OM’s Philosophy: How Today’s Portfolio Fits

As a follow-up to OM’s last piece on his investment philosophy and strategy, this one looks at how the current portfolio fits within that framework.

Dislocations – 35.4% NAV, as of end of June 2018 
OM seeks to take advantage of dislocations – areas of the market where performance has been abysmal and investors have lost hope.  In addition to cheap valuations and fundamentals that are turning around, these investments require a narrative to help encourage investors to reexamine the opportunity.

Brazil (20.3% NAV) 
The longer-version of the thesis can be found here.  The shorter version is that Brazilian equities lost 80% (in USD-terms) between 2011 and 2016, and investor sentiment reached a nadir in early 2016 as the Carwash Scandal enveloped Brazil’s elite culminating in the successful impeachment of President Rousseff.  With sentiment at a trough, there were positive signs; new President Temer was viewed as competent and a short-term fix, and the length-and-depth of the recession meant that politicians were open to reform (especially pension) and companies had spent 5-years cutting costs to survive (i.e. created operating leverage to any pick-up in demand).  This was supplemented by the macro environment picking up (Brazil exited recession in 2017) and stock prices rising.

However, the big current question is whether the narrative peaked in December 2017, when Brazilian stocks continued to rise even as the planned pension reforms were shelved.  If so, this position should be vastly smaller especially considering the uncertainty of the upcoming election.

Uranium (9.5% NAV) 
Uranium remains the most frustrating position in the portfolio, which is a sign that it should probably be a smaller one.  Nothing has changed in the thesis;
- The primary demand is nuclear power plants which are slowly coming back online (post Fukushima) and being built (mainly in China and India).  These plants have long-term contracts (2-10yrs) and the majority of existing contracts come due in the 2018-2020 time frame.
- The supply-side is now rational.  A multi-year price war saw suppliers seek to build/retain market share, but the continued falling price meant there was no investment and most mines currently operate at a loss.  Two suppliers (Cameco and Kazakhstan) now control over 50% of the market, and have both been disciplined and aggressive in shutting down capacity.  Our Man hoped that these public demonstrations of supply-side discipline, especially the major cuts coming into 2018, would help start to drive the narrative and price but despite strong rallies on the shut-downs, there’s been little price follow-through.

Greece (5.6% NAV) 
Greece suffered through the Great Depression (and more) and everyone’s still annoyed/frustrated with them, with investors having been burned more than once.  However, Greece exited its third (and final?) adjustment program a couple of weeks ago and the IMF/EU came to a French-brokered understanding re. its future debt path earlier in the year.  While there is much reform that still needs to happen, it’s also too easy for outsiders to discount what’s already been done (e.g. reforms making it easier to fire workers, new laws to work out NPLs, etc.).

OM has limited the position size since while all the ingredients are in place there is no compelling narrative to force people to look at Greece again.  As such, OM is waiting to see (i) Greece come to market with another debt issue, and especially (ii) elections.  OM suspects that the latter will prove a strong driver of the narrative, especially if Kyriakos Mtzitokis’ New Democracy look like winning.  They represent a much more palatable partner to investors/the EU/the ‘media’/etc. than current Greek PM Alex Tsipras and his Syriza party.

Thematic – 28.8% NAV, as of June-end 2018 
This represents OM’s exposure to long-term secular themes.  The themes likely won’t change much over time though the underlying components and position sizes may do.

The 3^rd/4^th Industrial Revolutions (14.2% NAV) 
The Digital Revolution (3^rd Industrial Revolution) was the shift from mechanical/analogue technology to digital electronics; at the simplest level think sending mail to email.  It began with the invention of the transistor (1947) which led the advent of digital computers, and it continues through today cellphones and the Internet.  The Fourth Industrial Revolution is building upon and extending the Digital Revolution, and seems likely to transform society in the coming years/decades.  So far, it has been characterized by breakthroughs in fields such as robotics, artificial intelligence, machine learning, autonomous vehicles, genome science, and cryptography.  Most will have at least heard of some/most of these fields, but they are all still emerging and their impacts and relative importance isn’t yet known.

Our Man has long-held various technology and biotech names in the old Equities book; while the companies have their own attractive traits, these “Industrial Revolutions” are the overarching theme that binds them together.  OM suspects that by classing all the positions that are predominantly driven by this theme together, it will help from a sizing and risk management perspective.

If you’d like to read a simple primer on the 4^th Industrial revolution, here’s a good one from World Economic Forum.

