In the first 9 months of 2023, the Value & Opportunity portfolio gained +6,5% (including dividends, no taxes) against a gain of +8,3% for the Benchmark (Eurostoxx50 (25%), EuroStoxx small 200 (25%), DAX (30%), MDAX (20%), all TR indices).
Links to previous Performance reviews can be found on the Performance Page of the blog. Some other funds that I follow have performed as follows in the first 9M 2023:
Partners Fund TGV: -0,9% (as of Sep 15th)
Profitlich/Schmidlin: +12,9%
Squad European Convictions 5,7%
Frankfurter Aktienfonds für Stiftungen +4,9%
Squad Aguja Special Situation +2,4%
Paladin One -4,7%
Alphastars Europe +4,9%
Performance review:
Within a quarter, the YTD performance jumped from close to the bottom of the peer group to second position. Looking at the monthly returns, it is not difficult to see that especially August and September were in relative terms very good:
As mentioned in the Q2 report, my portfolio stocks carry very “idiosyncratic” risks which can result in a significant “tracking error” compared to an index. Therefore, quarterly or even annual returns can deviate a lot from the benchmark in either direction. At some point in August, the portfolio was down more than -10% compared to the benchmark. But then luckily, my largest position, Schaffner received a take-over bid out of nowhere. Without this, my performance would have been -5% lower.
2023 is a good reminder that a lot of things are ouside the control of any investor.
Another interesting thing to mention is that on a quarterly basis, Q3 2023 is an all time high for me, on a monthly basis, August was the all time high.
Quite unbelivable if you think that we had a pandemic, a landwar in Europe, blown up Gas pipelines, the return of inflation and a massive interest rate increase over the last 3 years. If I would have had a crystal ball that would have shown me these events 3 years ago and a fairy would have given me the option to either stay invested or go 100% in cash, I would have happily taken cash. So another reminder here: Even if you would be able to predict geopolitical and Macro events, predicting what the stock market does is even more dififcult.
Transactions Q3:
The current portfolio can be seen as always on the Portfolio page.
Q3 was a quite active quarter. I added 4 (!) new positions: Energiekontor, Italmobiliare, Laurent Perrier and Broedr. Hartmann. I fully exited Meier Tobler and reduced Schaffner after the bid to fund the new positions.
Meier &Tobler was clearly one of the major perfomance drivers in the last few years, not only did I realize 3x of the initital investment (plus dividends), but it was also my largest position for some time.
Average holding period for the portfolio is around 4 years. The top 10 positions are around 50%. This is a little bit on the low side, so I will prioritize increasing higher conviction positions for Q4.
Comment: “How tall should your hurdle be ?”
I am deeply convinced that in the long term, any investor or trader will only be successful if she/he is able to calculate an estimated return for a new investment before she or he invests, based on the specific assumptions made. Why ?
Because this is the only way to track if your assumptions are valid and to have the opportunity to identify systematic mistakes in the investment process.
“I like this stock”, or “this company has a great product” will in the end not lead to a good result if this is the only basis of an investment.
In any case, when you calculate the expected rate of return, you need to decide at some point if you invest or not. There are many ways to do this, many investors however use a “hurdle rate”, i.e. a minimum rate of return in order to decide if to buy a stock or not.
But how to decide on which hurdle rate to use ?
First, one should establish a baseline. What is the expected return of this asset class that you should get if you invest in a broad index. For stocks, the common approach is to look at the long term rate of risk free interest rates (10 or 20 years) and add a “equity risk premium”, usually something like 5-7% p.a. on top for developed markets.
Now if you aim to outperform the market, you should aim higher. The question is: How high ?
In theory, one could say: I aim for 50% p.a. and only invest in stocks that offer me an IRR of 50%, so why should I aim lower ?.
That sounds easy, right, aim higher, get higher returns. However one should understand a few implications here. If an investment offers an expected return far above the market, there is ALWAYS a lot more risk involved. This risk comes in many ways:
- The actual outcome is distributed much wider around the expected return, often including the risk of a total loss of capital
- The price of such an investment is often much more volatile than the market
- The high return might only be available if some event etc happens quickly, so timing is important
- The company might have governance issues or is in a very difficult jurisdiction
- The investment is in a different currency with much higher base rates
On paper, a lot of investors often say: I don’t care about volatility, but in reality, high volatility often creates behavioral issues, even for hardened capital market veterans.
Sometimes you even hear in a stock pitch: There is now downside, only upside. In my opinion this is pure BS, like Monish Pabrai’s “Dhando investing” head fake. If there is a potential high return, in the stock market there is always a corresponding risk. If you think a 30% expected return has no risks, then you most likely didn’t analyze it very well.
Another important aspect is: How much volatility can you afford ? If you know for instance that within a few years you need to take out a larger sum to finance a large purchase, you should limit volatility and aim lower. If you are young and have inflows into your portfolio, you can afford much higher volatility.
If you run third party money, another variable comes into play: How will your investors react ? In many cases that I have seen, investors react very differently to what they might have said in the beginning. Investors don’t like downside volatility and try to pull money out exactly at the wrong moment. There are many studies, that investors on a money weighted performance badly underperform fund mangers in mutual funds, due to bad timing.
It is also a different experience if you experience downside volatility after you have made good eturns before or if you start on the downside.
For investors that are only in the market for the past few years, it might also come as a surprise that draw downs and recoveries are not always “V” shaped as it happened over the past 3 years or so, but that sometimes drawdowns can last much longer than that.
In general, very high expected value/high volatility stocks as a whole offer inferior returns. This is often called the “lottery ticket” effect. One of the most prominent examples are IPOs as a group. Yes from time to time, you get a nice first day “pop” but on average on d over the long term, IPO’s significantly underperform. A similar pattern can be seen in “hot stocks” on social media like Twitter.
Pulling this together, my advice would be the following:
In order to have long term success, either as a private investor or fund manager, you need to be able to consistently make good investments over a long period of time. But more importantly, you need to control your (and your investors) behavior when things go wrong.
For new investors my advice is to start aiming not too high. For experienced investors, you should really be sure that you can stomach draw downs as good as you think if you aim high.
One exception would be, if you start a hedge fund and you don’t care about your investors and you want to maximize the possibility of becoming very rich in a short time. Then starting with a very high hurdle rate makes a lot of sense. If things go well, you will be able to manage a lot of money quickly and share a significant part of the upside. If things go bad, your investors will hold the bag. Bill Hwang (Archegos) is a good example for this approach and it seemed to have worked almost for him, depending on the outcome of the upcoming trial..
Personally, as many readers know, I try to aim a little higher than the market but not much, as I (think that I) know my limits. Being able to compound long term for me is more important than to beat my peers in any given period.
