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Can Factor-Based Investing Outperform The Market?

Factor-based investing is an approach that involves investing in stocks that exhibit a few or just one particular characteristic.

These characteristics could be value, quality, or size “factors” to name a few. For example, an investment approach based on the value factor will involve investing in stocks that trade at a relative discount to their peers, be it on a low price-to-earnings (PE) or price-to-book (PB) ratio.

Does factor-investing work?

The idea behind factor-based investing is that the factors that shape the investing approach should be highly correlated with positive investment returns. For instance, back-testing has shown that stocks that exhibit a low PE ratio have over the long-run outperformed the broader market.

Therefore, exposing your portfolio to stocks that exhibit these characteristics will, in theory, reward you over time.

Sieving the wheat from the chaff

But not all factor-based investing works. Choosing the right factor to invest in plays a huge part in your success.

Andrew Ang, BlackRock’s head of Factor Investing Strategies, explained in a recent article that investors need to be able to distinguish between factors that are simply “passing fads” and those that are “fundamentally-based.” He explained two criteria he uses to make the distinction:

Economic rationale

The factor should have an economic rationale for its return premium. In the world of Big data, it is easy to find coincidental correlations between a factor and returns. However, many of these correlations are due to chance.

By focusing on factors that have economic rationale which drives their outperformance, we can be certain that there is a legitimate and very real reason behind the correlation between performance and the factor.

Decades of data

For the retail investor, it is difficult to gather enough information to backtest a particular factor over decades or even longer. However, funds with access to big data, are able to use the information to see if a factor has a long-term correlation with performance.

Using factor-based investing

If you are thinking of using a factor-based approach for your investment portfolio, there are a few things to take note of.

First, define your investment goal and identify factors that can help you achieve your goals.

Second, not all stocks that exhibit a particular factor will produce similar returns. The correlation between factors and returns is based on a large amount of data comprising thousands of companies. As such, your portfolio needs to be heavily diversified in many companies that exhibit that factor.

Combining factors into a solid investing framework

There is good evidence that factor-based investing has worked well in the past.

However, investors need to identify the factors that are the most correlated with positive returns. It may also be useful to combine certain “style” factors together into a more robust investment framework. An investment framework can help you focus your portfolio on stocks that are even more likely to do well over the long-term.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

The ETF Checklist: 8 Key Points To Avoid The Pitfalls

Not every exchange-traded fund, or ETF, is built the same. Some can be dangerous. We can avoid th common pitfalls if we know where to look.

Exchange-traded funds, or ETFs, are rising in popularity. According to ETF.com, assets under management by US ETFs crossed the US$4 trillion mark earlier this year. That’s huge, to say the least.

It’s not hard to see why the investment vehicle is appealing. You can get wide diversification instantly with most ETFs. Expense ratios are typically low as well, enabling you to keep most of the returns generated.

But not all ETFs are the same. Before you invest in any ETF, you may want to take note of these eight key points.

1. What is an ETF

An ETF is a fund that is traded on a stock exchange, and it can be bought and sold just like any other stock on a stock exchange. An ETF can invest in all kinds of shares depending on the purpose of the fund, and there are many ETFs that aim to track the performance of a stock market index.

Singapore’s main stock market index is the Straits Times Index. There are two ETFs that track its performance, namely, the SPDR Straits Times Index ETF, and the Nikko AM Singapore STI ETF.

2. Mind the gap

The gap between a positive macro-economic trend and stock price returns can be a mile wide.

For example, gold was worth A$620 per ounce at the end of September 2005 and the price climbed by 10% annually for nearly 10 years to reach A$1,550 per ounce on 15 September 2015. But an index of gold mining stocks in Australia’s market, the S&P / ASX All Ordinaries Gold Index, fell by 4% per year from 3,372 points to 2,245 in the same timeframe.

In another example, you can refer to the chart below on the disparity between the stock market returns and economic growth for China and Mexico from 1992 to 2013. Despite stunning 15% annual GDP growth in that period for China, Chinese stocks actually fell by 2% per year. Mexico on the other hand, saw its stocks gain 18% annually, despite its economy growing at a pedestrian rate of just 2% per year.

