Guide: Mr. James Montiel is a member of the GMO asset allocation team. He is the author of "Behavioral Investing: The Practical Application of Behavioral Finance", "Value Investing: Tools and Techniques for Smart Investing" and "Behavioral Investing manual". He is good at explaining the effectiveness of value investing from the perspective of behavioral finance. His investment principles basically revolve around value investing, and today I will share Mr. Montier's ten investment principles.
Lesson 1: Markets are not efficient
As I have observed before, Efficient Market Theory (EMH) is like Monty Python's Dead Parrot. No matter how many times you say that the parrot is dead, believers still insist that the parrot is just resting.
Lesson 2: Relative performance is a dangerous game
Although practitioners generally do not believe in the efficient market theory, they are slightly inclined to advocate the derivative theory of the efficient market theory-CAPM. This dubious theory is based on a number of flawed assumptions (e.g. investors can take any size long or short position in any stock without affecting the stock's price, all investors can be optimized by mean-variance method to research stocks).
This also leads directly to the separation of alpha and beta, and investors invest a lot of time in this approach. Unfortunately, these concepts are heresy. The late, great Sir John Templeton said it well: "The real object of investing is to maximize the real return after tax".
The alpha/beta investing framework has fueled an obsession with market benchmarks, giving rise to a new class of investors who care only about staying in line with the mainstream, and who invest in ways that, as Keynes put it, "would rather be driven by the crowd." If you fail, you don’t want to succeed because you are unique.”
Lesson 3: This time it’s the same as before
Understanding historical bubbles can help you protect your capital. According to Ben Graham, investors should "have a proper understanding of stock market history, especially the history of big ups and downs. With this background knowledge, investors may be able to make some comparisons about the attractiveness and danger of the market Valuable judgment.” Nothing is more important in understanding history than understanding bubbles.
While the specifics of bubbles are constantly changing, the underlying patterns and patterns of change are remarkably similar. The framework for thinking bubbles has long been traced back to an 1876 paper by John Stuart Mill. Stuart was a remarkable man, learned and polyglot, a philosopher, poet, economist and member of Parliament. He played a great role in promoting social justice, wrote many articles against slavery, and advocated the expansion of voting rights. According to our insights, his understanding of bubble patterns is the most useful. "Economic crises aren't really about money, they're about people's perspectives," Stuart said.
His model was later adopted many times, forming the framework of the bubble theory of Hyman Minsky and Charlie Kindleberger, among others. This model divides the rise and bust of bubbles into 5 stages:
New investment hot spot --> credit creation --> extreme excitement --> critical state/financial distress --> capital flight
New Investment Hotspot: The Birth of a Prosperity. A new investment hotspot is generally an exogenous shock, prompting new profit opportunities in certain fields while making profit opportunities in other fields disappear. As long as the profits of newly created opportunities are greater than those that disappear, investment and production will increase, and investment will occur at the level of financial and real assets. In fact, this is the birth of prosperity. "New confidence emerges early in the stage, but the growth of confidence is slow," Stuart said.
Credit Creation: The Growth Stage of a Bubble. Just as fire cannot spread without oxygen, so flourishing growth needs credit to feed it. Minsky believed that monetary expansion and credit creation are largely endogenous factors. That is to say, not only existing banks can issue currency, but also the formation of new banks, the development of new credit instruments and the expansion of personal credit outside the banking system can also play the role of issuing currency. During this period, Stuart notes, “interest rates are almost low, credit growth is stronger, businesses continue to grow, and profits continue to grow.”
Excitement: Everyone starts buying the new investment hotspot. Everyone believes that the price can only go up but not down. The traditional value evaluation standards are left behind, and new measurement standards are introduced to justify the current price. There has been a wave of over-optimism and over-confidence in the market, causing people to overestimate rewards, underestimate risks, and generally believe that they are in control. Everyone is talking about the new era, and the most dangerous words in the investment world pointed out by Sir John Templeton, "this time is different", can be heard everywhere in the market.
Stewart writes: "A diseased excess of confidence has emerged in the market, and healthy self-confidence has degenerated into a diseased belief that is too shallow. beyond capacity....Unfortunately, in the absence of proper foresight and self-control, there has been a tendency for speculation to grow most rapidly when it is most vulnerable."
Criticality/Financial Distress: This leads to criticality, which is often characterized by insiders liquidating, followed by financial distress, where the huge leverage built up during the boom starts to become a serious problem. Fraud often occurs at this stage.
