Can retail investors outperform the market?

Lies, damn lies, and statistics” was popularised by Mark Twain to describe the persuasive power of numbers.

For many years I’ve replaced damn lies with facts. Lies, facts and statistics.

Facts, like statistics, can tell you whatever you want to believe. Many people believe the are looking at the truth through the lens of either statistics or facts, but they are often simply seeing what they wish to. They then use the “lies” to entrench their position.

Facts and statistics are often the trees stopping us from seeing forest.

I’m not implying it’s always best to focus on the forest, sometimes it’s the trees we need to look at. The important part part is to have the right focus for the circumstances, an open mind, and not to swallow statistics or facts without chewing.

Statistics tell us that retail investors woefully under-perform the market. Stats also highlight around 75% of fund managers lag the market. Many people concentrate on those dire figures and in the case of ETF and index funds heavily publicise them.

So why would a retail investor bother trying to outperform the market? Statistics say it is highly unlikely and individual investors are seriously out-gunned by institutions.

The answer is, invert those statistics.

Can retail investors outperform the market?

Market returns are the average of all participants. So if the vast majority of participants under-perform the market then a minority must be trouncing the market.

I occasionally communicate with one  of these market thrashing investors. Here are his returns to October 2014


Those are some awesome numbers. For some perspective on how good his performance is consider this. Over the last 5 years he would have turned $100,000 into almost $410,000 and over the last 3 years $100,000 would have grown to almost $290,000. Simply phenomenal.

Now let’s compare his returns to mine.


While we both handily thrashed the market, I trail by a considerable distance. Even though my performance over 5 years appears pretty close to his, it’s not. Instead of growing to $410,000 over 5 years, I would have “only” grown it to $309,000. A few percentage points makes a huge difference.

Investor X wonders why I hold such a high cash balance, around 50 percent at the moment.

One comment I would have, is the fact that you have moved to around 50% cash. I also watch Geoff Wilson’s performance with his LICs WAM, WAX and WAA, and he also likes to keep between 30-50% cash. I have always thought he could do a lot better if he was prepared to be more fully invested. Yes, you are both in an excellent position to take advantage of the down turn we are now in, but I wonder at the cost of lost opportunity. I rarely have more than 2-3% in cash. If I sell something, it is because I have found what I judge will a better investment to move onto.

Investor X is right. My returns would be much closer to his over the last 5 years if I was 100 percent invested. While close to meaningless, we’ve also compared monthly volatility and my portfolio is more volatile. So why do I hold so much cash?

The simply answer is personality. While investor X was able to live with a 60 percent fall during the GFC, I could not. Our portfolio dropped around 20 percent during the 2008 market crash. I prefer to sacrifice some upside to ensure I can sleep well at night.

The other answer is buy fear sell greed. While many market pundits present facts and statistics showing that the market is under or over value, or  just right, I focus on the trees, the individual companies. I raised cash in September as companies I held became overvalued. I’ll redeploy capital when it’s easy to do so, when companies I want to buy are being sold by fearful investors.

Investor X is older and probably wiser than me. He clearly has better performance over the last 5 years. But what happens if we layer on our respective 60 and 20 percent drops?

It turns out if we started with a $100,000 prior to the GFC and our returns included both the falls and gains from above then investor X’s portfolio would now be worth $164,000 while mine would be $247,000. Naturally if we exclude the GFC drop, but our portfolios fell by similar amounts now, the figures would be the same, i.e. $164k and $247k.

I’m not saying this is what happened or will occur, but I hope it illustrates why I focus on the downside. If not then perhaps this graph of gains required to make you whole again will.

See the difference. While it only take a 25 percent gain to make up for a 20 percent loss, it takes a massive 150 percent increase to recover from a 60 percent drop. (See this post on the lies behind this accepted fact and how it can take exactly the same percentage gain to make up for a loss.)

I am so far off topic I should change the title, but hopefully through the many diversions you can see two retail investors thrashing the market in two different ways. While there are many wrong paths, there is no one right path to market outperformance. Each investor must fine the path that is right for them.