So when finding themes to invest in via ETFs, make sure that the macro-economic theme you’re betting on can translate into commensurate stock market gains.

3. Replication method

ETFs can mimic the performance of a stock market index through two broad ways: Synthetic replication, or direct replication.

Synthetic replication involves the use of derivatives without directly investing in the underlying assets. It is the less ideal way to build an index-tracking ETF, in my view, because there is more complexity involved and hence a higher risk that a large proportion of the underlying index’s performance can’t be captured.

Direct replication has two sub-categories: (a) Representative sampling, where the ETF holds only a sample of the stocks within an index; and (b) full replication, which involves an ETF buying the same stocks in nearly identical proportions as the weights of all the stocks that make up an index.

You should try to invest in ETFs that use full replication if possible.

4. Reputation matters

Look for an ETF that is managed by a reputable fund management company. Vanguard, SPDR, iSHAREs, and Blackrock are just some examples of reputable ETF managers.

5. Track record

An ETF should ideally have a listing history of at least a few years, so that we can see how the ETF has actually done, instead of relying on the performance of the underlying index.

6. Watch your costs

The expense ratio (essentially all of the fees that you have to pay to the ETF’s manager and service providers) should be low. There’s no iron-clad rule on what “low” is, but I think anything less than 0.3% for the expense ratio deserves a thumbs-up.

Having a low expense ratio puts an ETF on the right side of the trend of investment dollars flowing toward low-cost index-tracking funds. This lowers the risk of an ETF’s manager closing the ETF down for commercial reasons.

7. The assets that are managed

An ETF’s assets under management (AUM) should be high – ideally more than US$1 billion. Having sizable AUM would also lower the chance that an ETF will close in the future. It’s not uncommon for ETFs to close. When a closure happens, it creates hassle on our part to find new ETFs to invest in.

8. Performance tracking

Lastly, you should look for a low tracking error. An ETF’s returns should closely match the returns of its underlying index. If the tracking error has been high in the past, there’s a higher chance that the ETF can’t adequately capture the performance of its underlying index in the future.

Timeless Investing Lessons From UK’s Best-Performing Fund

Established in 2010, Fundsmith is the largest mutual fund in the United Kingdom with £18bn assets under management.

Led by its founder, Terry Smith, the fund has more than doubled the market since its inception nine years ago. Investors who invested with Fundsmith from the get-go have earned a total return of 353.2%, or an annualised return of 18.3%, as of 31 October 2019. Comparatively, global equities in general “only” returned a cumulative total of 171.1% over the same time frame, or 11.7% annualised.

Its impressive performance makes FundSmith the number one performing fund in the UK. From its inception to the end of 2018, Fundsmith had a cumulative margin of 13% over the second-best fund and 188% over the average for the sector, which delivered a market-lagging 81.9% cumulative return.

Although I am not invested in the fund, I am extremely impressed by the way Fundsmith is managed. Terry Smith’s annual letter to shareholders is also filled with insightful comments and timeless lessons that we can apply in our own investing. With that, here are some of the key takeaways from Fund Smith’s latest annual report.

Stop trying to time the market!

We are all too familiar with market commentators warning of an impending bear market. Smith says:

“I can now trace back six years of market commentary that has warned that shares of the sort we invest in, our strategy and our Fund would underperform.

During that time the Fund has risen in value by over 185%. The fact that you would have forgone this gain if you had followed their advice will, of course, be forgotten by them if, or when, their predictions pay off for a period. I suggest you don’t forget it.”

Legendary investor Peter Lynch once said that “far more money has been lost by investors preparing for corrections than has been lost in corrections themselves.”

If you find yourself worried that the bull market has run its course, it will be wise to remember these words of advice.

Growth versus Value

Fundsmith’s investment strategy involves buying and holding fast-growing companies. This strategy has outperformed value investing over the last decade. However, with growth stocks reaching rich valuations, some market commentators believe that value investing may come back in favour.

In his annual shareholder letter, Smith outlines two main handicaps he sees in the value investing strategy:

“One is that whilst the value investor waits for the event(s) which will crystallise a rise in the share price to the intrinsic value that has been identified, the company is unlikely to be compounding in value in the same way as the stocks we seek. In fact, it is quite likely to be destroying value.

