Commandment 8: Investment Selection
This is the eighth of a ten part series where we look at Haven’s Ten Commandments, a short list of investing fundamentals we like to teach to our clients. It’s nothing too fancy, but a good foundation we believe everyone should understand.
In our previous discussions we’ve established that according to Dr David Swensen, asset allocation accounts for 90% of our overall portfolio performance. We also talked about how timing and rebalancing account for about 5%. It doesn’t take a mathematics PhD to determine there’s still 5% missing. What might that be? It’s our “Investment Selection”
If you haven’t already noticed, there’s an entire hoard of different investment strategies. Just like there are a lot of permutations and combinations available to complete any task.
Maybe it’s because I like math, but the way I think about it, is quite simply, how does one get the number 9? You could add 1+1+1+1+1+1+1+1+1=9, multiply 3x3=9, or add 4+5=9, and so on and so on. There’s a lot of ways anyone could complete any given task, and that includes investing. Just like getting to 9, there are more efficient ways than others, multiplying is more efficient than adding. There’s not necessarily a right and a wrong way, but there are ways more efficient or effective than others.
Warren Buffett, who is today’s most famous and successful investor had long ago adopted the strategy of ‘fundamental value investing’. Value investing is the practice of finding out what a company is actually worth. You combine variables like: assets, debts, revenue, industry and outlook to put a valuation on the company. By multiplying the current share price by the number of shares you get the market capitalization, or in other words, “the value the market has placed on the company”. If you think a company is worth more than its market cap, you would expect its share price to eventually go up — signalling it could be a good time to buy. If you find a company isn’t worth its market cap, this could be a signal that it’s time to sell or a poor time to buy.
Common sense economics states that the market cap should always reflect what a company is worth, but in truth it rarely does, and that’s how bubbles are formed. Bubbles are those exponential increases in value without any rational basis to support the price. Mostly it’s excitement over a new industry or technology (DotCom bubble, cryptocurrency, weed stocks, etc.) that causes shares to skyrocket without any real underlying value.
Other less publicized strategies include: dividend investing (investing in companies that offer regular high yielding dividends and reinvesting into the company), size (investing in smaller, riskier companies that can offer higher returns), momentum (investing in the latest hot stocks and emerging markets to capture quick growth), amongst countless others.
There’s no necessarily right and wrong way to invest, but there are ways to invest that are more proven or backed by statistical proof. By being able to specialize in one or more of these strategies allows you to be in a position that will help you squeeze the most out of your investments. Again, the benefits of nailing your selection over your investment lifetime is small in relative to the impact of asset allocation, but getting the selection right affords us an advantageous position. It is essentially putting ourselves in a position to get the best return possible.
Haven works with some of the industries most talented portfolio managers to give our clients their best investment options from the start. We have access to passive and actively managed portfolios that allow us to perfectly fit our clients needs and wants.
If you have any questions about selection and factors, investing in general or learning about how Haven can help you, please don’t hesitate to contact us.