Barton Biggs had an interesting start to his financial career. His father instilled a tradition whereby each of his three sons, on turning 18, would be presented with a portfolio of about 15 stocks worth roughly $150,000. They were encouraged to ask questions and learn more about the stocks.
One year his father organised a family stock-picking contest. Each of them had to pick 5 stocks. Biggs does not mention on what basis the winners were evaluated, except to say that he finished last and his mother won.
After graduating from college, completing a stint with the U.S. Marines, playing semi-professional soccer and teaching English in an up market school, he approached his father and told him he wanted to be an investor.
His father told him to read Benjamin Graham’s classic Security Analysis from cover to cover and they would then resume the conversation. He did as was told.
His father gave him another task. Read the book again. He wanted his son to have a deep grounding in value investing and come to terms with the fact that investing was hard, grinding work.
Biggs learnt that. He joined business school, went to work as an analyst with a brokerage, set up his own hedge fund – one of the first hedge funds in the U.S. (Fairfield Partners), joined Morgan Stanley as partner and managing director, and on quitting set up another hedge fund (Traxis Partners) at the age of 70. He was one of the most innovative and successful investment managers on Wall Street, and the first "global investment strategist", being one of the first to invest in emerging markets.
In a very engaging book called Hedgehogging, he writes candidly about the characters he encountered in his investment career. Intertwined with all those experiences are some amazing lessons learnt. Here we put together 10 investing insights revealed in his writing.
- Don’t hold on blindly to a stock.
As a value investor and believer in the inherent efficacy of fundamental analysis, he disdained momentum investing – buying strength and selling weakness. But he was always respectful of the knowledge of the market.
If a position went against him by 10%, he conceded that maybe somebody has understood something he has missed. That would lead him (or rather his team) to conduct an extensive and systematic review of the fundamentals with both internal and external resources. After the review, if nothing has changed except the price of the stock, they bought more. If they lacked that conviction, they would sell at least half of the position.
- Be a disciplined reader.
A compulsive reader, his interests were beyond just business and financial reading.
Investing, he believed, is about glimpsing, however dimly, the ebb and flow of human events. That drove him to read history. He also believed it is very much about breasting the tides of emotion too, which is where the novels and poetry came in.
However, it’s not just reading, but reading smart. Hence he cautioned against getting overwhelmed with all the research reports and the flooded inbox. The investor must dominate his own intellectual intake environment and not let the outside world control him. Internet and e-mailing can be brilliant, time-saving inventions, but also huge distractions.
- All good investors have cold spells.
The hard reality in the investment business is that you are only as beloved as your most recent performance. It’s a numbers game. Fame and glory are transitory events. Clients’ loyalty, salesmen’s admiration, management’s love are all totally fickle, so don’t get cocky. Smooth investment sailing inevitably is followed by vicious storms. And at the bottom of a performance cycle, it’s a hard, unforgiving business. All this is perpetuated by the fact that senior business management in most firms don’t understand that investment performance is cyclical.
- Love art for itself, not as an investment.
Whether a particular piece of art is a good investment is far more a matter of fashion than is the valuation of equities where, in the long run, the growth of book value, earnings, and dividends count most. The bear markets in art have been silent but brutal. Rush’s art index rose from 100 in 1925 to 165 in 1929 and then fell to 50 by 1934.
Within the long-wave secular cycle, there are also sector cycles driven by fad and fashion where the price changes are even wilder. Amateur collecting can be a loser’s game if you misjudge future fashions in taste.
Art of exceptional quality probably does have fairly immediate liquidity, but this is not true of run-of-the-mill pictures. Biggs recommended buying a picture because you love looking at it, not as a diversifier or as an investment.
- Identifying growth stocks is extremely difficult.
Growth stock believers argue that you want to own stock in companies whose earnings and dividends are consistently increasing. What you pay for the shares of these companies is important, but not as crucial as correctly identifying true growth companies. By definition, these companies tend to have excellent managements, proprietary positions in businesses that are not particularly cyclically sensitive, and to be highly profitable.
Ideally growth investors want to hold shares in great businesses and sell only when the business itself falters, not because the price of the shares has risen. Academics have proved that if you had perfect foresight and bought shares of the companies with the fastest earnings growth, regardless of valuations, over the long term you would outperform the market by an immense amount.