Moreover, it is a much more active strategy. Even when the value investor succeeds in reaping gains from a rise in the share price to reflect the intrinsic value he identified, he or she needs to find a replacement value stock, and as events of the past few years have demonstrated, this is far from easy. Moreover, this activity has a transaction cost.”

Let time work its magic

FundSmith has a simple three-step investment strategy: (1) Buy good companies, (2) Don’t overpay, and (3) Do nothing.

While some actively managed fund managers may scoff at the idea of the third point, it is actually one of the key reasons why Fundsmith has done so well since its inception. Smith explains:

“Minimising portfolio turnover remains one of our objectives and this was again achieved with a portfolio turnover of 13.4% during the period. This is the highest level of annual turnover which we have undertaken to date, but it is still tiny in comparison with most funds.”

He adds:

“Why is this important? It helps to minimise costs and minimising the costs of investment is a vital contribution to achieving a satisfactory outcome as an investor.”

The low portfolio turnover ratio resulted in FundSmith having by far the lowest transaction costs among the 15 largest active equity funds in the UK.

In fact, Smith attached a table of the returns of the 15 funds over a 3-year and 5-year period and compared them to their transaction costs. There was, unsurprisingly, a strong correlation between funds with lower transaction costs and higher returns (With FundSmith sitting at the top of the pile).

Final Thoughts

Terry Smith has become one of the most successful fund managers of his generation. He has even been compared to the legendary Warren Buffett. From his investing principles above, it is easy to see why Smith has found so much success in an industry that has traditionally underperformed low-cost index funds. His guiding investment principals can also help retail investors invest better. If you want to read more of Terry Smith’s letters to shareholders, you can head here.

REITs With Overseas Properties: Yay or Nay?

Mapletree North Asia Commercial Trust and Eagle Hospitality Trust, two REITs that are listed in Singapore with overseas assets, have been in the news for all the wrong reasons.

If you are not familiar, Festival Walk, one of Mapletree North Asia Commercial Trust’s key assets in Hong Kong, was vandalised by protesters earlier this week. Meanwhile Eagle Hospitality Trust is at risk of losing one of its key assets, The Queen Mary, due to actions from its sponsor.

Both REITs have seen their unit prices fall considerably when the respective news broke.

The predicament that the two REITs are in has shone some light on the risks involved with investing in REITs with overseas properties. As such, I thought it is an opportune time to discuss some of the advantages and risks of investing in this asset sub-class.

The Positives

Let’s start with the main reasons why investors may want to invest in these REITs.

Diversification

The most important advantage is REITs with overseas portfolios give investors the chance to gain exposure to a different geographical market. This gives investors the opportunity to participate in economies that could be faster-growing than Singapore’s. It also helps to diversify your portfolio away from Singapore.

Higher yields

REITs with overseas portfolios tend to trade at a discount to REITs with predominantly local portfolios. It is common to find that REITs with overseas properties have much higher yields, offering the potential for better returns.

The downside

While there is the possibility of higher returns, investors also need to be familiar with the downsides and risks.

Withholding taxes

Certain countries have a withholding tax law. This means that cash sent back to shareholders in Singapore end up being taxed, which reduces the REIT’s distributable income.

EC World REIT, for instance, has had to pay a withholding tax to authorities when they repatriated income to Singapore.

Currency fluctuations

If you want to receive your distribution in Singapore dollars, you may have to contend with currency fluctuations. REITs with overseas properties tend to collect rent in the local currency. As such, if the currency depreciates against the Singapore dollar, you may be left with a lower distribution.

Ascendas India Trust is a good example. The steep depreciation of the Indian Rupee has had a big impact on the REIT’s Singapore-dollar-denominated distributions.

Political environment

Singapore enjoys a relatively stable political climate. We tend to take the peace of our country for granted. However, this may not be the case for other countries.

Right now, Hong Kong is facing a major political crisis with protests stretching for more than six months.

As mentioned, earlier this week, Mapletree North Asia Commercial Trust saw its share price stumble after protestors vandalised Festival Walk and set fire to the Christmas tree in the mall. As Festival Walk contributed more than 60% of the REIT’s revenue in 2018, the REIT’s rental income could drop.