Argentina (8.0% NAV) 
Argentina started in the dislocation book; Kirchnerism from 03-15 resulted in a poorly managed and distorted economy, with no access to global capital markets.  However, political change was imminent; President Cristina Fernandez de Kirchner couldn’t run in the 2015 elections, and any of the 3 candidates would be more market friendly.  She was replaced at the end of 2015 by President Macri, the most market friendly of the candidates.  President Macri began an impressive liberalization of the economy including removal of currency controls, inflation targeting independent central bank, settling with the bond hold-outs allowing Argentina to access capital markets, etc.  

The thematic bet is long-term that Macri-ism succeeds and Argentina becomes a ‘normal’ country and market economy, with single digit inflation and normalized interest rates.  This allows the development of a broader credit market (both corporate and personal) and businesses have greater ability to plan/invest for the future.  Think of the US in the early 1980s, following Volker’s raising rates to tame inflation, as a good but vastly simpler historical rhyme.

India (4.9% NAV) 
The long-term bull case for India is widely known, and OM doesn’t have much special insight.  The thematic case starts with the 2^nd largest country in the world, which also has great demographics and is (relatively) technologically advanced.  These natural advantages are supplemented by some self-help.  While there is much to criticize the Modi government over, it has made some structural shifts (taxation changes, bankruptcy code and financial reform, etc.) and the push to digitize the economy, highlighted by the introduction of Aadhar (a unique individual ID number based on biometric information), is potentially world-leading.

Vietnam (3.1% NAV) 
The cliff notes for the Vietnam is that it looks like China/Thailand 15-25 years ago and is treading down the same path.  The longer form can be found here; expect Vietnam to be in the portfolio for a long time though the position size will vary depending on the pace of reforms, the strength of the economy and the proximity and likelihood of any MSCI upgrade (to Emerging Market status, from Frontier).


Idiosyncratic – 18.2% NAV, as of June-end 2018 
The idiosyncratic book is made up of two things; a small number of attractive individual stocks and some Funds.  These Funds take advantage of some structural inefficiency be it through active stock picking/time horizon or using a combination of (valuation) factors to systematically allocate capital. 

Texas Pacific Land Trust (TPL, 6.7% NAV) – if there could be a poster-child for the type of individual stock in the idiosyncratic book, it would be TPL.  It’s attractively priced, not covered by any Wall Street analysts (of note), not in any ETFs, and its business (oil royalties, land leases, and water rights) has no real peers to benchmark it against.  Throw in the uniqueness of its structure – it was created in 1988 as a result of the Texas Pacific Railway co going into receivership, and all it does is manage/sell land and use the proceeds to buy back shares – and nobody really knows or cares about it.   

Fannie Mae (FNMA, 0.3% NAV) – Either the government should not be sweeping all of FNMA’s profits to the Treasury and it’s worth multiples of the current price, or they should and it’s worth almost nothing.  For a resolution, it requires political decisions to be made on a topic nobody wants to make-them on (government’s role in the mortgage market) and with no immediate need for a decision.  Think of it as a glorified option with lots of unknowns and very attractive risk/reward payoff.  Also, it has no time decay but also no strike date…it could be here forever and worth the same, or worth multiples next quarter/year.

As previously noted, the Funds (11.3% NAV) are within the idiosyncratic book.
- GVAL and CAPE are both based on applications of Shiller’s PE Ratio (aka Cyclically Adjusted Price Earnings, CAPE).  GVAL applies it to International stocks (finding the cheapest stocks in the cheapest countries), and CAPE applies it to US sectors.  To Our Man’s mind Shiller’s PE Ratio/CAPE is a tool that is poorly applied in finance with too many trying to use it as a timing mechanism or reason for a short-term decision, whereas it’s real value is as a very long-term measure of relative value.  The intent of both ETFs is to buy things that are cheap on a relative basis (compared to other countries/sectors) and Our Man’s wager is that over the long-term this will prove to be more profitable than the market.
- CWS:  Our Man has read the Crossing Wall Street blog for most of the last decade, and this ETF is based off that blog.  CWS publishes an annual “Buy List” of ~25 stocks at the start of each year, which are equally weighted and then no changes can be made during the year.  Each year only 5 stocks from the Buy List have been replaced, with the others carried forward (with any additions) onto the new Buy List.  This longer-term focus (typically, 4-5 years on the Buy List) leads to a bias towards quality and value and if the process can remain disciplined this can lead to out-performance over time.


Technical - 32.9% NAV, as of June-end 2018 
The Technical book was added back in 2014, to help compensate for OM’s natural skepticism by formulaically take long positions (in the levered ETFs for the S&P 500, Dow Jones and Nasdaq 100) to capture long-term trends in these markets.  The position-sizing of these positions is also rules-based, and more information on the genesis and rules for the Technical book can be found here.


