Scottish novelist Walter Scott once mused:
What is a diary as a rule? A document useful to the person who keeps it. Dull to the contemporary who reads it and invaluable to the student, centuries afterwards, who treasures it.
To publicly invest sums of money -- and detail your theses for those to judge -- is akin to keeping a very public diary. And for the past four years, I've done just that in my Real Money Portfolio. It is with some regret, therefore, that today, I'm writing to announce that I'll be closing the portfolio.
It's not that I want to; instead, my responsibilities have become too much to manage it. I was recently named Co-Advisor (or co-lead) of The Motley Fool UK's flagship portfolio product, Champion Shares PRO, and have taken expanded responsibilities as Senior Analyst on Million Dollar Portfolio.
With all this, I figured the diary-esque qualities of my portfolio's creation and ongoing investment process offer an opportunity to reflect on my performance, lessons learned, and notable successes and failures. So, anchors away.
The long and short: Performance
On its face, you might argue that my portfolio is an abject failure: The headline reads 52% versus 83% for the S&P 500. And certainly, I'd prefer it were different, but I'd also argue that the headline is a tad deceiving.
Part of it is my own doing. I dragged my feet investing cash balances near the market's nadir in 2010 and early 2011. But part of it is also due to the idiosyncratic elements of performance measurement on an institutional basis. Where my portfolio's performance is compared to the S&P 500 from the date of inception, in November 2010, I received cash contributions to my portfolio on an ongoing and continuous basis, and invested money at intervals across this horizon -- making it an apples to oranges comparison. That's not an excuse as much as reality.
An alternative performance measurement method gives a bit of perspective -- measuring each pick's performance against the S&P from the date of each investment. As an example, I recommended investing in Asbury Automotive (NYSE:ABG) on 12/31/11. How did it perform relative to the S&P from that date?
Viewed in this context, the results are a bit different. The average pick returned a 55% total return versus 39% for the S&P 500. (Note: Returns are not audited, include dividends, and are as of 9/4/14. Data is from Capital IQ.) By that measure, I don't think I've done anyone a disservice. I've also been lucky to invest during a period when the market afforded a large number of outstanding businesses at stellar values.
Lessons learned, or reinforced
That being said, a few lessons also stick out. In no particular order, they follow.
1. Understand thyself
Many investors attempt to engineer an investment philosophy around the flavor of the day, or by adopting the mentality and mannerisms of those around them. That, I'd argue, is a recipe for failed investments.
Instead, investors should understand their personal proclivities, strengths, weaknesses, and psychological tics; examine the habits and practices of successful and empirical research; and develop an investment philosophy that marries all of the above. Humans, as a lot, are quite adept at making the same mistakes. Taking inventory of these, and attempting to develop intellectual models (and an investment strategy) that condition against them, minimizes the risk of these errors in the long run.
2. Of moats and statistics
In a general sense, capitalism works. A subset of companies can generate high returns on capital for a short time. But absent a moat, a unique set of capacities enabling reliable cash generation, most good things are not sustainable for extended periods -- because they attract competition, which pushes returns lower.
That's not to say business is a zero-sum game, but statistically speaking, it's not probable that high returns persist. Likewise, seemingly cheap investments more often represent gypsy values -- the sort that pilfer your accounts -- than legitimate values. There's no measuring how quickly a troubled business's prospects can erode.
For my real money port, solidly underpinned moats contributed to meaty returns in short-line railroad RailAmerica, which ended up acquired by Genesee & Wyoming (NYSE: GWR) to the tune of a 135% return; contract research organization ICON (NASDAQ:ICLR), which returned 140%, 166%, and 226% across three purchases, as big pharma moved to consolidate CRO vendors to a select few possessing global reach; and auto dealer Asbury Automotive, which returned 289%, as it capitalized on a cyclical recovery and auto dealers' highly scalable models. I expect that more recent investments in PotashCorp and Oaktree Capital will do the same.
3. Management matters
While a savvy management team rarely conveys a moat in and of itself, there's no accounting for how quickly ill-incentivized, or otherwise stupid, managers can destroy value. Capital allocation matters a great deal. In that regard, I expect my investments in Markel (NYSE:MKL) and Sirius XM (NASDAQ:SIRI) to reliably compound value -- they're backed by managers whose incentives align with shareholders, and who possess decades-long records of value creation.
An example in my portfolio comes in Cimarex Energy (NYSE:XEC), a 141% returner in less than two years, which I, in part, attribute to its management's steady-as-she-goes, conservative mentality to capital allocation. Or consider WellPoint, a serially under-managed, but competitively advantaged, health insurer, which has flourished under new management and delivered a 99% return. Conversely, despite the fundamental quality of its business, I was somewhat lucky to escape my investment in Mac-Gray -- a family controlled laundromat-management franchise -- unscathed.
4. Avoid brands
One of my portfolio's most noteworthy failures -- of process and on returns -- was my investment in Weight Watchers, one that I compounded by doubling down. My purchases are off 45% and 37%, respectively. Though Weight Watchers isn't just a brand, to be fair, it's greater parts that than anything.
Changing fashions coupled with marketing missteps have contributed to its recent difficulties. Companies in which the cash-generating capacity is underpinned by a brand -- retail, restaurants, and fashion -- are continuously on notice. Brand alone is rarely a source of enduring competitive advantage unless it's married to some other unique capacity.
Companies engaged in transactional industries, whose returns rely on brand equity, must continuously scrounge for customer dollars in highly competitive, low-switching cost environments. Put differently: Be wary of anyone claiming El Pollo Loco is the next McDonald's.
5. Consolidation stories pay
When industries with fundamentally attractive economics undertake consolidation, particularly those operating in niche businesses with relatively high costs of entry, there's a recipe for prospectively outsized returns. Two examples of that: ICON intelligently acquiring smaller, niche competitors, thereby strengthening its offering on a holistic basis, and the containerboard industry's consolidation, led by Rock-Tenn and International Paper's acquisition of Smurfit Stone and Temple Inland, contributing to my two Rock-Tenn investments returning 46% and 59%. And for what it's worth, I think there's room to run for both.
With that, I bid you adieu, at least in the context of my Real Money Portfolio. But don't worry... I'll be around.
Michael Olsen, CFA owns shares of ICON plc (ADR), Markel, and Sirius XM Radio. The Motley Fool recommends Genesee & Wyoming, Markel, McDonald's, and WellPoint. The Motley Fool owns shares of Asbury Automotive Group, Cimarex Energy, ICON plc (ADR), Markel, Rock-Tenn Company, Sirius XM Radio, Weight Watchers International, and WellPoint. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.