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What went wrong in 2013

January 11, 2014

Each year I try to do this same post. This year the answer is simple: Just about everything went wrong! My value portfolio, what I write about here, was up a measly 5% when the overall market was up over 30%! The only word to describe this is pathetic. OK, so now the humiliation is over, let’s dissect what exactly happened.

For starters my overall portfolio positioning was wrong. I took a macro view (something I have to keep reminding myself not to do) that the market was overvalued at the end of 2012, and thus I held a large cash position of 25%+ as well as S&P 500 puts throughout most of 2013. This was a drag on my returns, but not necessarily the cause of my egregious underperformance.  That can be largely attributed to my choice of investments.

My largest position, AIG, was up a comfortable 45% or some 15% more than the S&P 500. So how did I screw up? Three countervailing losses; Fortress paper (down 50%), NovaGold (down 43%) and, of course, the S&P500 puts (100% loss). Furthermore, my second largest position at year-end, Bank of America warrants, was up only 19% in 2013 and my third largest position, MFC Industrial, was down 6%. So what are my conclusions? and what should I do for 2014?

  1. No macro positioning: There should be no macro slant to my portfolio. I don’t know whether the market will go up or down in 2014 and therefore I should take no position that depends on market direction, i.e. no puts or calls on the indexes. By year-end I plan to be 90%+ invested.
  2. I have a number of  deep value plays that could take time to work out (MFC, Fortress Paper and Resolute Forest Products fall into this category). Perhaps I am ‘trying too hard’ and need to find investments that fall into the category of ‘shooting fish in a barrel’. It’s time to reassess my investment rationale for each of these positions in light of potentially ‘easier’ investments.
  3. It is also time to reevaluate my stock picking skills; perhaps they are not as good as I thought they were. I have been reading Quantitative Value by Gray and Carlisle and am considering a change of strategy back to a more probabilistic portfolio construction approach such as they propose. However, with the market at or near all-time highs and the possibility of a decent sell off this year, I will not be making the change until there is a market pull back of at least 20%; quantitative value approaches tend to have significant drawdowns during market retreats. (but am I gaming myself on market timing here?) Also acknowledging that one’s investing abilities are below average is a hard fish to swallow! Might take some time to digest this one.

So, concretely, what are my first steps for the new year? I think I will just be looking to harvest my portfolio further, especially reducing my stake in AIG opportunistically if and when shares begin to trade above 80% of book value ($55). I am looking to be out of that position entirely if shares were to trade between 90-95% of book ($60-65). Further, I will be reassessing each and every other position I have over the next couple of months to see whether we are near my estimate of intrinsic value (revised from when I first made the investment) or whether management simply is incapable of realizing what I thought was intrinsic value (MFC???).

  1. Thank you for an interesting blogg. Just a thought though.

    Dont you contradict yourself when saying. “No macro positioning” aswell as “However, with the market at or near all-time highs and the possibility of a decent sell off this year, I will not be making the change until there is a market pull back of at least 20%”

    Why is it important to wait for the market to act in general? Is it not more important to look for companies with good value, regardless of what we think the market might do sooner or later?

  2. Sparticus (nice nickname), thanks for your comment.

    Yes, a bit contradictory. That’s why I wrote ” (but am I gaming myself on market timing here?) “!

    What I really mean is that I think I will find it psychologically easier to make this transition when the market retreats, given that a Quantative value approach will often underperform in down markets. Just ask yourself what you would do if you purchased a stock and the next day it declinesd 20%, 30%, 40%, 50%? There is a threshold of ‘pain’ after which the psyche breaks and you sell because your conviction is not 100% (unless you’re Warren Buffett, that is). This happens (and don’t tell me it wouldn’t happen to you!) even though you ‘know’ the stock is worth 2x what you paid for it. One of my goals is to AVOID THOSE SITUATIONS AT ALL COSTS because I know I won’t have the stomach to make the right decision (buy more shares, of course).

    Right now the markets are at historic highs. They may go higher or lower, I don’t know, but I’ll feel better about investing when contemplating new purchases begins to make me feel sick to my stomach. Today’s market makes me want to invest. That’s a bad sign!

    So, in the meantime, whether it is a month, a year or more until the market turns down, I’ll be harvesting my current portfolio and investing only when I find shares that make me feel like I’m shooting fish in barrel. A great part of investing is knowing when to wait. Does the word PATIENCE ring a bell?

  3. bubbles permalink

    How does your result look if hypothetically you held cash instead of novagold and s&p puts? I bet it doesn’t look terrible.

    Buying productive assets at attractive prices is the name of the game. Gold mines are productive assets, but their prices had been inflated. S&P puts are definitely not productive assets.

    Good luck in 2014!