Some paths are easier to follow as they are clearly marked. Value, momentum and small caps are 3 paths that have provided strong tailwinds for up to 9 decades now.

A little meat

During September I sold, Analytica Limited (ASX:ALT) and Global Health Limited (ASX:GLH), and reduced M2 Group (ASX:MTU) and My Net Fone Limited (ASX:MNF).

While I say it’s the companies I focus on, that is simply part of the story. Market corrections are not fair to all comers. Some stocks get whacked 90 percent, some might only drop 10 percent and there will even be a few gainers.

In general stocks that are any of overvalued, speculative, small caps, without earnings or popular are hardest hit.

I continue to hold some stocks that are likely to get clobbered in a correction. Two companies that jump to mind are Somnomed Limited (ASX:SOM) and Nearmap Limited (ASX:NEA). I hold these and would look to buy on a correction as it is simply too difficult to ‘time’ individual growth stocks.

Disclosure: Long MTU, MNF, SOM and NEA.

Morphic Asset Management

Last year I wrote about fund managers I’d be happy to invest our money with. If you’re seeking global exposure here’s a manager worth taking a look at.

Morphic Asset Management

I’ve respected Jack Lowenstein for many years. He did a terrific job at Hunter Hall and now heads up Morphic Asset Management.
I like Morphic’s investment philosophy.

  • Only funds with flexible hedging strategies will be able to deliver acceptable, steady, real, absolute returns for investors over the next decade.

  • Slavish adherence to any single investment style, such as ‘value’, ‘growth’ or ‘momentum’ is unlikely to be in the interests of investors through all investment and economic cycles.

  • Buying lower-priced stocks with reasonable growth prospects is more often a good strategy than simply buying pure ‘value’ stocks or pure ‘growth’ stocks, it is also important to consider price momentum to increase confidence that returns from these investments will not be too far into the future.

Morphic believes that in today’s economic environment the best way to manage money is to adopt the approach of high-performance fund management pioneers, such as George Soros. This involves intense economic and market research to identify thematic drivers that are wrongly priced by the market combined with detailed analysis of individual securities that allow these opportunities to be exploited with the highest return and lowest risk.

That philosophy has a hint of fusion about it. More importantly it displays an open mindedness that is refreshing in the investment world.

It’s early days for the fund and thus far it’s neck and neck with its global index. But it is their through cycle returns that I expect will outperform.

Fees are typical, they’ll work out around 2 percent if the fund outperforms by 3 percent annually. (1.35% management fee plus up to 0.27% expenses and 15.375% performance fee.)

Disclosure: This is not advice. I am not authorised to provide advice.

Free SMSF Accounting Software Approaching Maturity

Back in late 2012 I wrote about Mclowd, the free SMSF accounting tool.

At the time Mclowd was a relatively new entrant, and the software was in public Beta.

I recently went back to check on their progress, and was amazed at how much the guys had achieved in just 18 months, and how quickly their online Community is growing.

Having spoken to Product Manager Graeme McGuire it is clear Mclowd has the potential to displace BGL and Class with a platform that is free to both individual trustees and practitioners.  (Mclowd makes it money out of a services Marketplace that is run alongside the software, as well as product distribution such as actuarial certificates).

With the release of version 3.0 at the end of September (2014) Mclowd expects to provide support for the full SMSF life cycle, including Statement of Taxable Income and Member Benefit Statements.

From that foundation Mclowd intends to address usability issues and help content, as well as targeting some of the bells and whistles (such as data feeds, peer-to-peer analytics and improved integration with the Marketplace).

But for the vast majority of trustees it is already a viable alternative to paid versions of the similar SMSF accounting software.

Graeme told me that trustees have responded to the consistent delivery of new functionality, with nearly $1m in SMSF assets being transferred each day.

But perhaps the most interesting aspect of Mclowd is the way an online Community is evolving.

Founder Ashley Porter started Mclowd because of the fees his mother was being charged for SMSF accounting, and he vowed to create an environment where trustees could manage their retirement assets in a much more empowered fashion, including their relationship with professional services providers.

