New Sunday Times Feature - Diary of a Private Investor

Colm's decision to start reducing his position in Apple last summer in starting to look particularly smart with the benefit of hindsight - the stock price has fallen by almost 40% since early October 2018. Ouch!
 
Sarenco said:
Colm's decision to start reducing his position in Apple last summer in starting to look particularly smart with the benefit of hindsight
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Thanks Sarenco, but I wasn't that smart: I only offloaded shares bought since June 2017; I held on to the ones bought before then. Needless to say, I'm now sorry I didn't get rid of the lot in October last.

Despite the recent bad news, I'm not inclined to sell at the current price ($148.25).
 
Colm Fagan said:
I only offloaded shares bought since June 2017; I held on to the ones bought before then
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Hi Colm,

I don’t understand; how did you manage that in the context of the FIFO rules?

Or do you have different pots which each held Apple shares (e.g. pension, corporate, personal)?
 
Gordon Gekko said:
Or do you have different pots which each held Apple shares
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Yes, Gordon, they're in different accounts.
Actually, following last night's post, I've been thinking about why I didn't sell the lot when prices were high. In retrospect, it was probably because I would have incurred a significant CGT liability if I had sold the rest (the account from which I sold isn't liable to CGT). There are two lessons from that: one is that we shouldn't let tax prevent us from doing the right thing; the second lesson is that, if the CGT rate were lower, the state would probably make more money from the tax, as people like me would realise gains more frequently.
 
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Sadly the State often has to ignore logic so it can pander to populism.

It’s been proven that cutting the rate would stimulate activity and generate greater tax revenues.

But the morons who moan and march about these things choose not to recognise such logic.
 
Colm Fagan said:
Actually, following last night's post, I've been thinking about why I didn't sell the lot when prices were high. In retrospect, it was probably because I would have incurred a significant CGT liability if I had sold the rest
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You are not alone anyway, warren buffet has a significant stake in apple, i think its one of his biggest. With regard to CGT liability the big sell off recently would have allowed you to sell other stocks at a loss, (you could still have increased your holding in other loss making positions and reposition later). Thats more or less what I did, I had a CGT liability but I wiped it out using the recent sell off to my advantage.
 
Colm Fagan said:
Needless to say, I'm now sorry I didn't get rid of the lot in October last. Despite the recent bad news, I'm not inclined to sell at the current price ($148.25).
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Colm,

I think your comments are very interesting (all of them as opposed to just the ones I quoted!). Your use of language indicates to me the emotional element of your decision making. Your decision to sell Apple left you feeling "annoyed" with yourself followed by relief when the price fell. And then the CGT barrier as you mentioned. Do you 'think' about the emotional aspect of your decision making and how do you manage it? Is there a different approach taken when operating in each of your Pension/Taxable Account/Spread Bet account?

In relation to CGT for example, I think about it in the context of my account and identify which holdings are subject to it but I consciously don't work out the unrealised CGT (as an example) for the holding and if I need to sell, I sell. I think about CGT (largely) separately from my selling decision, if that makes sense?! I feel like its not a barrier to my decision making. Now my liability would not be significant so maybe that's why my system works for me!

It's not a criticism, your experience is obviously significant, but (IMO) the emotional element seems to echo the views in another thread where a poster (criticised for being amateur) said that he had bought throughout H1 2018, the market fell in December, followed by thoughts of selling/holding off before jumping back in in 12 months time. They are both kind of 'feelings' as opposed to logical analysis; these are the reasons for buying, has my reasoning been reflected by performance relative to the operating market, is the valuation under/over my expected value etc.
 
