The Role of Macroeconomics in Value Investing

Date Added: September 19, 2018 | Comments Off on The Role of Macroeconomics in Value Investing | Filed under: Blog

At Takota as at our predecessor company we practise “bottom up” value based investing. This means that we search for attractive and inexpensive opportunities one at a time and our portfolios are the sum total of these opportunities.

In the lead up to the financial crisis I engaged in many conversations with customers about the growing risk of derivatives and what that might ultimately mean for the economy. However, our investing activity was only impacted by these discussions in that it reinforced our discipline to not pay up for securities and insist that they only be bought at attractive prices.

The financial crisis arrived at a time when I had not been doing much travelling and so was not as aware of the slipping standard in U.S. home financing as I might have been. While we had liquidated over 50% of our portfolio by July of 2007 as long held securities approached our estimate of their fair value, by the summer of 2008 we had reinvested some of the proceeds in seemingly more conservative securities with yield. These securities did not have the wherewithal to withstand the depth of the financial crisis and so really for the first time in our history we suffered losses.

As a result of that experience we decided that we should make ourselves more aware of the macro influences active in the marketplace at any time. While we continue to build our portfolios one security at a time from a “bottom up” perspective, we try to keep ourselves more informed of the macro forces at work in the economy. Now I am constantly fed a series of interesting articles about macro- economic issues by my staff. I generally read them as I walk back and forth to work.

What this effort does is reinforce our discipline to insist on big discount rates in the securities that we purchase for our portfolios. It causes us to look more closely at the balance in the portfolio and consider whether the addition of any one security is really just another bet on the same “theme” tipping portfolio risk in any direction. It causes us to consider what “cheap” securities are actually value “traps” and are at risk of becoming disintermediated by economic forces or technology.

Certainly we have observed this type of value destruction in many of the businesses that investors thought had sustainable competitive advantages (so called “moats) such as media properties and insurance companies but which, in the end do not.

This is the chief risk in my opinion to the form of value investing which mimicks the type of investing that Warren Buffett evolved towards, the buying of high quality companies with competitive “moats” at “fair” prices – a strategy which Buffett has executed well but which has become so popular that I would now call it a momentum strategy, and one which is likely to fail in the future for many adherents.

Why? Because most don’t have the patience to pay only “fair” prices, most don’t have the skill to identify companies whose competitive advantage is in fact sustainable, and because there are only so many companies with these particular characteristics and they are well picked over and therefore fully priced.

Scott


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