Looking at the various conversations taking place in the Mclowd Forum, it is clear that a growing number of trustees are making the Mclowd Community their own, and in doing so potentially changing the balance of power in the SMSF space.

M2 Group soars on no news

A long term favourite company of mine M2 Group (ASX:MTU) has been swimming against the retreating market tide. M2 leapt over 5 percent this week on no news.

That is on no real news.

M2 did get a mention in Pie Funds’ newsletter on Tuesday morning. Mike Taylor’s  widely following Slice of Pie outlined a very bullish case for M2.

The Fund has also made a direct investment into M2 Group. Pie has previously been an investor in M2 and sold out, however, due to a recent correction in price we felt that it was compelling value and have taken a direct position as part of the funds allocation to Australasia. With strong management, over 20% earnings growth, a P/E of 12x and dividend of 5% it’s a good fit for the Global Fund.

I wonder if copy cat investors fell for that bullish argument without checking the facts. I’d certainly be extremely interested in any companies selling for 12 times earnings, with 20 percent growth and a 5 percent dividend.

Unfortunately M2 is not such a company. The price earnings multiple is right, but sadly the growth and dividend are both meaningfully lower. To be fair the forward dividend yield is likely to be around 5 percent, but the current yield is closer to 4 percent.

As for the growth, well M2 regularly buys whatever growth it wants, so never say never. But it is unlikely it will achieve anywhere near 20 percent real growth. Analysts are estimating 13 percent growth this year followed by an anemic 3 percent in 2016.

I hope Mike is right, as like him I sold my original M2 shares and have bought back in.

M2’s debt is still worryingly high and you probably shouldn’t look at M2’s half year cash flow statement if you’re determined to buy, but management certainly are top notch integrators.

Disclosure: Long M2 Group.

Performance, Pigs, and Investment Process

Pigs at the trough

What’s the difference between an independent director and a shopping trolley?

You can load a trolley with grog but can’t push it anywhere you want.

Hat tip to Michael West @MichaelWestBiz for that amusing summary of Peter Swan’s damning report on the performance of independent directors. As Swan’s report was published in October last year, I’m guessing that you need to present your findings at a junket for the media to take note.

Anyway, it’s great to see the pigs at the trough have finally been exposed. The bigger question is why does the ASX governance council require all listed companies to adopt a majority of independent board members? Do they have any empirical or even strong anecdotal evidence to suggest people without skin in the game who often lack industry knowledge are capable stewards of shareholder wealth? Of course they don’t.

It’s time to slaughter the pigs! Have skin in the game or fork off.

6 Signs of a Good Investment Process

I enjoyed this post on the investment process by Todd Wenning at Clear Eyed Investing. Todd’s 6 signs of a good investment process are:

  • Stoic: It can endure both good and bad short-term outcomes without getting emotionally swayed in either direction.
  • Consistent: It doesn’t adjust to current market sentiment and sticks to core competencies.
  • Self-critical: The process is periodically reviewed, includes both pre-mortem and post-mortem analysis on decisions, and is refined as needed.
  • Business-focused: Rather than rely on heuristics like “only buy stocks with P/Es below 15,” a good investment process focuses on understanding things like the underlying business’s competitive advantages (if any) and determining whether or not management has integrity and if they are good capital allocators.
  • Repeatable: A process gets more valuable with each application — insights are gained, deficiencies are noticed, etc.
  • Simple: The less complex, the better. If you can hand off your process to another investor without creating significant confusion, you’re on the right track.

It’s a great list, though I disagree with some of his finer points. Anyway, Todd is well worth following.


With no disrespect to Todd, I always wonder when reading articles like his if the writer is struggling with poor performance. I hope not, but when my performance lags I often find myself reaffirming that it’s process not outcomes that count. Here’s how Michael Mauboussin put it in ‘More Than You Know’, as quoted by Todd.

Results – the bottom line – are what what ultimately matter. And results are typically easier to assess and more objective than evaluating process.

