TL:DR;
- Liquidity Is King
- Seek Dissent
- Probabilistic Thinking
- Di-worse-ification
- Arbitrage Human Behavior
- Counter Trend Following
- Price Of Admission
- Relative Selection
- Opportunistic Investing
- Fighting Internal Bias
- Replace Risk With Labor
- Stay Optimistic
- Lean Into Your Edge
- Anchor To Fundamentals
For information purposes only. This is not advice or a solicitation or offering of investment. Full Disclaimers.
“Liquidity is only there when you don’t need it.” — Old Proverb
If you have no discerning information when picking between two investments, pick the more liquid opportunity.
Having the ability to change your mind can significantly reduce risk and improve investment outcomes.
It should take a lot to convince you to lock up your cash in an investment. Accepting a 1-year+ lockup should only be reserved for a select few investments. These investments need to have a high probability of outperforming liquid investments, diversifying the portfolio significantly, or both.
A portion of your portfolio should always be liquid to take advantage of market opportunities and serve as a buffer for your life.
Instead of trying to maximize returns, you should aim to maximize liquidity-adjusted returns.
SEC doesn’t mandate liquidity requirements but emphasizes clear disclosure on liquidity constraints.
“The investor’s chief problem — and his worst enemy — is likely to be himself. In the end, how your investments behave is much less important than how you behave.” — Benjamin Graham
The best thing someone can do for an investor provides them with a well-structured dissenting opinion backed by evidence.
Investors spend most of their time seeking confirmation, which only incrementally improves their investment decision.
It is much easier to build conviction after carefully considering all opposing opinions.
Investing is not about being right. It is about being openly skeptical and curious, even of your own strongest held beliefs.
Promoting dissent aligns with a duty to act in investors’ best interests.
“The function of economic forecasting is to make astrology look respectable.” — John Kenneth Galbraith
Investing is not about predicting the future. No one has a crystal ball — that is what makes investing intellectually gratifying.
Investing is an exercise of probability-adjusted decision making. All it takes is being honest about the chances of the different possible outcomes and allocating capital accordingly.
The most difficult part is assigning probabilities to the different outcomes, but that should be the only part where any opinions are expressed.
If the expected value of an investment is above your benchmark after adjusting for the chances of the different scenarios — one should make the investment without any emotions involved.
Encouraging probabilistic decision-making aligns well with transparency in risk.
“Diversification is a protection against ignorance. [It] makes very little sense for those who know what they’re doing.” — Warren Buffett
The most successful and idolized investors (Soros, Buffett) and entrepreneurs (Musk, Bezos) did not get there by investing in a diversified portfolio (some have one position >90%).
The best investors build a deep understanding of their investments and manage them actively. In the case of the entrepreneurs, they stayed invested in their own teams, where they clearly understood the investment better than anyone else.
The idea that regular investors will be able to perform at the same level using index funds is illogical. A diversified approach makes sense for the vast majority of investors who do not have the time or training to manage an active portfolio.
Research shows that portfolios containing 12 to 18 stocks provide about 90% of the maximum benefit of diversification. After this point, further diversification reduces returns but does not significantly reduce risk.
The aim should be to understand and track your investments better than anyone else — so you can get the growth of a concentrated portfolio while still reducing the risk as much as possible without diversification.
We have to be careful of concentrated positions however. Avoiding over-diversification is compliant with SEC but requires disclosures on concentrated positions’ impact on risk.
“When the price of a stock can be influenced by a “herd” on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical.” — Warren Buffett
Investors assume that markets are generally efficient and rational. But aggressive movements (the pandemic), unnatural forces (the Fed), or even irrational but collective behavior can make markets behave in unexpected and illogical ways.
The best investors get paid for their ability to understand and exploit these temporary misallocations in the market. Arbitrage opportunities are difficult to find but can be discovered using simple and proven principles.
Some examples of arbitrage opportunities I see today:
- Early-stage companies without performance metrics are scrutinized less and valued less carefully than later-stage companies with more data to analyze.
- Private companies with significantly higher liquidity risk and lower access to information are valued higher than their public comparables.
- “Investable” teams with no experience in a specific field or geography get higher valuations than teams with sector-specific or region-specific experience.
- Investments are bought or sold in a group simply because of their sector or size (think index funds) with no opinions being expressed about the merits of individual investments.
The only way to consistently outperform the market is to be skeptical of widely held beliefs and pursue contrarian strategies grounded in fundamental principles. Market timing and arbitrage should be transparently disclosed.
“Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.” — Howard Marks
I am convinced the “Fear Of Missing Out” is the strongest force in markets and investors can outperform by training themselves to be counter-trend followers.
Trend following happens regularly (every 6–12 months in technology investing) at all levels (geography, sector, sub-sector, technology) and is something all investors are guilty of (institutional, individual).
There are many examples in hindsight of a never-ending cycle of investors jumping from trend to trend leaving bubbles and bursts in their path.
“History doesn’t repeat itself, but it does rhyme.” — Howard Marks
Focus on investments that are out of favor as investors have moved on to the next shiny investment trend. Build insight and conviction in not-so-popular themes, invest at depressed valuations, and then wait patiently for bidders to pay attention again. Counter-trend strategies should be disclosed for transparency, particularly in volatile markets.
“More money has been lost trying to anticipate and protect from corrections than actually in them.” — Peter Lynch
Volatility is the price investors pay for liquidity and performance.
Investors would like all the benefits of public market investments without the costs; many irrationally believe they can eliminate these costs through market timing.
“There is no such thing as no risk. There’s only this choice of what to risk, and when to risk it.” — Nick Murray
History has shown us the cost of having short-term concerns drive a long-term investment strategy, so effective investors appreciate that there is no free lunch and invest accordingly.
“Investment is the discipline of relative selection.” — Sid Cottle
There should be constant competition between positions in your portfolio and positions trying to make it into your portfolio.
Investors are inundated with opportunities so only a select few who achieve your goals the best should make the cut.
A lot of investors are eager to sell a position for cash if it achieves an arbitrary rate of return or price target. A position should only be sold if there is an immediate and better use of the capital — either in cash to reduce market exposure, another position with a higher expected value, or another position that diversifies the portfolio.
Each position has to earn its place not just before the investment is made but on an ongoing basis. If a position is not one of your top ideas to maximize risk-adjusted returns, swap it out until you have your highest conviction portfolio. This ongoing relative selection process should be documented for better regulatory transparency on selection criteria.
“The intelligent investor is a realist who sells to optimists and buys from pessimists.” — Benjamin Graham
The indiscriminate buying and selling of assets can present incredible investment opportunities. Investors find comfort in numbers and assume entire markets cannot be wrong.
“Your success in investing will depend in part on your character and guts and in part on your ability to realize, at the height of ebullience and the depth of despair alike, that this too, shall pass.” — Jack Bogle
When you are in the middle of a bear or bull market, it is difficult to take a step back to appreciate that whatever trend you are in, will eventually end. There is general confidence in the market’s ability to process information effectively which makes investors natural trend followers.
You can become a better investor if you are able to resist the assumption the market is efficient — instead, force yourself to have an independent and contrarian view of market trends.
“Traders and investors are humans, full of emotions, behavior biases, and good and bad past experiences. We don’t have much control over psychological shortcomings, and we routinely make decisions contaminated with our emotions and biases.” — Naved Abdali
We start each investment committee meeting with a blank slate. We want to build the most ideal portfolio today from scratch while resisting the natural bias we have towards what is already in the portfolio
I should be able to pitch my heart out about blockchain technology or a specific investment one day. If new information came forward, I should then be able to completely change my mind instead of holding onto bias tighter than the truth
“Humans are not machines. They analyze information through the lenses of their experience, knowledge, and cognitive biases. All of it makes their perception, their unique viewpoint.” — Naved Abdali
Investors get married to their portfolios as they hold certain beliefs and positions over time. But they must force themselves to be open-minded and unbiased when presented with new information. Keep a documented process for overcoming biases to ensure it’s transparent and replicable for audit purposes.
“There seems to be an unwritten rule on Wall Street: If you don’t understand it, then put your life savings into it.” — Peter Lynch
The goal for all investors should be to understand their investments better than anyone else. If you build conviction up front, you can hold positions through volatility and maximize the compounding effect of investments.
The best thing an investor can do for their portfolio is to find ways to reduce risk through manual labor. Dig in further than others to generate deeper insights than others.
“As time goes on, I get more and more convinced that the right method of investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes.” — John Maynard Keynes
Building an obsession around deep fundamental research that other investors are not willing to do should significantly improve risk-adjusted returns. It should also help you sleep better at night as other investors react emotionally to up and downtrends. We should clearly explain the extent of research conducted to reduce investor uncertainty.
“The market can remain irrational longer than you can remain solvent.” — A. Gary Shilling
Shorting has a maximum upside of 100% because the price of an asset can only go to zero. But shorting has an unlimited downside because the price of an asset can always increase.
“One painful lesson on the short side has been that mere absurd overvaluation is not sufficient reason to be short” — Whitney Tilson
Being pessimistic can sound smart so investors can be tempted to bet against assets. But being successful at shorting is a lot more complex than it may seem. Most investors come to the conclusion that their time is better spent building a great long book.
Shorting should only be done with: 1) disciplined position sizing, 2) strict stop loss levels, 3) clear catalysts, 4) specific timelines, and 5) an understanding that a short is equally a bet on individual assets and the overall market.
Most investors can achieve much better results by focusing on identifying long positions with positive and substantial long-term potential. As you lose money on a long, it becomes a smaller problem. But as you lose money on a short, it becomes a bigger concentration of your portfolio. Shorting can lead to unlimited losses as the stock price can rise forever and has no limit, whereas a long position has a price limit of 0. Even sophisticated investors have lost their shorts shorting against Robinhood traders, so investors should tread carefully.
“Your investor’s edge is not something you get from Wall Street experts. It’s something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.” — Peter Lynch
Every investor has an edge in understanding specific investments. It may be from how they grew up, what they studied, or even what year they were born.
Some of the most successful investors come from unexpected backgrounds which gives them a unique edge (Jim Simons was a math professor but generated an annualized gross return of 66% over 20+ years).
Professional investors are simply people who have identified their edge and are trying to use it to benefit their investors.
“The important thing is to know what you know and know what you don’t know.” — Warren Buffett
Investing is inherently competitive; the most reliable way to outperform is to identify and enhance your edge. It may not be obvious, but everyone should spend time identifying and utilizing their unique perspective and background.
“The stock market is filled with individuals who know the price of everything, but the value of nothing.” — Phillip Fisher
The only strategy that always (I don’t say this lightly) works is anchoring your investment decisions with deep fundamental analysis. This can include proven financial models like DCFs and comparable analysis but also “quanta-mental” models that are proven true through time.
“The four most dangerous words in investing are: ‘this time it’s different.’” — Sir John Templeton
All successful investments must align with base principles, which never change. These are some of my base principles:
- Cool technology is worthless; only useful technology has worth
- User-obsessed teams win the long game
- Rent-seeking can never become a sustainable business model
- Network effects are the only durable competitive advantage in an open-source world
- Investing is just as much about buying price as it is selling price
- All ventures must become sustainable beyond investor excitement
Fundamentals always win in the end, no matter how far the market gets off course. Investors must train their pattern recognition to these fundamentals and stick to them regardless of where the rest of the market trends. Clarify methods (DCF, comparable analysis) in reports to ensure investor understanding of fundamental principles.