The problem is that no one has perfect foresight. We are all generally overconfident and overoptimistic about our skill in picking growth companies.
Growth companies have a high propensity to fall from grace, in other words, to stop being growth companies. By the time you can clearly identify a stock as a growth stock, it usually will already be valued accordingly. Therefore, you end up buying the expensive stocks of good companies.
- Fall in love with people, children, and dogs, but not stocks.
Growth investors are inclined to fall in love with their growth companies that have treated them well. Remember that you are buying stocks, not companies, and don’t fall in love.
Value investors definitely don’t fall in love with their stocks. When the prices of the shares of the ugly companies they own go up, become expensive, and sell well above their intrinsic value, they sell and go searching for cheapness elsewhere.
Growth stock investors have portfolios filled with companies with great, growth franchise they can be proud of. Value investors have portfolio stuffed with the cheap shares of companies that are doing badly, and have hair and dirt all over them.
- Alpha investing is a zero-sum game.
The institutional investment world runs on the beloved alpha. This is understandable, but can be counterproductive. The pressure for short-term performance versus a benchmark can easily disorient the investment brain of a portfolio manager. What should matter is capital enhancement in bull markets and capital preservation in bears; in other words absolute, not relative, returns.
In this sense, professional alpha investing is not a winner’s game but a zero-sum game, because for every winner there has to be a loser.
Biggs explained that the right way to look at relative performance is relative to the dimensions of the gain. In other words, if the index was up 10% and the portfolio 5%, there is negative alpha of 500 basis points. That is a big deal! The relative underperformance to the benchmark is 50% (-5% of alpha is 50% of 10%). But if the index is up 56% and the portfolio is up 51%, that’s a relative underperformance of only a little more than 9% and a minor event.
Demanding performance versus a benchmark and focusing on short-term results are the two great banes of investing. The more you want performance and push for it, the more difficult it is to get. The more confident you are, the better you play; a relaxed, obsessive investor is best.
- The bliss of starting fresh.
Sometimes he suggested to his partners that they each go home, reflect as though they had nothing but cash, and come in just as they did on that Sunday before they started with a fresh portfolio and a new exposure position. He believed that it is a great discipline to pretend that you just got the money and have to build a new brand new portfolio - unencumbered with stale positions, where the story has deteriorated and is too cheap to sell.
There are unrecognized, subconscious, emotional hang-ups that block a portfolio manager from impartial, cold-blooded investment actions like selling. The baggage (what he already owns), gets in the way of excellence. There are positions one believes in but the market has not discovered them yet. It’s hard to give up on such a position.
There is a bias against switching, because you can be wrong twice. By the same token, it’s hard to sell winners because of what they have done for you and because you hope they have more to deliver.
The investment decision-making process should be completely intellectual and rational, not emotional, because they are just pieces of paper. The stock does not know you own it. There is no reward for being a faithful holder. It is those holds that are too cheap to see but not attractive enough to buy that make a portfolio stale and retard performance.
- Public money floods in and flows out at exactly the wrong times.
The big flood of public money comes in after, instead of before, the fund does well. Then redeems after it has done poorly and usually just before it’s about to do well again. Billions of dollars poured into tech funds in 1999 and 2000 when the Nasdaq was pushing towards 5,000. Around 80% of all the public money that was invested in mutual funds at the height of the bubble in the spring of 2000 went into tech funds. Over the next three years, as the Nasdaq sank to 1,000, investors lost 60%-80% of their money. Redemptions were heavy in 2002 and 2003 just before the Nasdaq doubled again.
The public never learns.
- Finding meaning in all the noise and babble.
The intellectual problem an investor must wrestle with is the constant barrage of noise and babble. Noise is extraneous, short-term information that is random and basically irrelevant to investment decision making. Babble is the chatter and opinions of the well-meaning, attractive talking heads who abound.
The investor’s task is to distill this overwhelming mass of information and opinion into knowledge and then to extract investment meaning from it. Meaning presumably leads to wisdom, which should translate into performance.
Noise and babble can be very hazardous to your investment health. One of Nassim Taleb’s major themes in Fooled by Randomness is that the wise man listens for meaning but the fool gets only the noise.