But investors often make the critical mistake of assuming that good outcomes are the result of a good process and that bad outcomes imply a bad process. In contrast, the best long-term performers in any probabilistic field…all emphasize process over outcome

While I think my process is good, I know my outcomes are great. Give me another ten years and I might also know my process is great.

What a cracking month. The All Ords Total Return Index blasted ahead 4.4 percent. I did slightly better with a 7.2 percent return.

Daily, monthly and even yearly performancefusion fund short term performance vs all ords accum 2014-07 mean little to a long term focused process such as mine, but they are the repeatable steps that facilitate review. And hey, if we can’t celebrate our small victories we’ll get mighty thirsty!

As Mauboussin says results are what ultimately matter and naturally in the investment game it’s long term results that really matter.

As the next chart show I continue to do exceeding well over the long term.

fusion fund performance vs all ords accum 2014-07What I find even more stunning is my results over the last year include an average cash holding of 45 percent. That’s like beating Mike Tyson in a fight with one arm tied behind your back.

Or is it?

fusion-fund-asset-allocation-2014-07I think a better analogy may be beating Mike Tyson when he has both arms tied behind his back. As this asset allocation chart shows when the market is winding up for a punch my cash position increases. The high cash position stops the market from delivering a knockout blow and allows me to continue taking big swings.

I’m not trying to time the market. Our cash balance is more a reflection on both the lack of opportunities and elevated risks in the market. Just because others are prepared to take more risk for less reward doesn’t mean I will.

Here’s some pearls of wisdom on holding cash from Seth Klarman and Warren Buffett as used by Steve Johnson in his article ‘The real reason you should hold cash‘.

One doesn’t need the entire market to become inexpensive to put significant money to work, just a limited number of securities. Klarman

Holding cash gives us optionality. Alice Schroeder, author of the definitive Buffett biography, The Snowball, says this is one of the most important things she learned: “the optionality of cash”.

“[Buffett] thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”

As the above asset allocation shows I found an inexpensive security this month, but more on that another day.

One final chart that tells me my process is on the right track and encourages me to keep perfecting it.



Stockbrokers can cost you a lot more than high execution fees

Is Marcus Padley getting desperate?

In this article Padley attempts to intimidate self directed investors into using the over priced services of stockbrokers.

Whether a trade costs $19.95 or $79.95 will have less impact on your long term wealth than whether it was a sound investment to begin with. In my experience full service stockbrokers provide lousy advice that can cost you significantly more than the $60 extra bucks you pay for a trade.

So to counter Marcus Padley’s long list of attributes he believes investors require — many of which are spurious — I give you this list.

Use a full service stockbroker if you:

  • want to feel like you’ve been shafted with dud shares that your stockbroker is trying to off-load for their preferred clients,
  • wish to make a salesman — as that is what stockbrokers are — rich,
  • like to feel bad about your well reasoned and researched decisions because the salesman at the other end of the phone has conflicting incentives,
  • enjoy investing in “guaranteed sure winners” that don’t,
  • like being encouraged to trade too frequently, thus sending your costs skyrocketing as fast as the salesman’s new Porsche can go,
  • enjoy selling your winners too soon, as the salesman needs to hit his commission targets,
  • like to lock in losses with stop loss orders due to simple market volatility rather than a fundamental change in business prospects,
  • want to be guided more by someone’s past experience and existing beliefs than by logical thinking and rational decision-making — see here,
  • think it’s good to be directed by a salesman who has difficulties disengaging themselves from vastly anchored thinking patterns,
  • are unable to take responsibility for your own decisions and need someone to blame.

When investing, don't use a monkey throwing darts

Beware of incentives

Marcus Padley is the same as almost every person involved in finance. They are all either unable to or purposefully choose not to disentangle their ‘advice’ from their own incentives. Stockbrokers advise you to use stockbrokers, while newsletter writers advise you to be self directed so they can sell you advice. Banks, brokers and financial advisors all advise you to to use margin, not because it is financially sound, but because they are incentivised to do so.

If you’re above average intelligence then manage your own money. No-one is as strongly incentivised as you are to make sure your wealth grows.

