positive return. But it has been a rollercoaster ride, and I can’t say that I took advantage of last year’s lows (12 months ago) when I should have. This was really an execution issue. This is a long term holding and I’d find it difficult to exit at this point. But I’m considering cutting back my position somewhat if the warrant price runs up substantially this year. So, in sum, my largest two positions don’t take advantage of my greatest edge, small size. My goal next year is to address this.
So my New Year’s resolution this year (like it was the last couple of years) is to be more disciplined. I want to define my ‘edge’ with each new investment. No,even more important, I want to justify each existing position with regards to my ‘edge’ and have the fortitude to make adjustments to my portfolio where appropriate. I’m going to be looking more at the microcap space and special situations.