From the 1964 Buffett Partnership Limited Letter:
“In looking at the table of investment company performance, the question might be asked. ‘Yes, but aren’t those companies run more conservatively than the Partnership?” If you asked that question of the investment company managements, they in absolute honesty, would say they were more conservative. If you asked the first hundred security analysts you met, I am sure that a very large majority of them would also answer for the investment companies. I would disagree. I have over 90% of my net worth in BPL, and most of my family have percentages in that area, but of course, that only demonstrates the sincerity of my view – not the validity of it.
It is unquestionably true that the investment companies have their money conventionally invested than we do. To many people conventionality is indistinguishable from conservatism. In my view, this represents erroneous thinking. Neither a conventional nor an unconventional approach, per se, is conservative. Truly conservative actions arise from intelligent hypotheses, correct facts and sound reasoning. These qualities may lead to conventional acts, but there have been many times when they have led to unorthodoxy. In some corner of the world they are probably still holding regular meetings of the Flat Earth Society.
We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive great comfort if they don’t. A public opinion poll is no substitute for thought. When we really sit back with a smile on our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course of actions obvious. In that case – whether other conventional or unconventional -whether others agree or disagree -we feel- we are progressing in a conservative manner.”
One of the biggest myths about investing is that conventional strategies equate to conservative strategies. Being long growth tech stocks in 2000, resulted in 50-75% losses by 2003, but if you unconventionally avoided them you looked like a moron in the late 1990s. In the 1960s, the crowd piled into the “Nifty Fifty” and were thus decimated when the stratospheric valuations came crashing down. In the mid 2000’s, the pervasive belief was that housing prices would never go down. We all remember the devastation that occurred. The reality is that conventional strategies are more conservative for the advisors recommending them than they are for the actual clients. Let me explain:
Let’s say that you are a perspective client looking to invest for the long-term. If an advisor puts you in a collection of index or mutual funds, they will collect a fee in addition to what you have to pay to the actual funds. You are almost guaranteed to underperform over the long-term because you are basically invested in an index but are paying higher fees, as indices themselves have no fees but cannot be invested in. With that said this is a very conventional strategy, so if the market tanks and you lose it is unlikely that the advisor would deal with too extensive of criticism. This conventional strategy is very risky when valuations are expensive. It is always initially a reasonable idea, such as housing prices have a tendency to go up over time, or index funds can be an attractive way to invest, that become orthodoxy and end up blowing up in investors faces. Without fundamental valuation, these types of activities are much more speculative and don’t meet the requirements of being an actual investment where upon a careful evaluation of the facts you have a reasonable expectation for profits.
At T&T Capital Management (TTCM), we focus on maximizing risk-adjusted long-term investment returns. We view ourselves as being extremely conservative in that our strategy seeks to absolutely minimize permanent losses of capital. When stocks are relatively expensive as they are now, we focus on buying well-financed individual securities that trade at deep discounts to intrinsic value. These securities are often out of favor in the short-term due to some issue, but have very attractive long-term prospects. We put the most money in our best opportunities, as opposed to spreading it around evenly, as diversification is a very poor surrogate for knowledge. When you are unconventional, there will be times of outperformance and underperformance but we believe that the probabilities are very high that we will outperform over the long-term. This is why 100% of my liquid capital is invested in the same strategies we do for clients.
Nothing gets us more excited than the types of opportunities we see today. Low interest rates and energy prices, combined with slow economic growth has caused financial stocks to trade off to levels not seen in years. We are able to buy the most financially strong companies, at significant discounts to conservative estimates of liquidation value. Even better, the intrinsic values are growing and the companies are overly-capitalized, allowing us a clear path towards increased dividends and stock buybacks. I have absolute confidence that we are right in our high conviction investments. We are even getting paid for waiting with covered calls that we have sold far out of the money. The only issue is the timing. It is the obsession with short-term performance chasing that is the death-knell to successful investing. I have seen it time and time again. Sometimes it is painful to go against the crowd, just ask Galileo who was tortured because he said that the Sun was at the center of the universe instead of the Earth. Because people agree with you doesn’t make you right and it also doesn’t make you wrong. The facts are what matters. This is why we need to let earnings play out over the next few years. Rising profits will increase intrinsic value and excess capital will result in larger dividends and stock buybacks. This in turn will create higher valuations placed on the businesses that we own. While being more concentrated can create more volatility on the downside, the impacts on the upside are just as great and if we are right, much more lucrative than anything else we can do via investing. These stocks that we own have 50-100% upside potential over the next 3-5 year period. I’d bet a lot of money that the market won’t do anything close to that and I feel it is very likely that we will see that kind of growth. Unfortunately, I also have no doubt that there will be those that panic or miss the boat because they are worried about the next quarter, or think that the market might drop for some reason but that they will time the recovery. It will be very clear if we are right or wrong, but the dramatic discounts to intrinsic value give me extreme confidence that this is a conservative strategy for the long-term investor. As always, please feel free to ask me any questions as I’m always available for clients directly. 805-886-8140