  4. Jack permalink

    If you were to choose stocks based on probability of success, wouldn’t it make sense to be extremely picky with the qualitative aspects of a business? A business with recurring revenues, high ROIC, simple capital structure, and competitive advantages has little room for error. This is the classic Buffett way to invest. You could be incredibly smart, but if you invest in a business with a lot of moving parts, that could screw you over. Charlie479 got screwed over by ZipRealty, Abercrombie, and Ambassadors Group because he incorrectly assessed the chances of adverse events.

    Another thought: why hedge by betting against the market when you could work on stricter portfolio management strategies? Mohnish Pabrai has good rules for portfolio management. Also, don’t fool yourself into thinking you can time the market. It’s better to be consistent: look for good businesses; when it’s a bargain, buy.

  5. ruinius permalink

    Hi, I have been following your blog for more than 6 months.
    Your blog and style is really good. I really like some of your stock picks like AIG and the other financial institutions that were trading below book. I think you are not giving yourself enough credit in your post. I do notice some bad habits dragging you down, which I think is easier for an objective bystander to notice… and I summarize as the following:

    1) Too many of your stocks are undervalued assets that are burning cash, like Gravity, Fortress, Novagold. With no liquidation or catalyst event, it is very uncertain (even historically) whether you will make any money or not. You should replace them with “shooting fish in a barrel” stocks like Nintendo 6 months ago when it was trading at net cash value with total disregard for their franchises and ongoing cash flow.

    2) You went into many highly technical areas, which requires tremendous industry expertise to understand, such as biotech (ENZN), govt contractors (XLS), and health systems (EBIX). As a result, it was probably very difficult for you to understand when to buy and sell or even value based on underlying operations rather than superficial financial metrics.

    3) I did some research in my spare time before. Timing the market is incredibly important (not day to day, but year to year) for return. Warren Buffett (hell, he liquidated everything and went on vacation right before the market crash once), Seth Klarman, Pram Watsa are not afraid to hold significant cash positions when good deals are sparse. Seth Klarman explicitly says that it is one of the keys to high returns in Margin of Safety. Although I do agree S&P puts are a bit overkill… but please keep having a strong, well informed macro perspective. 90% invested on a year everyone agrees is overbought sounds like emotions > logics to me.

    Hope the above is helpful.

  6. Dan permalink

    Interesting discussion on portfolio management, here are some of my thoughts:

    For myself I use kind of a combination of a whole bunch of successful investors’ portfolio strategies. I do use the Klarman approach to cash. Pabrai has an interesting twist on this approach but it applies to me less because I do a lot of special situation investing. I remember Buffett writing about the three categories of investments he purchases: generals, special situations, and control investments. He said that special situations and control investments work as a shield against poor general market developments.

    Along similar lines to Pabrai’s post-crisis portfolio management style: Chamath Palihapitiya (a very successful venture capitalist) sets up his portfolio to where 30% is invested in “shooting fish in a barrel” type of investments and the rest are somewhat riskier but potentially higher rewarding investments. (Because we’re value investors we should probably supplant “riskier” with “lower quality”).

    There is a lot of interesting takes on portfolio management in “the art of value investing” which has the Kelly growth criterion but also mentions a more defensive approach which I consider sort of the defensive version of the Kelly Criterion. This is where the investor estimates the downside of an investment and decides what max loss would be acceptable (say 1% on the entire portfolio). If one thinks that given a worst case scenario an investment could be worth $90 an investor would risk $100 if the investor made this a 10% position (and holds the rest in t-bills for the sake of an example). Also of course you could do the same thing for individual positions.

    So for my portfolio I have a few high quality generals (in Buffett nomenclature) that are about 30-40% of my portfolio. I have another 20-30% in lower quality but cheaper stocks. The rest are in special situations and cash. I should note that I don’t have any hard and fast rules about any investments I just make a judgement based on timeliness (annualized returns, liquidity), quality, cheapness and/or growth of an investment.

  7. Hi Jay,

    First of I like your blog! I started following it since yesterday, i know of the charts following record;) I’ll add my 0.2 cents to the discussion. I’ve read some, if not most of your articles, how ever I do notice some things. Those things are bit vague to me so I could be misinterpreting them.

    Now those vagueness got my attention, so let’s start out with a example. In this article you talk about, you simply want to focus “Microeconomics” and yet even in this article it’s clear you’re more oriented to “Macroeconomics”. How ever in other articles about “FortressPaper” you show you are also good in bottom-up investing. This confuses me a bit, I mean you have a philosophy and are not showing that much dedication to it. Why is that?

    How ever I also do think your going in the right direction with your investing skills, because as a counter argument using the same info as above, i can also conclude you’re moving in the “right” direction and show improvements in what you want to achieve. Now I would like to offer a piece of thought for you!

    Why not combine the ideas, first starting of with the bottom, compere the company to other companies, just finish everything company specific en then start looking if there is a sector wide possible catalyst? I think that with this you satisfy your emotions yet show the ability to detach your emotions!


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