This entry has been reposted from the Library of www.amglobalfio.com
Professional investors are very different than investment professionals.
The difference boils down to putting your own money on the line. When investing your own money as a professional investor does, you approach investments with a very different headset. Whereas investment professionals judge themselves by the relative performance of their clients’ accounts to various indices, professional investors just want to make money as close to “all the time” as possible. They are most interested in the dollars in their pockets. Consequently, professional investors spend as much time trying to figure out how an investment might lose them money as they do on how it might make them money; they look for a “margin of safety.” In fact, developing a full understanding of how and when they might lose money is the primary means through which the best professional investors have been able to make money, consistently, over a long period of time.
Below we identify what we believe are 10 of the most important insights from some of the world’s best professional investors, as expressed in their own words.
“Be fearful when others are greedy. Be greedy when others are fearful.”
– Warren Buffett, Chairman, Berkshire Hathaway
This insight offers clear instructions on how to make money as a professional investor. It speaks directly to times of market extremes, greed and fear. If markets were rational then Warren Buffett would not have said these words and he would be far less wealthy. The fact is that investors, as a group, are irrational. At times, the level of irrationality becomes extreme. When fear or greed become pervasive, the best professional investors sit up and take notice, and often become very excited to invest. Why? Because it is at these times when prices deviate most from intrinsic value.
“In investing, what is comfortable is rarely profitable.”
⎯ Robert Arnott, Founder, Research Affiliates
This insight speaks to the internal fortitude required to be a great investor. There are times when assets are hated by everyone or simply written off as dead. It’s not easy to invest in such assets. Yet, such assets can sometimes hold unrecognized value. Finding that value and waiting for the market to recognize it can be frustrating. There are also times when you have high conviction in an asset you own but the market disagrees with you. Successful investors do not fret about these situations. Instead, they view such times opportunistically, as markets offering them an opportunity to buy something they want at even cheaper prices. It is a perverse situation, but falling prices can actually get professional investors excited because they can buy more at lower prices. But remember, the best investment strategy can turn into the worst if you don’t have the stomach to see it through.
“I’m rarely optimistic.”
– Paul Singer, Elliott Management Corp.
Investors, by nature, are optimistic. They make investments convinced they will make money. However, in our experience, the best investors wake up thinking about what could go wrong. They wake up worrying about how they could lose money. Paul Singer has been a top investor for four decades with an uncanny ability to mitigate risk. He is not an optimistic investor, but has made money in 38 of his 40
years investing. Great professional investors, like Singer, focus first on understanding and mitigating risk.They are rarely optimistic.
“The overwhelming majority of people are comfortable with consensus. Yet distancing yourself from the crowd is an essential component of long-term investment success, because over the long term, the crowd is always wrong.”
– Seth Klarman, CEO & Portfolio Manager, Baupost Group
Successful professional investors chart their own path independently of the broader market, seeking out unusual market niches, investing in things that others have yet to find or just don’t want, and searching for investments that are broadly misunderstood. Often, this type of mindset leads professional investors to contrarian viewpoints, preferring out-of-favor market segments over market darlings. This behavior has the benefit of not being subject to the whims of market sentiment as companies and segments come in and out of favor. However, it requires the internal fortitude to own a portfolio that looks different than most and whose performance will vary dramatically from market indices.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
– Benjamin Graham, Investor, Professor and Author
This is one of the most famous investment quotes and rightfully so; it sums up the market succinctly. Professional investors explicitly recognize that short term market movements can be distorted, driven by the whims of “voters.” However, over the long term, markets weigh earnings and, therefore, will be driven by company fundamentals. The lesson here is that,
if you judge fundamentals correctly, the market will come around to your thinking despite its short-term fluctuations. In fact, understanding this lesson can provide the confidence to make attractive long term investments when voter sentiment turns negative.
“Wide diversification is only required when investors do not understand what they are doing.”
