Hi,
Perhaps the academics aren't crazy after all
Ed Croft over at Stockopedia wrote a piece about how the academics are all crazy and wrong and how beta isn't a measure of risk; essentially all the things that a lot of value investors say about the EMH and MPT approach to investing.
The general idea is that the volatility of a share's price isn't relevant as it's the intrinsic value of the business that we're looking at, and that's true. However, I have seen what share price volatility can do to investors and it isn't pretty. My opinion is that volatility is a measure of risk because it increases the risk that the investor will do something stupid.
I started thinking about how bull markets and irrational exuberance in the stock market (upside volatility) can make people lazy about saving and how they might start to think that the stock market is going to do all the donkey work for them of building a retirement (or education or speedboat) fund.
So I posted an article called 'how the stock market can affect your saving rate' which you can read here.
Somewhat overenthusiastically I then posted another article on the same day called 'risk is a three legged beast' which covers briefly how the often theoretically irrelevant market risk is in practical terms not irrelevant at all. Not because in itself it represents risk but because it makes investors do the wrong thing at the wrong time. You can read that article here.
This got me on to thinking about how other people view market risk and I came across an interesting academic called Zvi Bodie. What makes Zvi interesting is that his approach to investing for the layman starts with a zero risk approach. Effectively he says that the starting point for thinking about investing, and often the end point for a lot of people, is to invest in inflation linked government bonds.
This is as close to zero risk as you're going to get (ignoring the risk of sovereign default anyway). It has many interesting implications, not least of which is that it becomes incredibly easy to make a savings plan in order to reach your goal.
Although we don't have inflation linked bonds in the UK that have a positive real return (Zvi mentions iBonds or TIPS in the US that have around a 2% real return) the assumption of 2% real returns in your savings calculations seems like a reasonable minimum case.
If you took that approach then it immediately makes the act of saving the main focus rather than getting super returns from the stock market. If you do get super returns then they are a bonus but you're not relying on them to get a comfortable retirement (or a good education for the kids or a fast speedboat).
Zvi's web site is here and he's got a book called 'worry free investing' as a real book or PDF download. It has certainly re-focused my attention on the need to save well now to live well later.
Enough theory, how about some investment ideas
The week wasn't just full of theoretical blurb. I did manage to highlight Flybe, the leading regional airline which I think is an interesting small-cap, low debt and low price to tangible book idea.
You can read the article on Flybe here.
And now that it's reporting time for a lot of companies the task of re-valuing them has become a major one. I don't like to invest where I have to keep a close eye on the company. I'm after big, stable and mature firms that have market leading positions and are very likely to out-live me. I don't want to read the news every day because most of it is irrelevant fluff anyway.
Instead I take a long view and just re-value my investments yearly (although I do read interim results and interim management statements and also just about anything else the companies put out… but it's all pretty much a skim read other than the annual report).
I posted an article about BAE now that the results are out and I am an owner. The process is pretty simple. Basically I look for big and obvious reasons why the intrinsic value of the company may be damaged. If I can't see any (which I can't for BAE) I turn to my trusty long term fundamental metrics and re-calculate them.
For BAE my estimate of its intrinsic value has gone up by about 7% so I'm not selling yet and you can read that post here.
Findings from around the web
I mentioned the method of time-arbitrage in one article which a reader commented on asking for more info. A good overview of the benefits of a long time horizon is this document from Brightworth (a wealth management firm). The PDF download is here.
Another good document which I've added to the books page on my site is 'Seven sins of fund management' by the closest thing I have to an investment hero, James Montier. As usual James pulls apart the idea that we can forecast the future or gain an investment edge by knowing everything there is to know about a company in this 100 page booklet. If you want a great introduction to the human foibles in investing you could do much worse than start here (PDF download).
And finally…
I don't have any violin playing cat videos for my 'and finally' section, but I do have a couple of links to interesting videos relating to physics (something about which I know very little but find fascinating anyway).
Good old Richard Dawkins and Lawrence Krauss have done a few videos (and a book from Krauss) on the subject of 'something from nothing', which has come about as part of the Arizona State University's Origins Project.
It's interesting because it gets at the idea of why is there something rather than nothing, which is a pretty big question. For Krauss it's about why the universe exists rather than doesn't exist and for Dawkins it's about why there is life rather than no life.
Krauss is a great speaker so here's a video of him covering the universal something from nothing question (click here to view on youtube). Or you could do something hi-tech and watch in on your digital media hub on the TV.
Or if you have a couple of hours to spare there's an on-stage conversation between the two covering origins of all sorts of life/universe things (click here to view, there's a high definition version as well).
Don't forget you can reply to this email to speak to me and you can trial my Defensive Value Report newsletter for 60 days here.
Have a good weekend
John
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