The Problem With Doing The Right Thing!

Date Added: December 14, 2018 | Comments Off on The Problem With Doing The Right Thing! | Filed under: Blog

I was bemused when the head of the Quebec pension fund sited market volatility as a reason why the Quebec pension fund was moving more money toward private equity investments and holding less in public market investments. Here was a man who surely understands the difference between “real risk” (meaning the risk of a permanent impairment of capital, i.e. of a real loss of cash) and “paper risk” (market price volatility, meaning that quoted prices change every day). Certainly value investors would find nonsensical this focus on a definition of risk as being share price volatility rather than business value. For value investors the chance of a permanent capital impairment from buying a security at a price in excess of its business value, or from a destruction of business value leading to permanent impairment of capital are risks to be avoided and are true risks for long term investors like pension funds as they grow capital to meet their obligations.

But now I get it. It is political. When managing outside money or the money of pension plan beneficiaries, one cannot afford to endure substantial pricing volatility even if it is, in true economic terms, meaningless without taking career risk. The same applies to individual portfolio managers. It is much easier -and safer- to be in the company of other mediocre investment professionals by not straying too far from the market return and collecting your fees for being “in the ballpark” (although we all know that it is this very action that causes most portfolio managers after their fees to under perform a cheap passive index investment).

With “mark to market” performance reporting, portfolio managers are required of course to report the market value of their portfolios at some predetermined reporting period, generally monthly. Private equity portfolio managers on the other hand are not subject to mark to market reporting but rather report their results based on business metrics from time to time.

That is why we at Takota focus on the intrinsic (or business) value range (it is always a range) of our portfolios. We know that over time, in aggregate, our portfolios will trend toward their intrinsic value due to either markets recognizing their pricing error or corporate interests realizing that it is cheaper for them to acquire these securities rather than build business assets from scratch. When long term investors understand the gap between business value and market value they generally recognize the opportunity in staying the course and enduring whatever volatility the market throws at them so as to pursue the higher capital base that a realization approaching intrinsic value will bring to their net worth.

The path can be uncertain. The outcome generally is not. Some investors will fall victim to the inevitable ups and down of irrational market pricing. Others will not.

  • “I wrote a book several years ago called the Big Secret for the Small Investor… In the book, I looked at several studies including the performance of the best mutual fund over the period 2000 to 2010. During this decade, the best long only equity mutual fund returned around 18% per year, compared to the market which was flat. The average investor in the mutual fund lost 11% a year on a time-weighted basis. The way that they did it is that after the market went up, people piled in. After the market went down, people piled out. After the fund outperformed, people piled in. After the fund under performed, people piled out. That’s how they turned the 18% analyzed gain into 11% dollar-weighted losses.” – Joel Greenblatt

Season Greetings,


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