Difficulty assessing the quality of the properties

It is easy to visit a shopping mall in Singapore to assess the crowd and the tenants. However, assessing the quality of overseas properties is much more challenging.

Investors who are unwilling to go down to physically examine a REIT’s portfolio will have to rely on annual reports and the details of the property in the company’s quarterly filings.

REITs with overseas properties: Yay?

Knowing both the pros and risks, the question now is whether it is still worth investing in REITs with overseas portfolios?

I think the answer is yes!

Despite the recent mishap at Mapletree North Asia Commercial Trust and Eagle Hospitality Trust, the potential for a higher return is too good to ignore. The market is currently very apprehensive of such REITs and has generally priced them at a large discount to their peers. The price mismatch has created an opportunity for more yield-hungry investors.

Don’t let the two recent sagas deter you. I believe many REITs with overseas properties, despite the risks, are likely to continue dishing out stable dividends and will continue to provide investors with great long-term returns.

We can also reduce risk by choosing the REITs within this sub-class that have more favourable characteristics. If we do our research and diversify sufficiently, I think it is still a good idea to have REITs with overseas properties in your investment portfolio.

Taming Our Ego When Investing

Preventing ego from getting into our heads is of utmost importance. Without ego, we can invest in a safer manner by not falling prey to overconfidence.

In his book Open Heart, Open Mind, the Tibetan Buddisht educator Tsoknyi Rinpoche recounted a conversation he had with his late father, Tulku Urgyen Rinpoche.

The younger Rinpoche was about to visit the US for the first time to deliver teachings on Buddhism. He wanted advice from his father on how he should approach educating a new audience. Tulku Urgyen Rinpoche responded:

“Don’t let the praise go to your head. People will compliment you. They’ll say how great you are, how wonderful your teachings are… Whatever compliments your students give you have nothing to do with you… How you teach is not important. What you teach is.”

The elder Rinpoche also said that he had observed many Buddhist teachers develop a mistaken notion – that they are special because their ways of imparting Buddhist lessons are popular with students. Tulku Urgyen Rinpoche gently reminded his son: “What’s really special, is the teaching itself.”

The investing analogy

If we invest soundly in the stock market with a long-term, business-focused mindset, it’s likelier than not that investing success will knock on our doors. When we taste success, it’s easy for ego to enter the picture. We may look into the mirror often and proclaim, “I’m a special investor!”

But the entrance of ego plants the seeds of failure. My friend, the fund manager Goh Tee Leng, recently wrote in his website Investing Nook that Pride, or Ego, is one of the seven sins of investing.

If we have done well in investing using the underlying framework that stocks represent a piece of a business and that the value of the stock is a reflection of the value of the underlying business, we’re not special. This framework was already fleshed out thoroughly by Benjamin Graham 85 years ago in his 1934 book, the first edition of Security Analysis. We may each have our own unique interpretations and applications of Graham’s then-groundbreaking ideas. But what’s really special, is the framework itself.

Conclusion

Preventing ego from getting into our heads is of utmost importance. Without ego, we can invest in a safer manner. That’s because we won’t fall prey to overconfidence. When overconfident, we think we know more than we actually do, and we may end up doing risky things, such as borrowing to invest or overly concentrating our portfolios.

This post will serve as a constant reminder to myself, a barrier that keeps my ego at the door. I hope it can serve the same purpose for you too.

“Should I Buy Mapletree North Asia Commercial Trust Now?”

Investors are fearful of Mapletree North Asia Commercial Trust right now. Should we buy its shares? The answer is surprisingly complicated.

Yesterday, a wise and kind lady whom Jeremy and I know asked us: “Buying when there is blood on the street is a golden rule in investing. So should I buy Mapletree North Asia Commercial Trust now?”

I responded to her query, and I thought my answer is worth sharing with a wider audience. But first, we need a brief introduction of the stock in question.

The background

Mapletree North Asia Commercial Trust is a REIT (real estate investment trust) that is listed in Singapore’s stock market. It currently has a S$7.7 billion portfolio that holds nine properties across Beijing, Shanghai, Hong Kong, and Japan.

