Running a small investment fund is a little bit like waiting for summer when it is winter. There is no hurrying the process along.
My style of investment management must be one of the most passive ways of making an active living yet invented. One or two decisions a year is what I aim for these days, way less than what my psychological need for activity and control requires. Intentionally limiting the number of decisions that one makes provides a singularly powerful incentive to prepare very well for the decisions that one does make. This essay describes the basic shape that my preparation takes and presents some specific thoughts resulting from that part of my job that could be considered active.
Investment management is a gigantic enterprise with what I take to be essentially one overarching function. The industry derives its importance from being the capital allocator of an economy. The market, whether liberal capitalist, welfare socialist, or some other “ist” or “ism”, needs someone to collect money from those who save and then either allocate it themselves, or channel it to those who are in a better position to do so.
Every economy has at least one capital allocator (investor). In capitalist and capitalist-like economies the capital allocation function is performed by hundreds of thousands of people, from the small town bank manager in Somewhere-ville to the slick hedge fund manager in New York. In communist countries such as North Korea or yesteryears China the function of allocating capital is usually the responsibility of a small number of people. History has shown that where only a few people are in charge of allocating the financial surpluses of an economy, the result is often a lower standard of living for its citizens. Being part of the South African financial community, I am one of thousands of people allocating the savings of South Africa’s people. In my case, for reasons of circumstance and intellectual interest, I have decided to fulfil this function as an investor in South African equity (shares).
My intellectual interest and approach to managing money is derived from my love for, and study of, philosophy. Philosophy is very enriching, the intellectual equivalent of a lifetimes worth of sensual delights. Philosophy has taught me what I take to be my most valuable intellectual lesson: weigh every investment premise, every argument, and every investable conclusion in the scales of fine-tuned thought, and never fail to improve the sensitivity of the scale. Philosophical writers of all persuasions, particularly those of the so-called analytic tradition, are exceptional at thinking “accurately”. By “accurate”, I mean that they use the thought-equivalent of an electron microscope. They see features of the intellectual world that most of us ordinarily miss due to the coarse-grained nature of ordinary language. It is no accident that many analytic philosophers have also been excellent mathematicians. Analytic philosophy is the mathematics of ordinary language.
How sensitive is your mental scale when it comes to investing? Are you able to provide compelling reasons for why you have invested in MTN shares for example? Claiming that the reason for holding MTN is that it is a good company is no reason at all if you cannot tell what it is for a company to be good. When is a company bad? Can a good company be a bad investment and vice versa? Are your reasons for investment or divestment based in reality or in emotional hopes and fears of a wished-for or dreaded future? Many people think investing is easy because they have made some money selecting some or other share. If these same people cannot provide reasons explaining why they expected the company in question to do well with such and such a probability before it did, their present favourable experience is a result of good fortune.
I will explain some of the possible steps of building and tuning a mental scale by highlighting some lessons that I have learnt along the way. Unfortunately, there are no three or four easy steps to stock market success or some such gimmick. The best way of building and increasing the sensitivity of your mental scale is to read. A lot. Before you grab the “Huisgenoot” (reading desert) a few pointers on how and what to read.
It is impossible to read everything that is available for the purpose. There are millions of different books in the world, you and I will do very well indeed if we manage to read a thousand in our respective lifetimes. Therefore, the first important truth to learn is that you must be extremely selective in what you read. If you can never hope to read 99,99% of the books available for the purpose, then the tiny percentage that you are able to finish should be of primary importance. How should you pick what to read? This is a bit of a chicken and egg problem, because over time you generally become better at what to read by reading what not to read. Reading will improve your knowledge and your knowledge will then improve your reading.
A good place to start is by reading the “classics” in the field, the ten or 20 or 100 books that recognised masters in the field have written or recommended (see my article “what all the great investors have in common for a annotated list”). Merely reading, without giving yourself time to think carefully about what you have read, is like the man always intending to act but never intentionally acting. A good test of effective reading is asking yourself if you are able to teach what you have read to others in your own words using few if any notes while helping to germinate at least an elementary understanding of the material in the mind of your student.
A very useful heuristic of going about ones reading is to make a distinction between books that primarily serve the function of building ones mental tool box and books that provide the raw material for those tools to be used on. For example, investing requires a basic grasp of probabilistic and statistical concepts, and some financial mathematics. In addition, a thorough knowledge of the meaning of accounting is a must. Reading books on these topics will either provide you with new tools or sharpen those you already possess. The investor who has nothing but tools is the investor in training. The practicing investor requires informational material, which he or she shapes into possible investment decisions using the investment tools at his or her disposal. The primary source of information shaped by the investment practitioner is accounting, economic, or statistical in nature. Examples include company annual reports and industry statistics.
What can I say in conclusion? I love what I do and I strongly suspect that those who share my passion for shares will find some of the thoughts I have shared useful or at the very least will concur with the thought that reading and thinking is of first importance in this business.
Happy reading and careful thinking.