Into every life a little rain must fall and a consequence of one of our portfolios outperforming its benchmark by more than 20 percentage points for two years in succession – for the first time ever in its 42-year history – is we are increasingly being asked if we are planning to ‘lock in’ our returns. there are, of course, worse problems to have but the phrase is beginning to grate a little.
After all, what exactly do people mean when they say this? Do they mean ‘go to cash’? .No, we will not be going to cash because we still believe many of the ideas in the portfolio are attractively valued. If we did not believe that about any holding, we would sell it and if there were nothing attractive to buy in its place, then we would go to cash. But we will not go to cash simply to ‘lock in’ recent profits.
Do they perhaps mean ‘go and buy big businesses that are perceived as stable and make up significant weights in the portfolio’s benchmark index – regardless of how expensive they might be at present’?
No, not a chance – that would mean adopting a relative mind set, which we see as the path to mediocrity and disaster. It is not a path we are inclined to take.
Do they mean ‘go and buy lots of large, cheap, stable businesses that make up some element of the portfolio’s benchmark so at least it should underperform less’? Well, sure – if those businesses existed and were the cheapest stocks we could recycle money into, we would do that. But we would do so because that is where the value was in the market not because we wanted to ‘lock in’ recent profits.
No, in all probability, we will end up doing precisely what we always do, which is focus on what we see as the most attractively valued parts of the market and then, within those, identify businesses with acceptable balance sheets, decent track records of producing earnings and free cash flow, and management teams with a solid history of sensible cash allocation.
Whether they mean to or not, anyone asking the lock-in question is also drawing a distinction between existing and future investors. Those who have been in the portfolio a while may be happy with the returns they have made – in which case perhaps the real question may be whether it is they who should be looking to lock in – but new investors will not want to pay active-type fees for an index-like fund.
To put this all another way, whenever someone asks us if we are going to lock in – whatever they mean by the term – they are effectively asking us if we are going to change our style, to which the answer is a resounding ‘no’. Whether we are outperforming or underperforming, we will not change our style because the moment you do – no matter how you try to rationalise it – it is the beginning of the end.
It is not our job to tell people what they should do with their money but, rather, to stick to our investment process. However, history allows us to offer a few observations about the pattern of future performance. We know, for example, the portfolio does not outperform its benchmark by 20 percentage points a year over the long term. As a result it is reasonable to concede that current returns are, sadly, unlikely to continue at this pace.
However, that does not mean the apocalypse is around the corner either. in the same way that, just because you have flipped three heads in a row, it does not follow a tail must come up next – the portfolio’s recent performance in itself has no bearing on its future. The fact it has outperformed in recent years is expressly set by valuation. Existing and future investors need to be sure that – like us – they are comfortable with the valuations in the portfolio today.
When all is said and done, perhaps what frustrates us most about the lock-in question is the implication that there is no hard-and-fast process to what we do – which we merely took a gamble, the gamble paid off and now, to be safe, we should take a bit of money off the table. But we are not gambling, here on The Value Perspective, we are investing – a crucial differentiation.