Festival Walk is a retail mall and is the REIT’s only property in Hong Kong. It also happens to be Mapletree North Asia Commercial Trust’s most important property. In the first half of FY19/20 (the fiscal year ending 31 March 2020), Festival Walk accounted for 62% of the REIT’s total net property income.

Hong Kong has been plagued by political and social unrest for months. On 12 November 2019, protestors in the special administrative region caused extensive damage to Festival Walk. Mapletree North Asia Commercial Trust’s share price (technically a unit price, but let’s not split hairs here!) promptly fell 4.9% to S$1.16 the day after. At S$1.16, the REIT’s share price had fallen by nearly 20% from this year’s peak of S$1.43 (after adjusting for dividends) that was reached in July.

For context on Mapletree North Asia Commercial Trust’s sliding share price over the past few months, consider two things.

First, the other REITs under the Mapletree umbrella have seen their share prices rise since Mapletree North Asia Commercial Trust’s share price peaked in July this year – the share prices of Mapletree Industrial Trust, Mapletree Logistics Trust, and Mapletree Commercial Trust have risen by 13%, 5%, and 12%, respectively (all after adjusting for dividends). Second, Mapletree North Asia Commercial Trust’s results for the second quarter of FY19/20 was released on 25 October 2019 and it was decent. Net property income was up 1.3% from a year ago while distribution per unit inched up by 0.6%. And yet, the share price has been falling.

To me, it seems obvious that fears over the unrest in Hong Kong have affected investors’ sentiment towards the REIT.

The response

My answer to the lady’s question is given in whole below (it’s lightly edited for readability, since the original message was sent as a text):

“Buying decisions should always be made in the context of a portfolio. Will a portfolio that already has 50% of its capital invested in stocks that are directly linked to Hong Kong’s economy (not just stocks listed in Hong Kong) need Mapletree North Asia Commercial Trust? I’m not sure. But in a portfolio that has very light exposure to Hong Kong, the picture changes.

Mapletree, as a group, has run all its REITs really well. But most of the public-listed REITs are well-diversified in terms of property-count or geography, or both. Mapletree North Asia Commercial Trust at its listing, and even today, is quite different – it’s very concentrated in geography and property-count. But still, the properties seem to be of high quality, so that’s good.

Buying when there’s blood on the streets makes a lot of sense. But statistics also show that of all stocks ever listed in the US from 1980 to 2014, 40% have fallen by at least 70% from their peak and never recovered. So buying when there’s blood on the streets needs a caveat: That the stock itself is not overvalued, and that the business itself still has a bright future.

Mapletree North Asia Commercial Trust’s valuation looks good, but its future will have to depend on the stability of Hong Kong 5-10 years from now. I’m optimistic about the situation in Hong Kong while recognising the short-term pain. At the same time, I won’t claim to be an expert in international relations or the socio-economic fabric of Hong Kong. So, diversification at the portfolio level will be important.

With all this being said, I think Mapletree North Asia Commercial Trust is interesting with a 2% to 3% weighting in a portfolio that does not already have a high concentration (say 20%?) of companies that do business in Hong Kong.”

Perspectives

I mentioned earlier that Mapletree North Asia Commercial Trust’s valuation looks good and that it owns high-quality properties.

The chart below shows the REIT’s dividend yield and price-to-book (PB) ratio over the last five years. Right now, the PB ratio is near a five-year low, while the dividend yield – which is nearly 7% – looks favourable compared to history.

On the quality of the REIT’s property portfolio, there are two key points to make: First, the portfolio has commanded a high occupancy rate of not less than 98.5% in each of the last six fiscal years; second, the properties in the portfolio have achieved healthy rental reversion rates over the same period.

