Dodgeball

When I meet our investors and potential investors I often make the point that one of the facets of our approach that I am most proud of is our track record of keeping investors out of mischief. There are a number of different ways that investors can lose money. Some are risks that are inherent in investing such as having to convert a paper loss into an actual loss because you have to liquidate a holding which is underwater which would likely recover if given time. There are many other ways to lose client money which are permanent. These are often a result of careless strategy selection rather than market characteristics.

The irony is that there is no track record that we can point to that overtly shows the impact of avoiding stumbles. Rather the absence of these potential drags on returns are only evident from the good long terms returns we have delivered to clients which would be lower had we seen greater impairments of capital.

There are a number of different types of potential mishaps that exist for the unwitting, but generally they fit into one of three broad categories.

The first are liquidity mismatches. There are a lot of funds available that are daily dealing but many of these daily dealing funds buy illiquid assets within them. This is a clear risk that is manageable in normal times but if there is a rush for the door these funds turn into lobster pots – very easy to get into but devilishly difficult (and all too often impossible) to exit when you want to. If these strategies become forced sellers, investor losses can accumulate rapidly. Worse still, they may be ‘gated’ and it could be months before you get your money back (at a likely discount).

The second are na?ve investment theses. Many sound good on paper but even the most level headed back tests are the product of hindsight which may not fit the future as well as the past. Hedges are often imperfect, long term relationships can break down sporadically and ultimately there have been many smart investors undone by a heady mix of overconfidence and the perniciousness of markets. Remember David Viniar’s remark in 2007: “We were seeing things that were 25-standard deviation moves, several days in a row.” That’s so vanishingly close to meaning “impossible” that we can allow ourselves to paraphrase it as such. Improbable is not the same as impossible, sadly. The usual suspects that can lead to a strategy coming unstuck include leverage, poor risk controls, mark to model, regulatory or tax changes and so on.

The third is malign intent. Rarely is this patently obvious, of course, but there have been a number of instances where we have recommended our investors steer clear of strategies that didn’t ‘smell right’. If something appears too good to be true, or too mind-bendingly difficult to comprehend or so opaque that it is difficult to fathom, we tend to walk away.

Our process is not infallible, and this article tempts fate, but over the years by doing very detailed research, being savvy and unafraid to ask simple questions we have saved our investors literally tens millions of dollars, if not more and, while far less glamorous than stellar gains, avoiding permanent losses is actually very rewarding indeed. Unfortunately, you’ll have to take my word for it. 

James Klempster, CFA