“Always be short extremity”

It’s been a few months now, and in my mind I’ve been roughly building out an approach to investing both in and out of a crisis.

Today I’m going to try and bring together what I’ve written so far. You can almost think of it as a quarterly report of sorts – linking together themes I’ve covered so far and maybe checking in on a couple of past predictions.

In many ways, one of the ideas I’ve been trying to foster is that investing is fascinating and mysterious, and worthy of more than just financial interest.

This Friday will be my second book review – first was The Zulu Principle by Jim Slater – and I’m just coming to the end of Capital Returns, so I’ll take a look at that next.

It’s something I want to try and do once a month maybe, because reading good investment books is something I love doing, and would recommend highly. So the books reviews are there to encourage you to read them yourselves.

Also, because I realise that’s not up everyone’s street, the reviews will hopefully provide a summary of a few investment books, for those who don’t want to read the whole thing themselves.

But the intellectual aspect of investing is certainly something I love, and have been trying to share with you.

Ever since I was young, I was fascinated by the idea of investment psychology. I loved the idea that there were two levels to picking stocks – is it a good company, and do people correctly understand it.

It’s not just maths, it’s an art and a science too. Sometimes the financial and economic side should reign supreme, and sometimes you should focus your intention on what investors are thinking, doing, and expecting.

That second level of thinking is one of the most interesting and challenging endeavours I have ever come across, and combined they make investment the most interesting lens through which to view the world.

Investing is all encompassing. I like to compare it to history in that way. You can be as broad or specific as you like, there are bits you find interesting, and bits you find boring. It’s endless, eternal, and there are no right answers – just better and worse arguments.

They are essentially studies of human nature and activity over time, and there’s something in it for everyone. Maybe you just like historical dramas on tv, or The Big Short, or maybe you want to do a masters in medieval gender relations, or the possible impacts of negative interest rates.

The addictive aspect of investing, which history cannot provide though, is money. It gives us the opportunity to make money, in so many different ways. The financial aspect also provides the main measurement of success, though perhaps not the only one.

An Ode to Balance

In investing, as in most fields of life, I believe in balance.

In politics, I reject extremism both of the left and the right. In cricket, batsmen, bowlers and captains want to balance attack and defence. It’s bad to eat too much (I am told that diabetes (read: obesity) has one of the biggest impacts on coronavirus mortality in the UK), but it’s also bad to eat too little. Some people want to exercise a bit, some want to run ultramarathons. I wouldn’t like to never drink alcohol, but nor do I want alcohol to consume my life by drinking too much.

That balance changes depending on the individual, the time, the situation, but, in any case in almost any realm, I believe in gently meandering around a point of balance.

In this newsletter and in investment, this is most clearly apparent in my desire to build a portfolio around two key themes – attack and defence.

What could go right, and what could go wrong?

How can I make money, and how can I avoid losing it?

These questions should be readdressed on repeat every time you think about your investments.

And I don’t mean to say that I am trying to seek a universally balanced approach – each person’s will be different depending on their normal levels of optimism, fear, risk appetite, their life situation, age, number of dependents, time to retirement, financial buffer, income…

There is no prescription, and I think it’s part of the Southbank Investment Research essence that we believe you are your own best financial adviser, and we are simply doing our best to help equip you for that task.

That’s partly why I like the educational aspect of reading investment books, and why I want to show you how investing can be fascinating and exciting, regardless of the financial aspect.

Back to balance though – the balance between defence and attack has been roughly covered so far by gold, beaten-down stocks in the March crash, and by green energy.

I prefer equities to bonds in most cases, because historically they have outperformed in the long run. For full disclosure, I don’t know much about bonds. But last week I tried to push the idea that the almost universal acceptance of bonds as a defensive, safe, uncorrelated asset has changed that.

This is where my idea of balance comes in useful – the bond argument has been pushed to an extreme. The more people subscribe to that view, the less room it has to run. Perhaps that will be true of equities one day too, and the balance will shift back in favour of investing in bonds.

For now though, everyone buying into the idea of bonds being safe and good pushes their prices up and yields down, meaning you get higher volatility and lower annual return.

As with every idea in investment, there is such a thing as diminishing returns.

Early adopters of successful ideas see their competitive advantage eroded as people see success, study it and replicate it for their own ends.

It’s the same as in business. If a profitable new venture is discovered, capital is poured into it – new competitors, new businesses, business model, investments, etc, until competition has eroded your advantage and your margins. It’s the capital cycle, as old as society itself.

That’s also I want to avoid becoming wedded to a single investment idea – growth, value, or a single sector: energy. Better to be the reeds, resilient but buffeted by the wind, rather than the resistant oak, sturdy but ultimately fragile.

The investment process is a constant and unbiased search for value – value being assets that offer more value than people think they do, or will.

Look at restaurants, or Warren Buffett. Competition has grown and grown to the point where a competitive margin has either eroded profits, or forced innovation and change.

Buffett used to be a pure Benjamin Graham value investor, seeking bargains. Then he became a brand “goodwill” compounding guy, and now he’s basically a big cash pile with a great reputation who can therefore invest in huge distressed companies on phenomenal terms because no one else can or will. They are all linked, but subtly different, approaches to seeking value.

At Southbank Investment Research, we try to really focus on things which most institutions and mainstream financial commentators ignore – the energy transition is a good example, as is cryptocurrency, or gold. These are all now gaining traction, but years ago we were helping people to get ahead of the curve.

I say “we”, but let’s be honest, I wasn’t involved at all! I was just lucky enough to land on James’ team when I joined here, focusing on the energy transition which turns out to be the most exciting sector of investing I’ve found to date.

We have to wait until tomorrow to know what tomorrow will bring

The inherent unknowability of the future is another theme I’ve tried to draw out. It’s why I believe in balancing attack and defence – no matter how pessimistic or hopeful you feel.

If you truly realise you cannot know and bet successfully on the future, it allows you to focus more on where valuation and sentiments are today.

It allows you to be more systematic, and helps you to buy when others are growing more fearful, and to sell when others are more hopeful.

It also helps us to say “I don’t know” when faced with unknowable questions about what will happen next.

As Mark Twain’s opening quote for the film The Big Short attests,

“It ain’t what you don’t know that gets you into trouble, it’s what you know for sure that just ain’t so.”

That’s why I started to encourage calmness and even some buying as the March crash worsened. The more certain people became about a future they saw, the larger the opportunity to bet against it.

And as the rally accelerated, the same started to become true in reverse.

A rejection of the idea that we can see what tomorrow will bring helps us to study what is happening today. It blocks us from taking extreme positions based on exceptional forecasts of eternal growth or imminent disaster. It makes us hold gold, for the ghost of inflation or the erosion of fiat currency, but hold our energy transition stocks, while still seeing opportunity in massively oversold oil and gas stocks.

Always be short certainty…

… is a quote attributed to a wise friend of mine in a piece last week.

Over the weekend, I was thinking about all of this, about politics too, and about life.

I have been struggling to reconcile the fact that I opposed both the brutal crash and the soaring rally. It’s not straightforward warning of deep recession and a market crash, yet recommending energy transition growth stocks.

But in a slight adaptation of my friend’s quick quote, I think I have found a nice principle for life and investing.

Whether in politics, investment or life, my advice is to:

“Always be short extremism.”

I hope you have enjoyed the newsletter so far, and I’ll continue to colour in, and fill in the gaps of these broader investment principles.

Best wishes,

Kit Winder
Editor, UK Uncensored

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