Closed-end funds: still a land of opportunity?

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Closed-end funds remain a fascinating topic and an interesting source of investment opportunities. For an overview of the closed-end puzzle and a behavioural theory, have a look here and here at the papers by Nobel winner Richard Thaler, written in collaboration with Andrei Shleifer and Charles Lee.

My favourite closed-end fund investments meet the following 3 criteria (in this order):

1. The underlying assets are attractive.

2. The fund trades at a significant discount to its net asset value (NAV).

3. There is a catalyst that will lead to a narrowing of the discount.

A couple of examples:

Aberdeen Emerging Markets Smaller Company Opportunities Fund. The fund is managed by the experienced Aberdeen team, has a reasonable TER of 1.55%, and trades with a discount to NAV of around 7%. Whilst the discount is lower than in the past few years, there is now a clear catalyst, as announced here.

Pantheon International Plc. Pantheon invests in private equity funds globally. Over the past 20 years, it has delivered a compound annual return to investors of 12%. It currently trades at discount to NAV of 17% (again, the discount has been wider in the past). Pantheon continues to buy back shares and is working to narrow the discount (see recent announcement).

 

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Book review: Big Money Thinks Small

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This book is a solid candidate for the best investment book of the year!

Joel Tillinghast, the author who has successfully managed the Fidelity Low-Priced Stock Fund for almost 3 decades, introduces 5 key investing principles:

 

 

1. Invest patiently and rationally / not emotionally.

2. Invest in what you know / not in things you don’t understand.

3. Invest with capable, honest managers / not with crooks.

4. Invest in resilient businesses with a niche and strong balance sheet / not in faddish, commoditized businesses with a lot of debt.

5. Invest in bargain-priced stocks / not in pricey “story” stocks.

This emphasis on a margin of safety is nothing new. What is enriching, however, are the insights Joel Tillinghast shares when covering a variety of topics including technology stocks, commodities, accounting, psychology. The author’s learnings on Enron / Petrobras / CMGI / Valeant are also very interesting.

Some thoughtful bits and pieces:

“While I generally avoid commodity businesses, if you must invest in one, go with oil, because of the limit on supply and relatively inelastic demand”.

“Contrary to popular wisdom, picking stocks based on low P/Es and high free cash flow yields often works particularly well with technology stocks”.

What could look like anecdotes and unrelated points come together to form a valuable approach to investing – one business at a time (ie. thinking small). This is not a cookbook with recipes; it’s a collection of investment widsom.

I’ll certainly re-read many passages of this book over and over again. Highly recommended for seasoned investors.

Book review: The Best Investment Writing

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In this new book, the editor Meb Faber brings together an eclectic collection of investment texts.

You won’t find here some classics like Warren Buffett’s Superinvestors of Graham-and-Doddsville or Charlie Munger’s Psychology of Human Misjudgment or John Maynard Keynes’ essay.

Rather, this volume 1 includes texts by acclaimed investing journalists (Jason Zweig, Barry Ritholz), bloggers (David Merkel, Ben Carlson), academics (Aswath Damodoran), advisors (Ken Fisher).

The 32 articles are all useful. I especially liked Morgan Housel on competitive advantage, Ben Carlson’s 20 rules of personal finance, and Todd Tresidder’s due diligence questions before making any investment.

As there is hardly a common thread across the articles, I find it hard to write a comprehensive review; suffice to say that this is an interesting collection of articles.

Let’s see what Med Faber has in store for volume 2.

Book review: Invest like a Guru

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I’ve been a user of GuruFocus.com for some time. When looking at a stock, I like to check on the site its Piotroski F-Score, potential warnings signs, and trades of renowned investors. Hence I was interested to better understand the philosophy behind GuruFocus.com, which founder Charlie Tian describes in Invest Like a Guru.

A physicist by training, the tech bubble was a defining moment for Charlie Tian. Following his poor experience with stocks during that period, building on the teachings of Peter Lynch, Warren Buffett and Donald Yacktman, Tian developed one of his core principles: Buy Only Good Companies. By ‘Good Companies’, the author means consistently profitable businesses (with double-digit operating margins and returns on invested capital) that can continuously grow revenues and earnings through their operations.

Chapter 6 provides a useful 20-item checklist for investing in good companies at fair prices (see pages 102-103). Also, the author has developed a series of Warning Signs (e.g., weak Altman Z-Score, asset growth faster than revenue growth, issuance of new shares), which are flagged on GuruFocus.com

The author prefers to stay away from cyclical stocks – especially leveraged cyclicals – and deep value situations where value erodes over time. Based on investors’ experiences with Sears, Weight Watchers, BlackBerry, Tian comes to a surprising conclusion for a value investor: “never buy low-quality companies again, no matter how undervalued they seem to be!”. This is too radical for me.

I find Invest Like a Guru a helpful companion to GuruFocus.com, with useful suggestions to avoid permanent losses of capital.

 

Stocks on the watchlist: an update

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For some time, I’ve been keeping a watchlist of stocks on this blog. This list of 9 companies has not changed since the beginning of the year. Here’s how the stocks have performed year-to-date (for simplicity, in local currency).

Alphabet +17%.

Admiral Group +10%.

Visa +17%.

Ryanair +9%.

Roche +15%.

S&P Global +25%.

Kinepolis +25%.

DeVry +21%.

Van Lanschot +25%.

