Sunday, January 04, 2009

Developing An Investment Philosophy Part 5 25 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
A friend joined a fund management firm recently and was amazed at how the analysts were expected to cover multiple geographical markets simultaneously, since the firm managed several Asia-Pacific funds. How was he supposed to do it, he wondered, since he previously was only familiar with the Singapore market. Indeed, was it even humanly possible for a person to cover many markets at the same time?

To me, there are three distinct aspects to developing one's expertise and effectiveness in the stock market: depth, breadth and philosophy. Be deficient in one aspect and he will be a much less effective investor by an order of magnitude because of it.

In fact there are many analogies that I can draw between this and kungfu (which I like watching, and in the mood to indulge in today because of the movie Ip-man) so I'll use the analogies liberally here. Depth is easiest to understand. If you master a certain kungfu style eg. Snake style or Eagle Claws (in that old Jackie Chan movie), you will know all the intricacies and be in a great position to fight all comers. Ditto for the investor who knows a market (usually his home market) or an industry really well; he will understand what drives it, the industry dynamics and cycles, the key market players etc, from which he can make money with more than even odds. This is what my friend had: depth of knowledge in the Singapore market. Often, depth of knowledge in one market can serve as a good launching pad for expansion into the next aspect --- breadth --- because the groundwork has been done; one knows what to look out for the second time round.

Just like the single-style kungfu expert who encounters other schools of kungfu. He will find it easier to learn them because he has the basic understanding gained from his mastery of his first kungfu style. And as this exponent encounters more and more different schools of kungfu, he gains breadth of understanding and knows their various interactions and how to deal with and counter each and every school. In the same way, breadth of knowledge of different markets will move the individual investor up another level because it will reinforce his knowledge of how sector peers in different countries operate, and relative valuations provide a guide to whether the particular stock he is holding might still be undervalued or is merely fairly-valued. Personally, I follow a "buy local, monitor global" approach given my limited time; at the same time I recognise the importance of expanding breadth, hence my "monitor global" emphasis ("My Research Routine").

But a lack of breadth, I said to my friend, could be made up for by excellence and consistency of application in the third aspect, which is sound investment philosophy/principles. A kungfu analogy will be the "internal strength" that shields top martial experts from serious damage by opponents eg. the ultimate Jiuyang Zhenjing in Jin Yong's Heaven Sword Dragon Sabre. Or how about Zhang Sanfeng's tai-ji ("no style is the best"). Once one has internalised certain values, he does not need superior knowledge across many markets or insider news to succeed in the market. Intangible facets of investment philosophy, such as an appreciation for value, decision-making based on upside potential vs downside risk, a balanced understanding of the key parts of business value, consistent and logical thinking and discipline in application, trading philosophies such as cutting loss and when to average down/pyramid up .... if one can internalise a philosophical framework within his investment approach, he will indeed be more effective in that most important measure --- market profit --- than the professional who is continually scrambling to expand his breadth of knowledge (sometimes at the expense of depth, I understand).

It will indeed be the most desirable to attain expertise in all three, for one can then claim to have achieved Investment Nirvana (and then spend the rest of his life peddling away to stay at the same point). Then again, for want of time, it is often important to prioritise, in which case I would advocate a clear investment approach anchored by frameworks of thinking, and depth of understanding in the various sectors that one is interested/vested in. One will then be confident of his position when he faces his counterparty in the transaction.




Blogger PanzerGrenadier said...

Frankly, I'm sceptical about fund managers given the recent global financial crisis that not many of them forsaw.

Even the Hedge Funds were conned by Maddoff and it is a classic ponzi scheme.

The value-added (or subtraction) for the fund management industry for 2008 is scary. And they continue to earn their management fees for seeing your portfolio go under by 50% or so.

1/06/2009 5:10 PM  
Blogger DanielXX said...

Many of them are restricted by their mandates (must put a certain portion into equities at all times) and also benchmarks. There is always the risk of underperforming the benchmark which is a greater danger because people tend to desert the fund if it underperforms, but won't blame it if it plunges together with the market.

It takes a brave fund manager to go against the flow. Stick with him if you find one.

1/10/2009 7:34 PM  
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