Fleeing Money: The final stage in the bubble life cycle is the flight of money. Investors are spooked by various events and are unwilling to stay in the market, which causes asset prices to fall to the bottom. "Usually," said Stuart, "it is not panics that destroy capital, but panics that expose the magnitude of capital previously destroyed by hopeless and unreturning investments. The collapse of large banks and commercial establishments is a symptom rather than a disease. the disease itself."
Stuart found that the recovery after the bubble was long. "The economic downturn, business closures and investment write-downs have reduced the purchasing power of many...Profits have lingered at low levels for a long time as demand is held back...Only time will restore the broken courage and heal the deep wounds."
Since bubbles repeat the same way over and over again, this begs the question - why don't people see the consequences that are coming? Unfortunately, we must overcome at least five behavioral barriers to avoid bubbles.
First, excessive optimism. Everyone thinks that they are not as likely to be addicted to alcohol, divorced, or unemployed as ordinary people. This habit of only looking at the bright side of things prevents us from seeing the dangers that we could have predicted.
Second, in addition to our excessive optimism, we also have an illusion of control, a belief that we can influence the outcome of events beyond our control. There are many illusions in many financial pseudosciences. For example, value at risk (VaR) is a measure that believes that as long as we can quantify risk, we can control risk. This idea is one of the biggest fallacies in modern finance. . VaR only tells us what the expected loss is under a given possibility, for example, given a 95% probability, what is the maximum loss in a single day. This kind of risk management technology is equivalent to buying a car, as long as the car does not crash, the airbags on the car will definitely work. This security is an illusion.
A third obstacle to spotting predictable surprises is self-serving bias. We have a natural tendency to interpret information and act on it according to our own self-interest. Warren Buffett said, "Never ask a barber if you need a haircut." If you had been a risk manager in 2006 and thought there might be something wrong with some of your bank's CDOs, you would have been fired and replaced by a risk manager who had approved such transactions. Whenever a lot of people are making a lot of money, it's impossible to point out the obvious flaws in their actions and expect them to stop.
Fourth, lack of foresight and excessive focus on short-term interests. We often make choices without considering future consequences. This shortcoming can be summed up as "drunk today, because tomorrow will go to heaven." The odds of getting to tomorrow are actually 260,000 to 1. St. Augustine's prayer: "God, make me chaste, but not now" is downright shortsighted. Those in the financial world think, another year of bull market and some bonuses, I guarantee that next year they will retreat from the financial world and enjoy life.
Inadvertent blindness prevents us from seeing predictable contingencies, and there are, frankly, things we ignore on purpose. There is a classic experiment in which a short video of two teams playing basketball, one team wearing white jerseys and the other wearing black jerseys, is played, and the viewers are asked to count the number of passes made by the white team. Halfway through the show, a man dressed as a gorilla walks into the field, beats himself on the chest, and walks out. Finally, ask the viewer how many times the white team passed the ball. A normal answer should be 14 to 17 times. Then ask the viewers if they have seen any strange things, nearly 60% of the viewers did not notice the gorilla! After telling the viewers that there was a gorilla, and replaying the clip, most of the viewers thought it was not the one they had just watched, they thought the first clip did not have a gorilla! Everyone was just too focused on counting the passes. I suspect something similar is happening in finance - investors are so focused on the details and the noise that they forget to see the big picture.
Lesson Four: Value Matters
In the simplest terms, value investing is to buy assets when they are cheap and avoid buying expensive assets. This simple truth seems to need no explanation at all, but I still have to be wordy. I have seen many investors who would rather distort their psychology than open their eyes to see the real situation of value.
Lesson 5: If you don’t see a rabbit, don’t scatter an eagle
According to data provided by the New York Stock Exchange, the average length of time investors hold stocks listed on the exchange is 6 months. It looks like investors are like ADHD, in other words, the average investor seems to only focus on the next quarter or two of statements and forget that stocks are a long-term asset. This kind of short-sightedness brings opportunities to investors who are willing to invest in the long-term.
Warren Buffett often reminds you of the importance of not casting a hawk when the rabbit is missing, and that your patience will be rewarded when the opportunity comes your way. Still, most investors seem impatient to wait, taking action at every opportunity they can find, and swinging at every pitch.
Lesson Six: Market Sentiment Matters
Investor returns are not only affected by valuation, but market sentiment also has a great impact on investor returns. While it might seem like a cliché to say markets are driven by fear and greed, it's actually pretty close to the truth. The market swings like a pendulum back and forth between irrational elation and deep despair. Keynes wrote in February 1931:
"Now the market is full of fear, and the price only reflects very little ultimate value... Various indescribable anxieties determine the price... Many people are very willing to buy when the boom is in progress... Believe that profits can continue to increase exponentially .”
