Bookworm: Is this the secret to exceptional long-term returns?
Acceptance may be an investor’s best friend.
Welcome to Bookworm, where I explores insights from books and other writing that I think can help investors. Each edition falls under one of three core principles: Owning high quality assets, fostering a long-term mindset and putting process over emotion.
Today’s insight falls under putting process over emotion – and it channels the wisdom and experience of a true value investing OG.
From the Bronx to the bourse
Marty Whitman was born in the Bronx in New York in 1924 and lived until he was 93. He is famous for co-founding the successful value investing house Third Avenue and for writing The Aggressive Conservative Investor.
Reuters’ obituary credits Whitman with 11% per year returns from the inception of Third Avenue’s value fund in 1990 to when he stepped back in 2012. This compared to a 9% per year return from the S&P 500.
Given the long period of time, that is an impressive level of outperformance. Today’s insight concerns something that I noticed while reading a collection of Whitman’s writing to his investors called Dear Fellow Shareholders.
A remarkably consistent approach
The collection includes a 1984 proxy statement filed by Whitman before he even established Third Avenue. In it, Whitman outlined the following basic criteria for investing in common stocks:
“1. Strong financial position. 2. Responsible management and control groups, especially in terms of their apparent recognition of the rights of outside shareholders 3. Availability of financial and related information 4. Availability at a market price which management believes is below its estimate of net asset value.”
Fast forward to April 2013 and Whitman had stepped back from making investment decisions at Third Avenue. Nonetheless, he included the following list of investing criteria in a note titled “Characteristics of Long Term Investing”:
- The issuer has as especially strong financial position.
- The common stock is selling at prices that reflect at least a 20% discount from readily ascertainable Net Asset Value (NAV) as of the latest balance sheet date.
- There is comprehensive disclosure including reliable audited financial statements; and the common stock trades in markets where regulations provide substantial protections for Outside Passive Minority Investors (OPMI).
- The prospects seem good that over the next three-to-seven years NAV will be increasing by not less than 10% compounded annually after adding back dividends.
Yes, some of the basic criteria were refined and others were added. But the consistency – shown by several other mentions of similar criteria in his writing in the decades between these examples – always strikes me.
Whitman honed an approach to investing that he was comfortable taking and that he thought could be successful. And he stuck to it for over 30 years. Despite there being many periods, I’m sure, where other approaches were reaping better short-term results.
This brings us to something that I think a lot of investors with exceptional long-term track records have in common.
The secret to exceptional long-term returns?
The quality I am referring to here is acceptance. Acceptance that your portfolio can’t possibly outperform the market and other investors all the time. And an acceptance that you can’t always own the market’s best performing investments.
In his letters to investors, Whitman often referred to targeting returns that were “good enough” as opposed than trying to “consistently or continuously beat the benchmark and/or a peer group”. The latter, he said, was impossible and counterproductive.
Warren Buffett also used to be very upfront that results could and would lag the market at times. More specifically, he used to warn that his approach would probably underperform during bull markets.
Both cases might look like an attempt to temper investor expectations. But I think there’s more to it. I think that Buffett and Whitman both realised that being oblivious to short-term performance could provide a crucial edge over the long-term.
One reason for this is that wonderful long-term investments can pass a short-term focused investor by. They are too scared of negative momentum and - for the sake of their track record - want to be assured that they have picked the bottom.
Another is that ignoring short-term performance can protect an investor from the perils of chasing it. Time and time again, we see evidence that optimising for short-term results is the surest way to harm your results over the long-run.
Instead of keeping up or getting ahead, such an approach is more likely to end up with you buying near the top or selling near the bottom. It also pushes investors towards crowded trades that are unlikely to offer good or even fair value.
Easier said than done?
The obvious downside here is that ignoring short-term performance is hard. We are human beings. And we are all prone to fear, excitement, envy and FOMO influencing our actions in financial markets.
I know this better than most. When I reviewed my year of investing in 2021 for an article that I wrote last year, I couldn’t believe some of the crap I had bought in the name of trying to match the returns that less price conscious investors were getting.
When it comes to avoiding this in the future, I am hoping to take a leaf from Whitman’s book. I want to be very clear on what I am trying to achieve and not trying to achieve. And I want to be equally clear – and specific – on what approach I will take to get there.
For more on forming a deliberate approach to investing, try this step-by-step guide to devising an investment strategy by Mark LaMonica. You can also read my thoughts on embracing short-term discomfort to gain an investing edge here.
Previously on Bookworm:
