Monday, November 3, 2014

Investing in (insert your favourite investment / asset class) for the LONG TERM

For me, one of the things that irritates me a lot about the whole finance industry is when people mix up and confuse investing and trading. If you don't know the difference yourself, then you are probably doing one of them wrong. To me, the main distinction is investment horizon. A trader is short-term while the investor is long-term.

Very interestingly, I came across a part of the Research Affiliates website which has very nice graphics and information regarding their 10-year real expected return forecast of different asset classes. Give the page a click-through, I think it is very interesting to get an insight into the minds of smart quants.

GMO also releases their forecast for some asset classes as well, but theirs is the 7-year returns, not 10-years. Perhaps you can look at US small cap and large caps of both tables and see why I really don't like the US markets.

However, the main thing that I want to share is the RA Investment Beliefs (pdf version):

1. Investor preferences are broader than risk and return. 
People do not rationally make investment decisions most of the time. Many behavourial bias set in and distorts their choices.

2. Prices vary around fair value. 
While prices can deviate from it's "fair value" over the short-run, it will not be able to deviate too far and will bounce around it's "fair value".

3. Lack of conviction (and/or internal governance constraints) restrict/prohibit investors from exploiting long-term value.
Many people rather fail conventionally than to succeed unconventionally. Managers and professionals face career risks and mandates that forces them into choosing certain (unwise) choices, while individuals face ridicule and loneliness adopting an investment style different from the rest.

Conclusion: The largest and most persistent active investment opportunity is long-horizon mean reversion.

Their strategy is to simply buy low, and sell high, or even at fair-value. Figure out what is cheap and buy it. Figure out what you have that is expensive or fair-valued, then consider selling it. Wash, rinse, repeat.

This brings me to the second thing that irritates me about the finance industry: There are some people that say that REITs, dividend stocks, blue chips, equities or gold are the BEST investment ALL the time. They are feeding you bulls**t.

There is time and price to buy and sell for everything. People might have been loading up on tech stocks during the dotcom peak, but hey, there are stupid people in this world too. People can engage in buying and holding whatever investment they like, but they should know the short-comings of their investment and strategy. They might be trading simplicity for volatility and the opportunity cost of not selling high, and re-entering at a much better price, but with more units.

No matter how good and fantastic the underlying investment is, there is a price when it is just stupid and ridiculous to own it. A Ferrari is sure as heck a nice car, but for $5 million bucks, you can just leave it in the showroom and let it collect dust and rust. If you can nod your head to that, now flip that table around. 

No matter how shitty and crappy the underlying investment is, there is a price when it is just so irresistible and tempting to own it. A Chery QQ selling for $500 bucks is a steal no matter how you cut it. Even if it's a crappy car and rattles when you drive it over 60km/h, you still can sell it for its parts and make money off it.

Everyone has their own investment style, beliefs and strategy. Buying and holding isn't wrong. Dollar cost averaging isn't wrong either. Buying only gold and keeping it under your pillow isn't wrong too. (naw, I'm kidding, this is probably wrong!) However, you have to know what is it about your investments and strategy that allows you to make money.

For me, I choose to believe that there is no single investment that will give you the holy grail. The answer is not REITs, it is not dividend stocks, it is not ETFs and it sure as hell isn't gold. Instead, my holy grail is a process. It is the process of systematically identifying what is cheap so you can buy it, and what is expensive so you can sell it if you own it, or avoid it if you don't.

Don't get me wrong. You can invest in the STI ETF only for your whole life and end up with a nice nest egg. However, I'm not satisfied with just mediocre. If I was, I would just log in to DBS ibanking right now and sign up for POSB Invest-Saver and be done with investing for the rest of my life.

That's what we all want isn't it? That's why we put in so much time and effort into investing, right? If our returns are not going to beat an index, then boy are we stupid for wasting so much time doing something that a person with no knowledge can beat us at. 

What do we want at the end of the day from investing? Enlightenment about the financial markets and how they work? Oh please, if you're not in it for the money, maybe you're playing the wrong game.


  1. Hi GMGH,

    Thank you for the sharing. On introspection, I guess I am all overweight in equities. And I can find all sorts of excuses for myself. Not keen on commodities as they earn zero yields. Not interested in active funds since they charge exorbitant fees. Properties? Out of the question due to high capital commitment. And bonds with their I-spreads, G-spreads and Z-spreads are out of my realm of expertise.

    Incidentally, Research Affiliates is a company I admire. They are the pioneer in smart beta strategies. Their founder, Rob Arnott advocated a way of allocating portfolio weights according to the 'fundamental footprint' of a company. This means assigning higher weights to companies which are better off fundamentally. I am attempting to practise this approach in my own portfolio allocation. :)

    1. Hi S-Reit System Investor,

      No problem! I am a fan of your REIT analysis :)

      Overweight equities itself is not a problem, as long as you have a sound strategy and stick to it. I agree with what you said, venturing into the unknown purely for the sake of "diversification" is not the correct answer because you'd be assuming risks that you might not know the ramifications of!

      I respect Rob Arnott deeply and I am a fan of his RAFI indices! I read a while back that his big picture opinion is low growth and low rates in DM for quite a while, with his preference to EM equities.

  2. Hi GMGH

    I sense some fire there in your post :)

    Sharpe ratio does indeed provide a good overall gauge of risk adjusted return and it appears that these asset classes do perform in different economic environment. So nothing is the best in a single go, it depends on which century we are living right now.

    1. Hi B,

      It is the fire of passion! Haha!

      I think within the local blogosphere, yield stocks are often touted as the secret weapon. I also have a strong preference for them, but I do not think that they are always the solution.

      Like you said, nothing is the best in a single go, it really depends on the prevailing environment and circumstances. Yesterday it could've be the US stock market, tomorrow it might be cash!

  3. Got Money Got Honey,

    Impressive. For someone so young, your knowledge (you yourself will know whether you can turn that into practice) is more complete than some many years older ;)

    "There is time and price to buy and sell for everything."

    "It is the process of systematically identifying what is cheap so you can buy it, and what is expensive so you can sell it if you own it, or avoid it if you don't."

    If you are comfortable with shorting (flying with both wings), you can short those that are expensive; and not just avoiding it. Don't waste but profit from that active research!

    Have fun!

    1. Hi SMOL,

      Thanks for your kind words, it's always nice to hear from the vets who have been doing this much longer!

      Shorting is very scary these days, especially when broad indices like the Nikkei can surge 8% on a single day! I vaguely remember a story by I think Jim Rogers. Early on in his career, he identified a few stocks that seemed horrible to him, so he shorted all of them. They all went to zero, but not before going even higher and squeezing him out first! The markets can stay irrational longer than we can stay solvent, so must short quite accurately!

      I'm still very fresh and lacking experience, but hopefully next time go long or short or upside down also can make money, hahaha!

  4. Give spread trading a shot, if you feel you have what it takes to short expensive shit, like SMOL suggested. Pair trades, very popular among hedge funds.


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