Luna Rossa Prada Pirelli AC75 and Emirates Team New Zealand AC75 Te Rehutai during practice racing on the Hauraki Gulf. Photo / Dean Purcell
By the eleventh race of the America’s Cup in San Francisco in September 2013 Team New Zealand was up 8-1 with only one race needed to win. The cup was seemingly in the bag.
In the week leading up to this dramatic scoreline media coverage increased dramatically as New Zealanders smelt a victory and interest in the regatta rapidly grew.
Suddenly there were news stories about the superpowers of the Team New Zealand crew.
Dr Brett Howes told the America’s Cup website about Dean Barker’s superhuman “vision memory” that allowed him to process visual information better than most normal humans.
Team New Zealand tactician Glenn Ashby was a master strategist and tactician on the water that could do no wrong and got every decision perfectly right.
Then, over the rest period, Oracle, who had been behind on their optimisation programme because of an earlier capsize, found another gear on their boat. When it returned to the water it was visibly faster up wind. Oracle’s boat went on to win the following eight races and retain the Cup.
It was a very painful reminder that the America’s Cup is not really about the sailors. The fastest boat wins. The sailors must be professionals to even be able to sail the boats. But a faster boat will make a sailor look like a rooster and the sailors in the losing team will be considered for feather dusters.
The investment industry can have a similar look. Gurus are often quoted in the paper with seemingly superhuman investment vision. In our opinion there are no investment gurus. What makes them look like gurus is the investment boat they happen to be sailing on. In the investment world your boat is your philosophy, the principles you use to invest by.
Like sailing, most importantly, your boat needs to be strong enough to get you to your destination. Only then should you consider how to get there quickly. The importance of this was demonstrated by another painful America’s Cup lesson for New Zealand.
In 2003 Team New Zealand failed to defend the America’s Cup following the surprise departure of Russell Coutts, Brad Butterworth and some other key Team New Zealand members to Alinghi.
It appears the Team New Zealand design team tried to compensate for this loss of personnel by making a boat that was very light, possibly betting on the fact that the America’s Cup would be sailed in February when winds were normally much lighter than the challenger series. Unfortunately winds in February were stronger than normal and the Team New Zealand boat broke up.
In the investment world, Long-Term Capital Management spectacularly collapsed in 1998. Members of Long-Term Capital Management’s board of directors included Myron S. Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences.
Long-Term Capital Management was a hedge fund that used absolute return trading strategies combined with high financial leverage.
Because of the guru status of the founders, it was able to raise large sums of money, to the extent that there were fears about the financial stability of financial markets following its collapse. Long-Term Capital’s boat was not strong enough for the freak winds that passed through markets that year.
Once you have designed your boat you need to have a disciplined process in place to optimise it. In the America’s Cup this might be the fully choreographed way that the team moves from one side of the boat to the other. In investments it is the processes and disciplines you put in place to ensure that you adhere to your investment philosophies.
So why have a professional crew at all? It is still handy to have smart people at the helm of a good boat. Passive investing, for example, is a bit like sailing a boat on autopilot. It will save some money by not having to pay for a professional crew and nine times out of 10 you will probably get to your destination roughly the same time as everyone else, but do you really want to be on that boat as it heads blindly through the eye of a storm?
In our opinion a successful investment philosophy in equities needs three key principles:
• Take long-term perspective – don’t worry about short term price movements.
• Avoid investments that could result in total loss of capital – be wary of leverage.
• Have a large margin of safety between what you are paying and what you think the company will be worth in the long run.
This is not rocket science. They are the core principals used by many successful previous investors such has Warren Buffett. In fact, Buffett in an entertaining coin flipping speech noted how a high proportion of his early investment colleagues had become very successful. They were all sailing the same boat (or “intellectual village” according to Buffett) skippered by Benjamin Graham.
These principles are simple, but they don’t make investing easy. Probably the hardest thing in sailing and investment is sticking to your philosophy and processes when the winds are not in your favour.
And there will be times when the winds are not. We are tempted every day by volatile price movements and media stories that attempt to find reasons for quick successes and failure when the real reason is just the short-term vagaries of the market winds.
You need to be able to stick to your investment principles even when you are behind if it is due to the conditions being temporarily unfavourable. It can be emotionally difficult at times and that is when having a good boat helps.
Just don’t believe the crew are gurus.
– Richard Stubbs is a co-founder of Castle Point.
Disclaimer: The following commentaries represent only the opinions of the authors. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement or inducement to invest. All material presented is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without prior notice. Castle Point may or may not have investments in any of the securities mentioned.