@Itchy Very interesting comments. To be honest, I'm not certain why I only sold a portion of my holding. It used to be different (before I started the diary). I either liked a company (at a price) or I didn't. If I didn't like it, I just sold the lot, irrespective of the tax consequences, often acting against my broker's advice to "top slice" (I think that was the expression he used). I don't know whether the fact that I'm recording what I've done is causing me to be different. Also, while it's easy to know in hindsight that Apple was grossly overvalued in October last, I wasn't certain at the time, hence the decision to hold on to part of my holding. Despite my earlier comment, I'm not sure that CGT considerations played that big a role.
Itchy said:
Is there a different approach taken when operating in each of your Pension/Taxable Account/Spread Bet account?
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Yes, absolutely. I think that's a more important driver than CGT. I am much more likely to sell a share that I hold in the spread bet account and tend to treat shares held in the pension or "personal" account as more long-term investments, and I'm less likely to sell if I think I'll get good value over the next (say) five years from shares held in those accounts, irrespective of whether I think they're marginally overvalued at the moment. There's definitely an emotional aspect to that.
joe sod said:
With regard to CGT liability the big sell off recently would have allowed you to sell other stocks at a loss
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I would find it very hard to sell a stock that I thought was undervalued (and I think that some of my holdings are grossly undervalued at the moment). It may be possible to argue that it might be still worth while selling in order to crystallise the loss (in order to reduce the CGT bill) and then buy back at the lower price, but I would be loath to incur the costs involved in stamp duty, broker's commission and bid-offer spreads. Also, at the end of the day, you'd have a share with a lower cost price and thus a higher CGT liability when you eventually sell.
 
A Homemade Hedge Fund?

“Diary of a Private Investor” Update #10 Colm Fagan 7 January 2019


Hedge funds are sometimes represented as the Holy Grail for investors. They offer the enticing prospect of positive returns, whether markets are rising or falling. Their main technique for delivering positive returns in falling markets is by shorting, i.e. selling stocks they don’t own and buying them back later, hopefully at a lower price. This wonderful feat of levitation doesn’t come cheap: the typical remuneration package for a hedge fund manager is known colloquially as “2 and 20”: an annual charge of 2% of assets under management plus 20% of profits (of course there’s no 20% refund if the fund loses money!).

Over the last difficult few months, shorts have been among the few winning investments in my portfolio. I have two short positions – three if we count a sterling hedge– and all of them increased in value during December.

I closed most of my short position in Tesla in October[1] at a nice profit but kept a small residual exposure. Tesla’s share price fell 5% in December, presenting me with a gain of $17.50 a share. It fell another 7% on January 2, after it was revealed that car sales for the fourth quarter had fallen short of analysts’ expectations. This netted me a further $22.80 per share. The price has now recovered from that fall, but I’m holding on to my remaining short position. I believe that Tesla will run out of cash within the next few months and will have to come to the market in search of additional funds, from either shareholders or bondholders – or both. If that happens, I reckon that the market won’t take kindly to the news.

My short position in sterling also delivered a profit in December, but the purpose of the sterling short is to hedge currency risk on my domestically focused UK shareholdings, so I tend to ignore any gains (or losses) on the hedge.

My most spectacular gain in December was from a short position in the Japanese company, SoftBank.

SoftBank started life as a mobile phone company. It acquired the Japanese arm of Vodafone in 2006 and owns the US mobile operator Sprint. It also sees itself – with some justification - as a visionary investor in technology start-ups. Its most profitable investment is Alibaba, China’s answer to Amazon. It also has major stakes, either directly or indirectly, in the ride-hailing company Uber and in Yahoo and WeWork, the office-sharing company.

It recently got into trouble through the company it keeps. It has close ties with Chinese technology company Huawei, which is in trouble with the US authorities. It also has a close relationship with crown prince Mohammed bin Salman of Saudi Arabia, whose associates are currently on trial for the brutal murder of Jamal Khashoggi in Turkey. The Saudi connection and SoftBank’s stake in WeWork, which I think is grossly overvalued, were the main reasons why I decided to short the stock some months ago.

For a host of reasons, SoftBank’s share price started dropping like a stone in December. It fell more than 25% between the start of the month and when I finally closed my position on 28 December.