*Source: Mapletree North Asia Commercial Trust earnings presentation*

Mapletree North Asia Commercial Trust also scores well at some of the other traits that could point us to good REITs:

Growth in gross revenue, net property income, and distribution per unit – The REIT’s net property income has grown in each year from FY14/15 to FY18/19, and has increased by 9.4% per year. Distribution per unit also climbed in each year for the same period, and was up by 4.1% annually.
Low leverage and a strong ability to service interest payments on debt – The REIT has a high leverage ratio. As of 30 September 2019, the leverage ratio is 37.1%, which is only a small distance from the regulatory leverage ratio ceiling of 45%. But its interest cover ratio for the quarter ended 30 September 2019 is 4.2, which is fairly safe.
Favourable lease structures and/or a long track record of growing rent on a per-area basis – At the end of FY18/19, nearly all of Festival Walk’s leases included step-up clauses in base rent. Small portions of the respective leases for the other properties in the REIT’s portfolio also contain step-up clauses. In addition, the REIT has been able to produce strong rental reversions over a multi-year period, as mentioned earlier.

Conclusion

Mapletree North Asia Commercial Trust currently has an attractive valuation in relation to history. It’s also cheaper than many other REITs in Singapore – for example, its sister REITs under the Mapletree group have dividend yields ranging from only 4% to 5%. It also has other attractive traits, such as a strong history of growth, a safe interest cover ratio, and favourable lease structures.

On the other hand, Mapletree North Asia Commercial Trust has high concentration risk since Festival Walk accounts for more than half its revenue. Moreover, Festival Walk’s prospects depend heavily on the stability of Hong Kong’s sociopolitical fabric. I don’t think anyone can be certain about Hong Kong’s future given the current unrest (which seems to have escalated in recent weeks). These increase the risk profile for the REIT in my view.

To balance both sides of the equation on Mapletree North Asia Commercial Trust, I think my point on portfolio-level diversification given in my answer to the lady’s question is critical.

I’m often asked if a certain stock is a good or bad buy. The question is deceptively difficult to answer because it depends on your risk appetite and your investment portfolio’s composition. A stock that makes sense for one portfolio may not make sense for another. Keep this in mind when you’re assessing whether Mapletree North Asia Commercial Trust is suitable for your portfolio.

Can We Really Do Good While Investing?

Here’s how investors can make the world a better place through good investing decisions.

Are we really able to do good while investing?

This question irked me at the time I was thinking of making a career switch to investing. I wanted a career that was both fulfilling and enabled me to make a difference to the world at the same time.

Thankfully, through further reading, I can say the answer to that question is an emphatic yes.

As investors, we are a small cog in the financial markets that help make the world a better place.

Every drop counts

So how do we do good when we invest? Well, let’s start at the very beginning.

When a start-up that is looking to improve the world develops an idea, it needs funding. Venture capitalists help to fund these ideas.

In turn, these venture capitalists invest because they know that there is a stable public market system behind them.

Along the way, these startups enrich the lives of numerous stakeholders, including employees, customers, and shareholders.

At its initial public offering, the company then raises more funds through a public offering of shares.

Those who invest in initial public offerings do so because of the assurances of the liquidity of the public market and the ability to sell shares at a future date, which is when we (stock market investors, or public market investors) usually come in.

The final piece of the jigsaw

All of which means that we, public market investors, are a small but important piece of the jigsaw that helps drive innovation and the improvement of society through capitalism.

As you can see, by participating in the stock market as investors, we are indirectly part of the reason why startups are able to raise much-needed funds in the first place.

Impact investing

Besides simply being part of the financial markets, we can also choose to invest in companies that are actively improving the world.

One way is to invest in companies that are building a better future for tomorrow through innovative technologies such as Google. We can also invest in companies that uphold a high standard of corporate social responsibility by giving back to society or through actions that help reverse climate change.

The more investors embrace Impact investing, the more firms are likely to embrace the need for a strong corporate social responsibility to enrich the lives of other stakeholders and the world.

Recently, the Singapore government set aside US$2 billion in funds to participate in public market investment strategies that have a strong green focus. Singapore Education Minister, Ong Ye Kuang, described how investments help to shape the world saying, “Finance fuels the economy and business. It determines investment decision and it drives action.”

Enriching others

As you can see, investing is certainly not a zero-sum game. The injection of much-needed capital into companies that are improving the world aids numerous stakeholders along the way.

Even if we solely invest in the secondary market (the public stock market), we are still an important – albeit small – part of the financial markets that is essential in capitalism and the betterment of the world.

