Joining a gym is traditionally one of the most common New Year’s resolutions but with the latest lockdown measures thwarting such a good intention – at least for the time being – now could be the perfect time instead to work on your investment discipline. Unfortunately, as our most recent podcast guest, Jake Taylor, points out, maintaining good portfolio habits can be as tough as continuing to visit your gym past February.
The versatile Jake Taylor is not only chief executive officer of value manager Farnam Street Investments but also the host of a number of podcasts, including ‘Five Good Questions’ and ‘Value: After Hours’ – not to mention the author of the unlikely sounding novel The Rebel Allocator, whose plot he likens to “The Karate Kid but where Mr Miyagi is Warren Buffett”.
“Keeping an investment journal, using a checklist, doing pre and post-mortems, tracking and scoring your decisions, seeking an outside view, thinking about base rates – all those things are incredibly simple when you read about them and look at them in isolation,” he says. “Yet they become very hard to execute as a package of best practices.
“Even one of the most important things an investor can do – making a clear plan so you know ahead of time what you would do at what Michael Mauboussin calls the ‘man overboard’ moment – it takes work. There is no secret here – you know what you should be doing – but it’s hard. Like having a gym membership but not going as often as you should, you are working against the human tendency to take shortcuts.”
One ‘investment gym’ exercise we make time to do, here on The Value Perspective, is after-action reviews. Regular readers may be aware of our company archive – a database of the hundreds of businesses we have analysed in detail over the years, with all the information held in a consistent format – which we have discussed in more detail in pieces such as Four investment edges and The Lego way.
From here we pick out a list of companies and revisit what we – and others – thought about them at the time and how things have played out for them in the years since. The aim is to assess what we have been getting right and wrong – and always with the proper context. Was the balance sheet in the right shape? Are we normalising revenues and thinking about margins the right way? Did we fully appreciate the levels of debt?
This remains a work-in-progress but, as the years pass, we expect it to grow into an increasingly valuable resource. “It is so easy to forget or misremember,” says Taylor as he endorses this approach. “You need to untangle what was available to you and what you knew at the time you were making a decision and then look at how it played out eventually. What, if anything, did you miss?
“The human brain is wired to tell stories and we will readily misremember a story if it helps us – and, if it protects our ego or our identity, that is especially where our brain will work double-time. So writing down what information was available and what you were thinking at the time and later working backwards to see if you could have done anything better – that cannot help but make you a much better decision-maker.”
The Ulysses contract
A second ‘investment gym’ exercise that crops up in our conversation is known as the Ulysses contract – something Taylor admits could have saved him from making a mistake last year, which still rankles. “For a long time I had owned this company where management were big owners and so held most of the cards,” he sighs. “And in March of 2020, as markets fell, they repriced their options at an incredibly low number.
“Of course, their share price went back up after that, which meant management had stripped out an incredible amount of value at the expense of the other shareholders. I was so mad about it – I just felt like I was getting stolen from. When I thought about it, I realised there had been other little red flags along the way that I should probably have recognised – and maybe even anticipated something like this could potentially happen.
“My big mistake, though, was not selling right away. A little part of me was thinking it was the worst time to sell – it is a travel-related stock so March was ‘peak pessimism’ – but that was where my process was sloppy. I should have pre-programmed that ‘man overboard’ moment – if the company does this, sell right away because, if this is what they are prepared to do publicly, who knows what else they are getting over on you?”
A Ulysses contract could well have helped. The idea references the Greek myth where Odysseus, also known as Ulysses, and his crew sailed near the home of the sirens, who had a nasty reputation for luring unwary sailors to their doom through their irresistibly beautiful singing. Odysseus ordered his men to block their ears and then tie him to the ship’s mast so he could still hear the singing but not be tempted to jump overboard.
“What I should have had was a Ulysses contract with myself that said, if management ever does this to you, you sell right away and that’s that,” says Taylor. “That way I am pre-programming things while I am calm and not making a decision in the middle of it all happening to me. You would think I had already made all the mistakes to be made in this business but apparently I am still making new ones to learn from. I have known about using a Ulysses contract for ages but, like you know you are supposed to go to the gym, I just didn’t.”
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