Certain kinds of investment and certain investors have been accorded legendary status in the investment community. Most of the time, this amounts to worshipping a false idol. Either that or legendary investors are just exceptionally good at public relations. Here are some stories about legendary investors you might find illuminating.
Ben Graham, the father of Value Investing (from the Psy-Fi blog)
Following the Wall Street Crash he geared up, borrowing money to invest in the huge range of cheap value stocks that were available in the market. Not being psychic he failed to divine that the recovery in ’30 was the prelude to the even greater drop in ’31.
Faced with ruination for himself and his clients he was lucky enough to be recapitalised by his partner’s father-in-law and restored his and their wealth over the next few years, as the markets stabilised and some sort of normality took hold again.
Yep, Ben Graham blew up and needed a bailout.
John Maynard Keynes, the father of Keynesian economics and manager of the King’s College, Cambridge endowment (from the Psy-Fi blog)
For Keynes investing was about figuring out what everyone else would want to buy and buying it ahead of them. Back in the Roaring Twenties he expressed this approach through currency speculation. Prior to the First World War this would have been an exercise in futility as major currencies were all pegged to the immovable Gold Standard: exchange rates didn’t move. However, the disruption to major economies caused by the conflict forced countries off gold and into a world of strangely shifting valuations.
In this new world Keynes saw the opportunity to apply his animal spirits philosophy and rapidly managed to generate a small fortune, by trading heavily on margin, as the German economy collapsed into hyperinflation, France struggled with an accelerating rate of change of governments and financial scandals, Britain failed to recognise its new place in the world order and the USA lapsed into protectionism. And then, as is the way of the investing world, there was a sudden and inexplicable reversal in the trajectory of exchange rates and Keynes found himself and his fellow investors suddenly short of the cash needed to make good their positions.
As Ben Graham found, when you’re in dire need the best thing to have handy is a wealthy friend. In this case it was Keynes’ father who bailed him out.
Yep, Keynes blew up and needed a bailout from Dad.
Warren Buffett, the King of Buy-and-Hold (from CXO Advisory)
In their July 2010 paper entitled “Overconfidence, Under-Reaction, and Warren Buffett’s Investments”, John Hughes, Jing Liu and Mingshan Zhang investigate how other experts/large traders contribute to market underreaction to Berkshire Hathaway’s moves. Using return, analyst recommendation, insider trading and institutional holdings data for publicly traded stocks listed in Berkshire Hathaway’s quarterly SEC Form 13F filings during 1980-2006 (2,140 quarter-stock observations), they find that:
The median holding period is one year, with approximately 20% (30%) of stocks held for more than two years (less than six months).
Yep, Warren Buffett has 100% turnover. He blew out 30% of his portfolio selections within six months, and held about 20% of his picks for the longer run. That is active trading by any definition.
All three of these investors were quite successful over time, but the reality varies from the perception. What can we learn from the actual trading of these legendary investors?
- Using a lot of leverage probably isn’t a good idea. If you do use leverage, then make sure you have a big pile of cash set aside for when the margin call arrives. Because it will arrive.
- A variety of investment methods probably work over time, but no method works all the time. All methods have the ability to create a painful drawdown. In other words, there is no magic method and no free lunch.
- It makes sense to keep a portfolio fresh. In Buffett’s portfolio, about 20% of the holdings make the grade and turn into longer term investments. Things that are not working out should probably be sold. (In passing, I note that relative strength rankings make this upgrading process rather simple.) In Buffett’s portfolio, the bulk of the return obviously comes from the relative strength monsters—those stocks that have performed well for a very long period of time. Those are the stocks he holds on to. That merits some attention as a best practice.
As in most arenas in life, it is usually more productive to pay attention to what people do, not what they say!