Further, by focusing our investing efforts on responsible companies that are not solely profit-driven but have a strong corporate social responsibility to do good, we can mold the way investment decisions are made and help to prod business towards socially responsible investment decisions.

The Best Investing Speech, And 5 Lessons

Timeless investing lessons and wisdom were shared in an investing speech delivered 38 years ago in 1981.

Surprise! The best investing speech I’ve ever come across is not from Warren Buffett or other well-known investing legends such as Peter Lynch, Benjamin Graham, or John Neff. It’s from the little-known Dean Williams.

The speech, Trying Too Hard, was delivered 38 years ago in 1981, when Williams was with Batterymarch Financial Management. But its content remains as relevant as ever. Here are five gems I took away from Williams’ timeless speech.

1. Confidence and accuracy

“Confidence in a forecast rises with the amount of information that goes into it. But the accuracy of the forecast stays the same.”

Keep this in mind the next time you come across a market forecaster who is highly confident just because he’s backed by mountains of data. Bad data, however much the amount, can lead to bad forecasts. A poor understanding of how markets work (such as assuming that price movements in the financial markets follow a normal distribution) will also lead to toxic outcomes even when there’s plenty of data involved.

In fact, research by Philip Tetlock, a psychologist at Berkeley, brings this Dean Williams quote one step further by suggesting that confidence and accuracy in a forecast can often be inversely correlated.

2. Don’t just do something, stand there!

“The title Marshall mentioned, “Trying Too Hard”, comes from something that happened to me a few years ago. I had just completed what I thought was some fancy footwork involving buying and selling a long list of stocks. The oldest member of Morgan’s trust committee looked down the list and said, “Do you think you might be trying too hard?” At the time I thought, “Who ever heard of trying too hard?” Well, over the years I have changed my mind about that.”

Finance professors Brad Barber and Terry Odean published a paper in 2000 that looked at the trading records of more than 66,000 US households over a five-year period from 1991 to 1996. The research was astonishing: The households who traded the most generated the lowest returns. The average household earned 16.4% per year for the timeframe under study, while the most frequent traders only earned 11.4% per year.

Investor William Smead once said that “Your common stock portfolio is like a bar of soap. The more you rub it, the smaller it gets.” How true.

3. We know less than we think we do

“Here are the ideas I’m going to talk about: the first is an analogy between physics and investing… The foundation of Newtonian physics was that physical events are governed by physical laws. Laws that we could understand rationally. And if we learned enough about those laws, we could extend our knowledge and influence over our environment.

That was also the foundation of most of the security analysis, technical analysis, economic theory and forecasting methods you and I learned about when we first began in this business. There were rational and predictable economic forces. And if we just tried hard enough… If we learned every detail about a company. . . .If we discovered just the right variables for out forecasting models… Earnings and prices and interest rates should all behave in rational and predictable ways. If we just tried hard enough.

In the last fifty years a new physics came along. Quantum, or subatomic physics. The clues it left along its trail frustrated the best scientific minds in the world. Evidence began to mount that our knowledge of what governed events on the subatomic level wasn’t nearly what we thought it would be. Those events just didn’t seem subject to rational behavior or prediction. Soon it wasn’t clear whether it was even possible to observe and measure subatomic events, or whether the observing and measuring were, themselves, changing or even causing those events.

What I have to tell you tonight is that the investment world I think I know anything about is a lot more like quantum physics than it is like Newtonian physics. There is just too much evidence that our knowledge of what governs financial and economic events isn’t nearly what we thought it would be.”

Investing involves human psychology, which is incredibly hard to model. The great physicist Richard Feynman apparently once said “Imagine how much harder physics would be if electrons had emotions.” That’s the problem we as investors have to deal with.

Investing is not always a case of “if X, then Y.” According to a study done in 2004, South Africa’s economy expanded by 6.5% annually from 1900 to 2002, but saw its stock market rise by less than 1%. The Federal Reserve in the US started its bond-purchase programme, Quantitative Easing, in 2008. Investors thought back then that interest rates would rise when QE stopped since the Fed’s massive presence would be gone. QE officially ended in late 2014 but the Fed had stopped and restarted QE on a number of occasions. Morgan Housel showed that, contrary to the general idea, interest rates rose each time the Fed stopped QE between the beginning of 2008 and April 2013.