I was lucky in my timing: I got out almost exactly at the bottom of the market. On its own, my short position in SoftBank contributed almost 0.7% to the portfolio’s performance in December.

Unfortunately, the short positions in Tesla and SoftBank were among my few winners in December. My top four long holdings all fell in value. Apple, which is still one of my top exposures despite recent share sales, fell by a whopping 11.6%; Ryanair was down 7.7% and Phoenix Group Holdings fell 6.2%. By comparison, Renishaw held up relatively well, falling “only” 1.3%.

The contrast between the gains in my short positions and the losses in my long positions caused me to toy briefly with the idea of making a fundamental change to my investment strategy. I considered adding more shorts to the portfolio in order to get some protection from market downturns, like the one we’re experiencing now, while recognising that it would mean surrendering some upside in the good times. I reckoned that a strategy on these lines could reduce the volatility of my portfolio.

I was encouraged in this thinking by news that a hedge fund run by Crispin Odey delivered a 53% positive return for 2018. Ironically, in the light of Mr Odey’s political leanings – he’s an ardent Brexiteer - one of the top contributors to his positive result in 2018 was a short position he took on sterling.

I then discovered that Mr Odey’s fund returned minus 22% in 2017. By coincidence or otherwise, his returns in 2017 and 2018 were an almost exact mirror image of my portfolio’s performance of plus 50% in 2017 followed by minus 28% in 2018, or an average of plus 5.3% a year. (For the numerically minded, the average is money-weighted and allows for the fact that I splurged big-time when returns were good in 2017). Mr Odey had an even worse 2016. That year, his fund fell in value by almost 50%; in contrast, my portfolio delivered a positive return of more than 5% in 2016.

I decided therefore to stick with my current strategy of being primarily long in my investments, while adding a small number of short positions in companies I think are grossly overvalued.

There are very few in that category at present. On the contrary, I think most of my holdings are seriously undervalued. Although I’m now at the stage in life where I’m withdrawing more than I’m investing, I’ve managed to limit the number of shares sold at current depressed prices. I’ve even succeeded in increasing my exposure to Phoenix Group Holdings, which I think is particularly undervalued at its current £5.71 a share. As regular readers know only too well, though, my views on value don’t always coincide with those of Mr Market.


[1] See post #414 in https://www.askaboutmoney.com/threa...re-diary-of-a-private-investor.195710/page-21
 
Colm Fagan said:
The Saudi connection and SoftBank’s stake in WeWork, which I think is grossly overvalued, were the main reasons why I decided to short the stock some months ago.
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SoftBank announced today that it is scaling back its planned investment in WeWork from $16 billion to $2 billion, in response to investor concerns at WeWork's prospects. They must have read my update and agreed with my assessment!!! The share price jumped 5.7% on the news.
 
Jayz, Colm, 5% a year over 3 years. Okay, it's about 3 times as much as State savings. But all the same if I was offered a daredevil ride to Belfast, bouncing off the hard shoulder, I think I would prefer the train even if it was a few minutes slower

Are you still confident of a 6% target return?

I don't think shorting stock is yet a respectable investment strategy in the actuarial syllabus. Surely it is gambling. Bitcoin was different, that was a cert
 
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Duke of Marmalade said:
Jayz, Colm, 5% a year over 3 years.
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Yes, I thought it hilarious too when I did the sums: all that bother for a small margin over a low-risk investment.

Duke of Marmalade said:
But all the same if I was offered a daredevil ride to Belfast, bouncing off the hard shoulder, I think I would prefer the train even if it was a few minutes slower
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Staying with your analogy, Duke, the experience of the last three years is like heading for Belfast from Bray, hitting a few bumps at Foxrock, and judging the quality of the ride on that basis.

