New Delhi: Investing, much like contract bridge, is a loser's game which means that the best performers succeed by minimising their own errors and taking advantage of other people's mistakes. The behaviour of most investors today suggests that risk is not uppermost on their minds. Since future returns are driven by perceived risk, the equity market today is not priced for above average returns during the next 12 months. The Sisyphean lure of the mantra that higher risk means higher return is inescapable in the current risk-tolerant, fully valued investment landscape.
Despite an unusually troubling macro outlook, vulnerable to issues that include:
- a complete fiscal mess in the peripheral EU countries,
- the political chaos in the Middle East and corresponding uncertainty about the price of oil,
- an incredibly topsy-turvy monetary policy and excess indebtedness inthe US,
- a structural change in the outlook for commodity prices, climate change and the possibility of correspondingly higher inflation and interest rates and
- a highly uncertain outlook for the euro and the greenback,
investors are unwilling to accept paltry absolute returns. In fact, their keenness to jettison the conservatism of 2008 for higher returns is a classic mistake best captured by Mark Twain's phrase, "History doesn't repeat itself, but it rhymes." Perhaps the attitude is similar to that of the inveterate gambler who said, "I hope I come out quits, because I need the money." It is worth remembering that riskier investments don't necessarily bring higher returns, just higher projected returns. Forgetting the difference can be fatal.
Warren Buffett was spot on in suggesting that the "smart" investor needs to be fearful when others are getting greedy. Legends emphasise buying at low prices relative to what the business is intrinsically worth thereby limiting risk and the likelihood of capital loss. So what makes for cheapness? In effect, the perceptions of the vast majority of investors about risk and likely future returns. The best investment lessons are typically learnt by examining earlier mistakes. My hunch is the mistakes we are most vulnerable to at the present juncture are errors of commission rather than of omission. This is a time to be cautious rather than aggressive, miss opportunities by sitting on the sidelines and watch others get rich rather than plunge in and get singed by permanent capital loss. What are the options?
- Invest for the long-term by sticking to high quality franchises, ignoring the more immediate risk of short-term losses.
- Hold cash, moderate your return expectations and keep your head down. You are a fair way down the road to becoming an investment super-star!
- Seek "niche" areas (art, precious metals, real estate et al) or superior fund mangers. This is where luck comes in.
- Build an investment approach that enhances the probability of your being a long-term survivor by recognising that:
- Nothing grows to the sky given the primacy of mean reversion.
Learn to cope with the anguish this approach will cause when you miss the most exciting part of the bull market. The truth is that to finish first, you need to first finish!
Disclosure: This column is neither an offer to sell nor solicitation to buy any of the securities mentioned herein. The author, a partner at Fortuna Capital, frequently invests in the shares discussed by him.
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