Some observations:

  • In a bull market, it’s the smaller value plays that perform best (e.g., Van Lanschot, DeVry).
  • Depending on the specific circumstances, both “averaging up” and “averaging down” make sense in a portfolio.
  • It’s time to update the list!

Stocks for the (very) long run

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Interesting data from the Credit Suisse Global Investment Returns Yearbook 2017, compiled by London Business School professors (authors of this book). It shows the real rates of returns of world equities over various periods.

The data is based on an all-country world equity index denominated in USD, in which each of the 23 countries is weighted by its starting-year market capitalization.

It clearly confirms that equities offer attractive returns in the (very) long run. If you started investing on 1 January 2000 (not a great entry point…), you suffered negative real returns in your first decade but you are now nicely in profit territory. If you started on 1 January 1970 (not a great time either…), you made 5.2% per year on average.

At a time when assets are expensive, geopolitical risks abundant, monetary policy less supportive… it’s encouraging to look at stocks as (very) long term investments.

Warren Buffett’s 2016 annual letter

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I summarize below the insights of Warren Buffett’s from his 2016 Berkshire Hathaway letter published today, around 3 topics: stocks for the long term, active vs. passive investing, and share buybacks. It would be foolish to paraphrase Buffett so I simply quote some key parts from his letter.

On stocks for the long term.

“American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.

Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively financed American businesses will almost certainly do well.”

On active vs. passive investing.

Buffett’s 10-year bet that a S&P 500 tracker will outperform 5 selected funds of hedge funds is looking good (see details here). According to Buffett: “the disappointing results for hedge-fund investors that this bet exposed are almost certain to recur in the future”.

“There are, of course, some skilled individuals who are highly likely to out-perform the S&P over long stretches. In my lifetime, though, I’ve identified – early on – only ten or so professionals that I expected would accomplish this feat. There are no doubt many hundreds of people – perhaps thousands – whom I have never met and whose abilities would equal those of the people I’ve identified. The job, after all, is not impossible.

There are three connected realities that cause investing success to breed failure. First, a good record quickly attracts a torrent of money. Second, huge sums invariably act as an anchor on investment performance: What is easy with millions, struggles with billions (sob!). Third, most managers will nevertheless seek new money because of their personal equation – namely, the more funds they have under management, the more their fees.”

On share buybacks.

“The question of whether a repurchase action is value-enhancing or value-destroying for continuing shareholders is entirely purchase-price dependent. It is puzzling, therefore, that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed. What is smart at one price is stupid at another.”

How to monitor funds and ETFs

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For the private investor, there are plenty of tools to monitor stocks (e.g., Google Finance, Yahoo Finance). Following up on mutual funds or exchange traded funds (ETFs) is a bit more difficult.

To do so, check out the Portfolio section of the Morningstar web site (of your country). You can easily construct portfolios of funds and other instruments, which I find very useful.

As an example, I put together a list of global equity funds I like to follow, as well as a MSCI World ETF.

Morningstar portfolio

Over the past 5 years, it’s not been easy to beat this $#& tracker…

Book review: Investing through the looking glass

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In this book, Tim Price starts by explaining the problems the investing world faces. The backdrop of these problems is diverse:

  • Banks failed in their traditional role of prudently accepting deposits and extending loans; we should let banks fail.
  • Central banks are compounding financial crises by implementing flawed monetary policies: QE, ZIRP, NIRP, etc.
  • Economists and financial theorists provide no useful scientific advice.
  • Fund managers are by and large asset gatherers and marketing machines.
  • The financial media exists to monetise airtime and column inches.
  • Bonds are uninvestible and you need an edge to do well with stocks.

Throughout the book, the author challenges a number of misconceptions and replaces them by more relevant alternatives.

Misconception Better alternative
Keynes’ metaphor of the economy as a machine The Austrian School sees entrepreneurial trial and error as essential; economic planning is virtually impossible
Risk = volatility Risk = permanent loss of capital
Markowitz’ Portfolio Selection Mandelbrot: markets are riskier, misleading and follow a power law
Asset gatherers, who aim to maximise assets by keeping funds open and constantly experimenting with new funds, represent smart money Look for boutique asset managers who limit their AuM to protect performance, invest their own money, and are owner managed
Financial media provide new, up-to-date, useful narrative in real time to explain the prevailing situation Jason Zweig: “My role is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think that I am repeating myself.”

In the second part of the book, Tim Price offers 3 solutions for private investors: value investing, trend-following strategies, and gold.

1. Value investing. The author builds on classic Graham metrics that work, as analysed by O’Shaughnessy. A look at the VT Price Value Portfolio shows that Price currently sees value in Japan and Vietnam (together they account for over 50% of the fund). A large part of the Japanese investments are done through Samarang Capital. Holdings like Fairfax (Prem Watsa) and Loews (Tisch family) are also well represented.

2. Trend-following strategies. Tim Price is fond of systematic trend-following, as it offers both performance (see page 182 for examples of successful firms) and de-correlation. The strategy has not performed well recently but the author remains confident in its merits. For more info, see here.

3. Gold. Given his criticism of monetary policies, it is not surprising that Tim Price likes gold and doesn’t view it as a “barbarous relic”. According to Price, “Gold is an insurance policy against both monetary and fiscal recklessness”.

In summary, the book gives a good overview of what’s wrong with the current state of investing, and offers 3 interesting solutions. As a lot of criticism is directed towards recent policies, I wonder how the views of the author are evolving in the era of Trumponomics.