Hedges/Shorts 
None currently.

OM's Investment Philosophy and Strategy

The biggest thing that OM has learned during his career in finance is that investing is a very personal endeavour.  When it is done well the investment philosophy reflects the beliefs, skill set and personality of the practitioner.  Furthermore, the best investors understand themselves and their strategy; they can clearly articulate their strategy, and explain why it suits them. 

So, what is OM’s strategy? 
Our Man believes that the markets offer three distinct ways to make outsized returns; (i) by investing in idiosyncratic opportunities especially where there are structural inefficiencies, (ii) by participating in long-term themes, particularly secular trends, and (iii) by taking advantage of sizable dislocations in markets.   The natural consequences of these beliefs are that the portfolio will be concentrated and will likely see mark-to-market volatility, and thus a long time-horizon is a prerequisite.

Long-time readers (commiserations y’all!) have seen the evolution of Our Man’s portfolio over the years.  The changes reflect a variety of things most notably the constraints of OM’s then employment and his maturation as an investor, which over time has led to a more defined investment approach.  In particular, the 2009-2011 period (when OM worked for an equity focused hedge fund) saw a portfolio that was more macro driven while the 2011-2014 period (when OM returned to allocating capital to others) saw a more stock-specific portfolio.   From 2015 onwards, the portfolio’s strategy has been largely unchanged, though the way the investments were broken down was less clearly defined.

So, dear readers, expect the portfolio to be broken down more clearly along the following lines in the future.
- Thematic 
This will likely be the biggest component of OM’s investments, as it reflects how OM thinks about the world.  He believes that many seemingly independent stock-specific positions have a common driver, or theme.  The themes are likely to be secular in nature, so they should be in the portfolio for a multiyear period unless OM is wrong/early.  Expect an articulation of the theme early on, including some flags on the risks, that OM will build on over time.  These descriptions should help keep OM honest and limit thesis drift, as well as making it easier to identify any commonality of risks across the portfolio.  Themes are likely to be largely be expressed using ETFs, though single names may be used where that makes more sense (and yes, OM should be able to explain why it makes more sense!).

- Dislocations 
OM believes that public markets reward contrarianism, so expect him to hunt around in sectors or regions that show dislocations.  The best time to invest in these is when it looks the worst and others have given up hope; they are fatigued with the situation and have a visceral reaction to it.  On first read, these ideas will look ugly.  Hopefully, your initial reaction will be “WTF???  Are you insane!” but will slowly trend towards “that’s weird, but kinda interesting!” over time.  They key will be to invest when valuation/fundamentals and narrative are aligned; the first two provide some ‘margin of safety’ while the latter is what will draw other investors in.  OM has seen some good research that the average/median for a dislocation to move from its trough to a peak is 18-24mos (e.g. Brazil 92-94, Greece/Spain 11/12-14, Argentina 15-17, etc.).  Thus expect a dislocation position to be in the portfolio for 1-3yrs.  In some minority of cases, if the dislocation leads to a significant long-term change, a dislocation idea could eventually move to become a thematic one.  If this happens, expect an update to explain the move and a change in the position size!

- Idiosyncratic 
This bucket contains 2 things; (i) individual stocks and (ii) the Funds book.  The individual stocks are likely to be very limited in number since OM’s day-job, and skill-set, isn’t sitting around taking advantage of structural inefficiencies to pick stocks.  However, OM does see a LOT of things and he has two big structural advantages over most professional investors; small size and a longer time horizon.   Thus expect OM’s idiosyncratic names to have some combination of limited sell-side/investor coverage and a longer time horizon.  OM’s putting the Funds book here since it seems like the best fit; the Funds take advantage of some structural inefficiency be it through active stock picking or using a combination of (valuation) factors to systematically allocate capital.

- Technical Book 
OM is retaining this as its own separate item.   One of his many life-flaws is that OM is naturally cynical; investment-wise, this means he has a propensity to be under-invested and the Technical book was developed to be a systematic hedge to this.  More on the rationale behind and construction of the technical book can be found here.

- Shorts/Hedges 
Finally, Our Man intends to keep shorts in a separate book to help track how they do.  However, they will be generated in the same way as the strategies above, with most likely to be themes or perhaps predicted dislocations.  The positions are likely to be executed through Short-ETFs or by buying puts.  For the vast majority of time, this book will be empty.   

Finally, OM also is hoping to start a semi-regular feature called “Half-Baked Ideas”.  The main reasons are that OM has many more ideas than ever make the portfolio and he doesn’t do a great job of tracking/sorting them or returning to revisit those ideas.  Hopefully, this should help resolve that and impose some discipline on OM re. tracking and following up on his ideas.