Disclosure: My main incentive is to grow my family’s wealth. As alpha — market outperformance — is a zero sum game that may mean that I’m incentivised to give you a bum steer! Maybe I think I can beat you more easily than I can a stockbroker.
Of course this blog is simply for my amusement. I am not authorised to give advice.

The Global Warming Religion

When did you last change your mind? And I don’t mean changing from hokey pokey ice cream to chocolate chip for dessert.

Can you remember the last time someone convinced you that one of your core belief was misguided?

I consider myself open minded, but I can’t recall the last time someone changed my mind on an important issue. Or that is I couldn’t recall. Then I read SuperFreakonomics by Steven D. Levitt and Stephen J. Dubner.

SuperFreakonomics changed the way I think about many things, but more importantly just as Freakonomics did, it enhanced how I think about all things. Both books are brilliant and deserve to read many times.

Thanks to a coupon clipping mother and a veggie growing father I am both frugal and a plant lover. Or as my kids say a tight-arse dirty hippie. I still dislike waste and love this planet. I agree with Al Gore and Jeremy Grantham that humans should change their profligate ways. But I am now a global warming agnostic.

My wife jokes that all I need to do is read another book and I’ll swap back to the global warming camp, but I don’t think so. This change has been brewing inside me for a while. I was ready to be “converted”.

The following quote in chapter 5 of SuperFreakonomics by the off-beat mayor of London Boris Johnson was the signpost I needed to change my mind.

Like all the best religions, fear of climate change satisfies our need for guilt, and self-disgust, and that eternal human sense that technological progress must be punished by the gods. And the fear of climate change is like a religion in this vital sense, that it is veiled in mystery, and you can never tell whether you acts of propitiation or atonement have been in any way successful.

There is no way I can simply convey Levitt’s and Dubner’s brilliant disrobing of global warming hysteria. Everyone should read SuperFreakonomics or at the very least chapter 5.

Whether global warming is actually happening or not no longer matters to me. Geoengineering or climate engineering solutions already exist to control global warming. Stratospheric sulfur dioxide injection may sound scary, but as 1/20 of 1 percent of our current emissions, positioned correctly should reverse global warming, climate engineering is the discussion that we should be having. Let’s face it we’re already climate engineering on a thoughtless massive scale, so what’s so wrong with a tiny thoughtful amount?

Unlike the $1.2 trillion annual bill the economist Nicholas Stern recommended is his British report on global warming, geoengineering solutions are incredibly cheap to implement and can be dialed up or down as we wish. Their impact is short term in nature and so if for some reason the models are wrong any global damage would not be permanent. While I dislike geoengineering as it replaces the need to alter our profligate ways, I have grown to accept that humans are unlikely to embrace conservation as we are by and large self interested and limited by our short term focus. And even if we do, it will be too little and too late.

I am now against any carbon tax. Our economic resources are limited and should not be wasted on what is at worst a minor contributor, carbon dioxide, to what may or may not be happening, global warming.

While global warming is most likely occurring, I view the degradation of our planet in plethora of ways and the over consumption of our finite resources a more pressing concern. Yet, as there are billions of humans who have as much right as me to a nice house and high protein meals I’m not sure how I can try to impose limit our rapacious desires. So for now I’ll continue to cycle or walk instead of drive as often as I can, use cloth bags instead of plastic for shopping, eat at least one vegetarian meal a week and teach my kids to consume less. Pathetic I know, and yet sadly it’s more than most.

Is Anteo Diagnostics the hottest ASX company?

Long ago, Keynes argued that the “central principle of investment is to go contrary to general opinion, on the grounds that, if everyone is agreed about its merits, the investment is inevitably too dear and therefore unattractive.” This powerful statement of the need for contrarianism is frequently ignored, with disturbing alacrity, by many investors. James Montier June 2011 GMO White Paper

There is little doubt that ‘everyone’ is agreed about the merits of Anteo Diagnostics (ASX: ADO) and its wondrous universal glue Mix&Go. Feckless ADO ramping posts on investment forum — and I use that term very loosely — Hot Copper garner so many positive recommendations that for now it seems investors can’t even think about any other ASX listed company. The image below is not from the ADO board on HC, rather it’s the top posts across the entire forum.