⎯ Warren Buffett, Chairman, Berkshire Hathaway
Warren Buffet earns two quotes in our list, well, because he’s Warren Buffett. We love this quote. For us, it speaks directly to the issues in the financial services industry and the misguided implementation of diversification1. It also speaks to the underperformance of most actively managed funds2. When the best professional investors have put the time into understanding an investment and have conviction in their work, they focus their dollars in that investment. Successful investors concentrate their bets. For them, diversification comes from making concentrated investments whose success or failure does not depend on the same set of outcomes.
– Sir John Templeton, Founder, Templeton Investments
We usually hear these words when we are near one end of a market cycle or the other. People start to rationalize why things are different now and use recent history as proof. They often put forth convincing arguments. In fact, these arguments are often a prelude to markets extending their irrationality to the extremes of fear and greed. Professional investors understand that while the “names may change, the game stays the same.” Factors such as economic growth, market valuation, and interest rates, to name only a few, are intertwined and over the years have formed the basis for market averages. They understand that mean reversion is real. They recognize that fundamentals are what markets ultimately weigh. The best professional investors are skeptical of views that attempt to rewrite market mechanics, and look to profit from them.
“Buy when there’s blood in the streets, even if the blood is your own”
⎯ Baron Rothschild, British Nobleman, Member of the Rothschild banking family
While echoing some of the prior insights, this quote stands on its own for its directness. Great investors, like Baron Rothschild, step in to buy things that have gotten financially massacred and they do so even though they may be under financial duress themselves. We can say with confidence that there is no better time to be an investor than when markets are at their ugliest. Admittedly, such times are treacherous and it is a dangerous game trying to “catch falling knives.” The best professional investors look to pick the knives up off the floor or do no worse than catching the knife below the knee (to avoid more serious injury). In all seriousness, professional investors really get to work when markets are stressed. These are the times when the best investors have made their greatest investments.
“Markets can remain irrational longer than you can remain solvent.”
– John Maynard Keynes, Philosopher & Economist
Successful investors keep this warning from Keynes in the back of their heads. It is important to appreciate, and respect, the fact that no matter how right you think you may be (or how right you ultimately turn out to be) the market can disagree for a long period of time. With this in mind, professional investors look for investments that offer more than one way to win. They also try to structure investments, either through the sizing of the investment or by hedging market risk, in ways that ensure they will be able to stick with the investment through thick and thin or offer multiple exits should their investment thesis not play out as planned. As importantly, wise professional investors avoid the potentially toxic cocktail of utilizing leverage to invest in illiquid securities as this combination is often a short path toward insolvency.
“You’ve got to be careful if you don’t know where you’re going, ’cause you might not get there.”
⎯Yogi Berra, Player and Manager, New York Yankees
While Yogi Berra was likely a much better baseball catcher, world series champion and manager than an investor in financial markets, some of his utterings are laced with brilliance. This is one of Yogi’s simple insights that we think is directly attributable to investing. We see this happen all the time: people invest in things without a clear understanding of why they are investing. Successful investors begin each investment with a clear thesis and understanding of what can go wrong, what needs to go right, and the role it plays in the overall portfolio. They have made an explicit judgement that, given all the unknowns, the return they anticipate more than compensates them for the risks they must bear. This insight also applies more broadly to an investor’s portfolio. An investor must be clear about the overall investment objectives of their portfolio if they expect their portfolio to get them somewhere they want to go.
While there are plenty of other valuable insights from these and other great investors, we have found those above to have particular relevance. They truly distinguish the thinking of the most successful professional investors from the typical thinking of investment professionals. All of these insights promote a few common best practices:
- be an independent thinker,
- maintain internal fortitude,
- approach markets with healthy skepticism, and
- always focus on risk.As professional investors ourselves, we often reflect on this thinking and have embedded many of the insights into our investment philosophy and process. At the end of the day, investors who put them into practice are likely to find more dollars in their pockets.