Next Up: Breaking the existing portfolio down into this structure.

Things from my Newsblur; 2018 Part III

Time for another edition of “Things from my Newsblur”.   Our Man has recently been thinking a lot about how to use time more productively, so today’s edition begins on that note.  It soon diverges into more lighthearted fare including LaCroix flavors and the Muppets.   As usual, the most investment-related stuff is at the end. 

On the Phenomenon of Bullshit Jobs

Anthropologist David Graber has just published a book – “Bullshit Jobs” – that stems from this article written 5-years ago.  After the article’s publication, hundreds of people across the world reached out to Graeber to talk about their white collar bullshit jobs!  Our Man will let you guess which of Graeber’s 5 categories - Flunkies, Goons, Duct Tapers, Box Tickers, and Taskmasters – he might fall into!  (David Graeber, Strike Magazine)

For those who’re curious about the book; Nathan Hellers, in the New Yorker, has a good review.

Maker vs. Manager: How Your Schedule Can Make or Break You

Most office jobs impose the same work rituals on people, yet different types of work require different types of schedule.  This concept was originally described by Paul Graham of Y Combinator in 2009.  He defined the two broad types of schedule – Manager and Maker.  The Manager’s schedule reflects the traditional appointment book, with the day broken up into blocks (typically of an hour) and meetings pre-set for these blocks.  The Maker’s schedule is less fixed and the units are larger (perhaps half-a-day), since you can’t write or think or program or even analyze an investment well in units of one hour.  As office jobs have consistently migrated to the Manager schedule, how do people whose job consists of both Managing and Making adjust?  What about those who are Makers in a Manager-styled firm?   The secret is in creating and defining your schedule, especially setting aside dedicated time for the Making even if that is at odd (i.e. very late night) hours.   This is something that Our Man is wrestling with as he thinks about investing (Maker) and ‘working’ (Manager, as it entails some investing, but mostly internal meetings, responding to clients, presenting, dealing with legal/tax/etc. questions, and all the other things that surround investing).  (Farnam Street Blog)

What’s the Most (and Least) Popular LaCroix Flavor?

Our Man is no fan of fizzy water, but he does live in Brooklyn where LaCroix is a thing!  Like Oat Milk is a thing!  Yeah, Oat Milk!  I know, people are weird!  So for all you Brooklynites, and fizzy water fans, here’s some research on the most popular LaCroix flavors.  (Pricenomics, and Oh My Green) 

It’s Not Easy Being Evergreen: An Oral History of the Muppets

The Muppets started as adult-focused entertainment on variety shows, before hitting the big-time on kid-targeted Sesame Street.  They eventually secured their own show in the late 1970s, but it was produced in England after no US network was willing to take the chance.  Despite numerous efforts, including recent movies (quite successful) and a 2015 TV show (not so successful), they have no hit the same heights since.  (Studio 360, Slate)  

Why Doesn’t Anyone Answer the Phone Any More

The headline says it all – unless you’re in OM’s contacts, the chances of him picking up the phone are almost exactly zero!   Sure, over the last decade Whatsapp, iMessage, WeChat, Twitters, Facebook, etc., have all become alternative ways to communicate.  However, the answer is simpler; spam and robocalls.  Answering these only ensures you’ll receive yet more of them!  (Alexis C Madrigal, The Atlantic)   

Facebook’s Gollum Will Never Give Up Its Data Ring

The recent debate about Facebook and ‘your’ data has largely missed the point.  Facebook doesn’t sell ‘your’ data, it merely leases it!  What folks should be more worried about is how it gets that data; by seeking to capture as much attention of as many people as possible, in just about any way possible.  The leasing of data from this, well that’s just how it monetizes you.  (Azeem Azhar, NewCo Shift)

Azeem is also the curator of the excellent free weekly Exponential View newsletter; let OM know if you’re interested in finding out more!  

The Luck of a Gecko

OM is in the midst of writing a blog post about his investment philosophy, and it’s thus timely to share this old article (2013) with you.  The article looks at the impact of GEICO on Benjamin Graham’s and Warren Buffett’s Success.  In particular, it’s the investment that Ben Graham (the father of value investing) built his reputation on; the profits from GEICO were larger than those from all of his other investments combined.  It’s also an investment where Graham broke numerous of his own investment rules; “the one company for which Graham threw out the playbook was also the company that accounted for most of his success”.  (Mark Hebner, Index Fund Advisors)

For those after a longer, and more detailed analysis, read the Wedgewood VIC presentation from 2013.