anteo diagnostics ado speculative bubble

I highlighted Anteo’s potential back in early 2011 and from a high level perspective very little has changed since then, that is except the intensity of vociferous longs, oh and the price of course, which is now 4 times higher. In fact very little has changed since way back in 2010 when Stuart Roberts at Southern Cross Equities said “Two licensees – Bangs and Merck – have been secured and prospective licensees in multi-billion dollar markets are showing interest.

anteo diagnostics ado speculative bubble chart

Yes deals do seem closer now than they have ever before. Perhaps Anteo will close two substantial deals this year and earn royalties of $20 million or more in 2015. Based on Anteo’s current market cap it’s trading at the fingers crossed possibility of 11 times 2015 sales. As Mix&Go is little more than a very clever glue that can be mixed up in someones backyard it will have high margins, let’s say 50 percent net margins. That gives Anteo a forward hopeful price to earnings multiple of 23.

While both those multiples are high, they are not outrageously so. Unfortunately there is a reasonable chance revenue and earnings will fall well short of those targets. And therein lies my concern. Everyone on the overcrowded Anteo boat are focusing on the upside potential without considering that the vast majority of speculative companies fail.

As Peter Lynch advised in One Up On Wall Street, hot stocks are best avoided.

If I could avoid a single stock it would be the one in the hottest industry, the one that gets the most publicity, the one that every investor hears about it in the car pool or on the commuter train, and — succumbing to the social pressure — often buys,” writes Lynch. “Hot stocks can go up fast, usually out of sight of any of the known landmarks of value, but since there’s nothing but hope and thin air to support them, they fall just as quickly,” he continues.

Second, avoid the stocks of companies that have been singled out as the next big thing: the next Google, the next Apple, the next Disney. “In my experience the next of something never is – on Broadway, the best-seller list, the National Basketball Association, or Wall Street,” writes Lynch. “In fact, when people tout a stock as the next something, it often marks the end of prosperity not only for the imitator but also for the original to which it is being compared.”  via Forbes

Flavor Flav of Public Enemy said it all in four simple words “Don’t believe the hype“.

Make no mistake Anteo is speculative. While I like and respect Anteo’s chief cheerleader Matt Sanderson I was gobsmacked by this exchange we had on twitter.

anteo speculative vs knowledge

I do appreciate the tremendous effort Matt has put in to analysing Anteo, but he seems to have imbibed to much kool-aid. No amount of research improves the odds of a speculative investment turning out favourably. Research does improve your odds of picking a winner, but from there it’s predominately luck. And certainly no amount of knowledge moves a stock from speculative to safe.

The other dangerous point about Matt’s comment is that most investors perform the majority of their research once they’re already long. Worse yet, that research is predominately to confirm their hypothesis. A speculative investor’s time would be be better spent trying to disprove their analysis. Either way no amount of post-investing research will improve the odds.

Another issue I have with Matt’s comments is that if Anteo delivers on all its promise, the retail longs will put it down to their skill, when as with all speculative investments luck plays the largest role.

I’m long Anteo but believe many investors would be best served by taking a bath on this speculative play rather than walking away victorious. It’s better to learn a good lesson early in your investment career than make a few lucky dollars and learn nothing. As Bill Gates said “success is a lousy teacher. It seduces smart people into thinking they can’t lose.”

I do believe there is room in a well balanced portfolio for speculative companies. But like all investments be they speculative or not, they must be bought when the expected value is considerably higher than the current price. That boat has sailed for Anteo.

Expected Value: “Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we’re trying to do. It’s imperfect, but that’s what it’s all about.” Buffett from the 1989 Berkshire Hathaway Annual Meeting via the brilliant PM Jar.

[Update 27 March: Perhaps the following song is more appropriate for Anteo. What do you think? At any rate, fabulous song and video.

Ha ha ha
Pump it
Ha ha ha
And pump it (louder)
And pump it (louder)
And pump it (louder)
And pump it (louder)
Turn up the Anteo

Disclosure: Long ADO

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