A letter a day!

A letter a day!

Letter #05 2005

1.It is a constant feature of the investment landscape that people applaud recent gains when they should be thinking more about the future.

2.Following what everyone else is doing may be hard to resist, but it is also unlikely to be associated with good investment results.

3.What is your competitive advantage in investing?

There are three competitive advantages in investing:

1)Informational (I know a meaningful fact nobody else does);
2)Analytical (I have cut up the public information to arrive at a superior conclusion) and
3)Psychological (that is to say, behavioral).

“Sustainable competitive advantages are usually a product of analytical and or psychological factors, and the overwhelming advantage with regard to Nomad is the patience of the investor base and the alignment of that disposition with the analytical and psychological traits of your manager. It simply would not work otherwise. In the investment objective section of the Nomad prospectus, we say that our job is to “pass custody [of your investment] over at the right price and to the right people” and that “the approach will require patience”. That’s what investing is, at least for us.”

4.What you are trying to do as an investor is exploit the fact that fewer things will happen than can happen.

5.Robustness ratio: The robustness ratio is a framework we use to help think about the size of the moat around a company. It is the amount of money a customer saves compared to the amount earned by shareholders. This ratio is more appropriate for some companies than others, the prime criteria being that the customer proposition is based on price.

“In the Berkshire Hathaway annual report this year, the Chairman tells us that Geico policyholders saved U$1bn on their policies compared to the next cheapest carrier. It also turns out that Geico earned around U$1bn as well. So that’s one dollar saving to the customers and one dollar retained for shareholders.”

6.As a fund manager, always focus on the performance of the fund rather than the fund size.

Several hundred million dollars could have been invested in each of Costco (US), New World Developments (Hong Kong), Amazon.com (US), Telewest (UK) and Liberty Media (Europe and Japan). But as each idea came one at a time, with a lag in between, we were reluctant to open the Partnership for the sake of one new idea. We erred on the side of investment performance rather than maximizing fund size. I know this is not how the industry thinks and behaves, but at Nomad we see our job as running an investment partnership first and commercial enterprise second.

7.Sources of mis judgment:

1)Doing what the crowd does rather than thinking independently.

2)Availability of the evidence and over weighing on the same.

Looking around you is the most important skill, and is largely innate, although Professor John Stilgoe at Harvard is trying to teach it and wrote an interesting book recently entitled “Outside Lies Magic”. In the markets, investors tend to latch on to what can be measured, aided by the accountants and to some extent by their own laziness. But there is a wealth of information in items expensed by accountants, such as advertising, marketing and research and development, or in items auditors ignore entirely such as product integrity, product life cycles, market share and management character (this is not an exhaustive list!).

3)Inability to perform probability-based thinking.

Understanding the value of a company involves assessing the likely outcomes given management behavior and competitive forces and weighing the probable. outcomes in a valuation. So, an inability to arrange outcomes in probabilities is a considerable error causing bias in investors decision making processes and is behind many mis- valuations.

4)Lack of patience.

In the beginning of the annual general meeting of the Berkshire Hathaway Company they show a video in which Buffett is asked what the main difference between and himself the average investor is, and he answers “patience”. There is so little of it about these days: has anyone heard of getting rich slowly? Jack Bogle, founder of the Vanguard Group, claims that the holding period for stocks is down to 10 months and the average mutual fund is held for 2 years.