Lesson 7: Leverage Doesn’t Make Bad Investments Good, It Can Make Good Investments Bad
Leverage is a dangerous beast - leverage doesn't make bad investments better, it makes good investments bad. Using a lot of leverage on an investment with little return doesn't turn that investment into a good one. From a value perspective, leverage also has a dark side - it has the potential to turn a good investment into a bad investment!
Leverage can limit your durability, turning temporary losses (meaning price fluctuations) into permanent losses. Stuart noted the risks posed by leverage, which can easily lead to forced fire sales of assets. "Traders who use borrowed capital beyond what they can afford to find their good fortune completely wiped out during the crisis and are forced to sell their products at extremely low prices in order to pay off their debts as they come due. .”
Keynes also believed that: "Investors who ignore recent market fluctuations need more resources to ensure safety, and cannot use borrowed money to invest on a large scale."
Lesson 8: Excessive quantitative thinking masks real risk
Finance has turned the art of complicating the simple into an industry, and nowhere else (at least not outside of academia) is more welcoming of overly complex structures and elegant (but not solid) of) mathematics. As to why there's such a passion for unnecessary complexity, it's clear that it's much easier to charge high fees that way.
Two of my investment heroes are well aware of the dangers of difficult mathematics. Ben Graham writes: "Mathematics is generally believed to produce precise and reliable results, but in the stock market, the more sophisticated and Esoteric and difficult mathematics, the more uncertain and speculative the calculated results... Whenever you use calculus or advanced algebra, you can take it as a warning sign that the trader is trying to use theory to In lieu of experience, such an approach deceptively disguises speculation as investment."
Keynes was also alert to the pitfalls of over-quantification: "With free choice of coefficients, and with time lags, anyone can concoct a very good formula that fits a limited range of historical data... to deceive, but it can indeed deceive many people.”
The place where doubts are most needed is the judgment of risk. Simultaneously with over-quantification, the definition of risk is very narrow. The risk management industry seems to believe that "if the risk is managed, this risk management method must be useful" and "build a house without worrying about no one to live in it." same. In the investment world, risk is often equated with volatility, which is not justified. Risk is not volatility, risk is the possibility of permanent loss of capital. Volatility brings opportunity, Keynes said: "Volatility brings bargains and uncertainty, because the uncertainty that volatility creates prevents many people from taking advantage of the opportunities that volatility brings."
There is much to be gained if we abandon our fascination with quantitative risk measurement to understand the trinity of risk. From an investment point of view, there are three main ways of permanent loss of capital - value risk (buying overvalued assets), business risk (fundamental issues) and financing risk (leverage). Only by fully understanding these three elements can we gain a deeper understanding of the true nature of risk.
Lesson 9: The macro is not unimportant
In his book on value investing, Martin Whitman states: "Graham and Dodd believed that macro factors . . . "If that's the case, I'm happy to say that I'm a Graham and Dodd investor.
Ignoring top-down macro analysis can be expensive. The credit crisis is an excellent example to help you understand why it is beneficial to have a top-down view that can benefit bottom-up stock picking. The past 12 months have been unusual for value investors, with two factions emerging from the otherwise uniform value investor camp.
Seth Klarman also has a point - top-down and bottom-up can complement each other. In Klarman's insightful book, "Margin of Safety," Klarman argues that the inflationary environment has a big impact on value investors. Whether it is from top to bottom or bottom to top, it has its own unique insights.
Lesson 10: Find Cheap Insurance
We should avoid buying expensive insurance at all times, the general public is always an afterthought, for example, when I lived in Japan, the price of earthquake insurance always went up after an earthquake! So, as always, contrarian moves can pay off handsomely when it comes to buying insurance.
In an investment portfolio, insurance can play a big role. If we admit that our ability to predict the future is limited, we can take advantage of cheap insurance to protect us from unknowable events. At present, we are faced with many incalculable things, such as the possibility of a resurgence of inflation, the moral hazard of long-term loose monetary policy, and whether and when the government will decide to end quantitative easing. It pays to look for cheap means of insurance to protect investors from all these twists and turns.
- Will we learn our lesson?
Unfortunately, both historical and psychological evidence suggest that we are less likely to learn from our mistakes. There are so many biases in our behavior that it is difficult to learn from our mistakes.
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