Some financial advisers would shove an auld fella like me into a tractor going at 20 kilometres an hour and tell me that I’d reach my destination (a real hot-spot in my case) in no time. I’m planning a longer journey. Besides, even on the bad road between Bray and Foxrock, I still managed more than double the speed of a tractor.
Duke of Marmalade said:
Are you still confident of a 6% target return?
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Absolutely. History – and logic – are on my side. Risk-takers must earn more in the long-term. Period. Anyone with an investment horizon of 8 years or longer can afford that luxury. (I would put it even shorter). Most pensioners fall into that category.
Duke of Marmalade said:
I don't think shorting stock is yet a respectable investment strategy in the actuarial syllabus.
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To misquote the Bard of Avon: “There are more things in heaven and earth, Actuary, than are dreamt of in your philosophy”. If I analyse a stock and conclude it’s undervalued, I buy it. If I analyse a stock and conclude it’s overvalued, I sell it. What’s not respectable about that?
 
Colm Fagan said:
If I analyse a stock and conclude it’s overvalued, I sell it. What’s not respectable about that?
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Sell? Maybe, but Short?
I'll accept the argument of the equity risk premium which says that the fear of short term risk makes them good value for long term investors- i.e. the price compensates for the risk. Shorting stock is riskier still than buying them but the equivalent argument that the market would then put a high price on the stock to compensate shorters for the risks they are taking, can't also be true. I know you are not making this argument, you are arguing that you can spot overpriced stocks in the way Brendan spotted overpriced crypto.

My point is a bit tongue in cheek of course but there are those who believe that the risk/reward trade off is almost a moral imperative. You get rewarded for taking investment risks and ergo you should expect extra rewards for shorting because of the extra risks.
 
Duke of Marmalade said:
I'll accept the argument of the equity risk premium which says that the fear of short term risk makes them good value for long term investors- i.e. the price compensates for the risk.
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This assumes the risk is worth the price, but if the market was efficient that should not be the case.

You cannot have a risk premium and an efficient market.

A volatility premium perhaps, but that is not often what is understood by risk.
 
cremeegg said:
This assumes the risk is worth the price, but if the market was efficient that should not be the case.

You cannot have a risk premium and an efficient market.
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I do broadly believe in the EMH or at least that there is no way that I can outsmart the market. But EMH does not rule out there being good value for some. That is because both risk appetite and risk assessment are very dependent on investment horizon. Thus a 25 year old both assesses that over her horizon the risk will pan out and they also have an appetite for short term volatility. A 75 year old will assess higher risk and also have a lesser appetite. Hence one could posit a stable model where young folk are buyers and getting good value for the risks they are taken and old folk are winding down their holding as they see the risks becoming progressively higher than the price of that risk in the market.
I do tend to see the whole issue of the ERP as a pricing phenomenon driven by supply and demand dynamics. I have a pet theory that in recent times with mass involvement in equity purchase through mutual funds etc. and driven by a financial advice industry which thrives on the mantra that "blessed is she who taketh the risks as she will reap the rewards" the ERP may have been priced out of the market. It has been posted elsewhere in these parts that the first 20% of this century has been quite disappointing for the mutual fund sheep. Add to this the current artificiality of QE induced demand (negative interest rates indeed), and I stick to my state savings
 
We’re getting into how-many-angels-can-dance-on-the-head-of-a-pin territory. Count me out if that’s where we’re heading.

I’ll try to summarise where I’m coming from on the ERP, efficient markets, risk, volatility, etc.

Every enterprise faces risk. This leads to uncertain outcomes. Views on whether that uncertainty is good or bad for the business vary over time. That in turn causes volatility in the price people are prepared to pay for a share of the business.

If I have a choice of putting my money where the outcome is reasonably certain or where it is uncertain, I will opt for the safer option every time - unless I can expect (in the mathematical sense) an adequate reward for taking the risk. Numerous studies have shown that the expected reward (again interpreted mathematically) is greater than what can be explained rationally. (I don’t understand the mathematics of utility theory; I leave it to others to explain what that means). In any event, I don’t care. All I care about is the expectation of a more than adequate reward for taking the risk of investing (positively) in shares. That’s the ERP. And I disagree with @cremeegg: you still have an ERP in an efficient market; you still have to get rewarded for taking the risk. I do accept though that, in a completely efficient, rational market, the ERP would be less than what it is in reality (I've tried to follow the arguments, but they're too high-brow for me; you can read up about the equity risk premium puzzle on Wikipedia).

