Show us your track record

This recent market decline is a good prompt to consider what we have actually invested in, and better yet, who we have entrusted to make do our investing for us.

Disclaimers always suggest that past performance is not an indicator of future performance. I disagree. What it should say is that past performance over LONG periods is a great indicator of future returns but it’s performance over short periods that is not.

A rising tide lifts all boats.

Warren Buffett

Just because a stock rises doesn’t mean it is a quality business. Just because an investment manager has printed good returns recently doesn’t make them a good manager in the long term. In fact, performance extremes can often mean the opposite of it first seems.

Often in late stage bull markets it is the most hyped companies which attract investment. This is typical of the speculative mindset of an investor who feels invincible after 7+ years of outstanding returns. We so easily forget how brutal financial markets can be.

The significant share price falls of Quintis, AfterPay, Blue Sky, Corporate Travel show how a small shift in sentiment can be brutal to a stock without valuation support. Those who have been late to the party in these names have done so more for fear of missing out then due to any solid fundamental view.

One of the larger challenges for us in recent years was justifying our avoidance of such stocks. Daring to be different is the most essential yet most difficult aspect of investing.

“Show me a guy who’s afraid to look bad an ill show you a guy you can beat everytime”

Lou Brock (sourced by Howard Marks)

I recently read through the annual letters of Seth Klarman, founding MD of Baupost group. He is one of the greatest investment managers of our time. In the late 90s while the market was rallying, Baupost returns lagged. You could have been excused for thinking Baupost’s style was no longer effective — as many did.

Recently we’ve seen similar calls that value investors like Klarman have lost their touch. But like in all other bear markets, those who prioritised the protection of client capital over short term performance, eventually shine once again.

It is counter intuitive to invest with a manager who’s recent record is poor. But the data is overwhelmingly clear, recent performance is a contrary decision indicator. The best time to invest with great managers is during periods of poor performance.

I feel strongly that attempting to achieve a superior long term record by stringing together a run of top-decile years is unlikely to succeed. Rather, striving to do a little better than average every year — and through discipline to have highly superior relative results in bad times — is:

- less likely to produce extreme volatility,

- less likely to produce huge losses which can’t be recouped and, most importantly,

- more likely to work (given the fact that all of us are only human).

Howard Marks

I’m amazed how many investment managers we recently with track records within this side of 2008. The performance numbers they are touting are untested and cannot be relied upon in isolation.

We are slowly but surely approaching our next test. Valuations are high and there is every reason for the market to be (much) lower. We want to ensure our investment partners are those which thrive into and coming out of a correction.

Time is not on the side of the bullish / growth oriented investor. Those who have earned outstanding returns in recent years will almost certainly be those who suffer the most in a correction.

Make the cycle your friend by acting contrary to it. Be wary of managers showing great (recent) returns, be dubious of hyped up stocks, and do your best to have more cash at this stage to ensure it is there when you need it.