If markets were completely efficient, it would be absolute folly to short shares, as the expectation would be negative, being the reverse of investing in them. I short (only very occasionally) because I think the market has got it wrong for specific shares, that it’s not efficient, at least not for those specific shares.

I don’t accept the Duke’s theory that the ERP is reducing over time. (Duke, are you actually going even further and claiming that it’s being eroded completely?) I don’t think the ERP is falling. One could propose the opposite hypothesis, that regulatory pressures are causing institutions to take less risks. For example, sponsors of DB pension schemes are being pressurised to reduce their exposure to equities and to match their fixed liabilities with bonds. Regulators are pressurising insurance companies and banks to allow for extreme tail events when proving their solvency, which also causes them to reduce their equity exposure. This reduces the supply of risk capital in the supply/demand equation, which, ceteris paribus (I love the occasional bit of Latin!), should cause the price of risk to rise. I'm not sure I accept that hypothesis either. I'm happy to believe that the ERP won't be much different in future to what it's been in the past. That's good enough for me.
 
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Colm Fagan said:
Every enterprise faces risk.
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Of course it does, we are seeing a beaut unfold at the moment. What happens when the CEO and 16% shareholder of the worlds largest company gets divorced. I have no idea, but it seems we are about to find out.

Could management decisions be determined by marital dilemmas. (sorry, Mrs B is a novelist). I cannot imagine how this could be included in investment risk models.

HOWEVER, this has nothing to do with investment risk for diversified investors in efficient markets. Not even in the aggregate of all such companies.

[I would love to go on here and make a positive point, but at the moment it eludes me.]

Colm Fagan said:
And I disagree with @cremeegg: you still have an ERP in an efficient market; you still have to get rewarded for taking the risk.
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If the market was efficient, the price would reflect the risk without a premium.
 
cremeegg said:
[I would love to go on here and make a positive point, but at the moment it eludes me.]
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???? I don't know whether you're referring to me, my contribution, or Mr and Mrs Bezos. I'll leave it go.
cremeegg said:
If the market was efficient, the price would reflect the risk without a premium.
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And how would the price to "reflect the risk" be calculated? Presumably by discounting expected future receipts at the bond yield plus the equity risk premium, so you end up in the same spot.
 
cremeegg said:
If the market was efficient, the price would reflect the risk without a premium.
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Just want to make sure we are talking the same language. Let's imagine we have a betting slip which pays €2 if a coin toss comes up Heads and zero otherwise. A fair (efficient?) price for this slip "reflecting the risk" would be €1. However, for investors anyway, they should want compensation i.e. a premium for the risk as well as a reflection of it. They might only give you 80c.

All the evidence shows that over the last 100 years (for successful economies) equities have outperformed "risk free" assets considerably. But it is impossible to tell to what extent that was because there was a risk premium or to what extent it was because things came up Heads. I used the qualification "successful economies" and indeed the Equity Risk Puzzle was based on the US and given the very propitious environment for economic development (technology etc.) over the last century, my own view is that there is no puzzle. The 6% p.a. outperformance of equities could indeed be a 1% p.a. risk premium, which is what the authors claimed was justified, and 5% p.a. because Heads came up (10 times in a row at least for the US IMHO).
 
Colm Fagan said:
???? I don't know whether you're referring to me, my contribution, or Mr and Mrs Bezos. I'll leave it go.
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None of the above.

I have explained ( to my own satisfaction if no one else’s) why the idea that “every business faces risk” has no connection with the risk faced by a diversified investor.

I have failed ( to my own frustration if no one else’s ) to progress from there to formulate an explanation of the risk that diversified investors do face.
 
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