The good thing is you and I need not be helpless. We can work with sound investing principles that are backed by strong logical reasoning and evidence, and we can invest with humility by diversifying.

4. The power of simplicity and consistency

“You are familiar with the periodic rankings of past investment results published in Pension & Investment Age. You may have missed the news that for the last ten years the best investment record in the country belonged to the Citizens Bank and Trust Company of Chillicothe, Missouri.

Forbes magazine did not miss it, though, and sent a reporter to Chillicothe to find the genius responsible for it. He found a 72 year old man named Edgerton Welsh, who said he’d never heard of Benjamin Graham and didn’t have any idea what modern portfolio theory was. “Well, how did you do it?” the reporter wanted to know.

Mr. Welch showed the report his copy of Value-Line and said he bought all the stocks ranked “1” that Merrill Lynch or E.F. Hutton also liked. And when any one of the three changed their ratings, he sold. Mr. Welch said, “It’s like owning a computer. When you get the printout, use the figures to make a decision–not your own impulse.”

The Forbes reporter finally concluded, “His secret isn’t the system but his own consistency.” EXACTLY. That is what Garfield Drew, the market writer, meant forty years ago when he said, “In fact, simplicity or singleness of approach is a greatly underestimated factor of market success.””

I’ve previously shared in The Good Investors about how a simple portfolio of US stocks, international stocks, and global bonds have bested even the best-performing endowment funds of US colleges that invests in incredibly complex ways. Here’s another good one, according to Morgan Housel: “Someone who bought a low-cost S&P 500 index fund in 2003 earned a 97% return by the end of 2012… Meanwhile, the average equity market neutral fancy-pants hedge fund lost 4.7% of its value over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices.”

5. Investing without forecasts

“And when it comes to forecasting—as opposed to doing something—a lot of expertise is no better than a little expertise. And may even be worse.

The consolation prize is pretty consoling, actually. It’s that you can be a successful investor without being a perpetual forecaster. Not only that, I can tell you from personal experience that one of the most liberating experiences you can have is to be asked to look over your firm’s economic outlook and to say, “We don’t have one.”

Successful investing can be done without paying attention to economic forecasts. I have been investing for more than 9 years, and have never depended on outlooks on the economy. My focus has always been on a stock’s underlying business fundamentals. It’s the same when I was with the Motley Fool Singapore’s investing team – the prospects of a stock’s business was our primary concern. In his speech, Dean Williams also said “Give life a try without forecasts.” I have tried, and it’s been great.

3 Portfolio Management Strategies To Adopt

These 3 portfolio management strategies can help you better manage the risk-reward profile of your investment portfolio.

Portfolio management is an important skill in investing. Take on too much risk and you may be left with sizeable losses. Take on too little risk and your returns will be mediocre.

So how do we balance risk and returns?

Given the uncertainty surrounding the market today, I thought it would be an opportune time to share some portfolio management tips that I believe investors can adopt.

Mind the size

Whatever you invest in, it is important to invest an amount that you are comfortable with.

Of course, this can vary depending on the size of your portfolio, your investment strategy, investment horizon, and even your risk appetite.

For stock investors, I encourage you to invest no more than 5% of your entire portfolio capital in a single stock. This reduces the risk that a sudden drop in price in the stock will have a detrimental impact on your returns.

It is not uncommon to find stocks fall more than 30% and never recover. Sometimes it may not be the fault of the investor. Unforeseen circumstances can cause a sudden and irrecoverable disruption to a company’s previously sound business.

We can avoid potentially painful losses when we sufficiently diversify our investments.

Manage the risk

Adding to the first point, it is important to assess the risk-reward profile of a particular investment. For an investment such as a high-growth stock that has a high-risk but high-return possibility, it may be wise to size down your investment to reduce the chance that a permanent fall in the price of the stock will cause a large loss to your portfolio.

Keep cash in hand

Although not all portfolio managers may agree, I prefer to keep some cash in hand. The cash will come in handy when a bargain suddenly appears in the market.

To ensure that I have the means to take advantage of an investment opportunity, I hold 5% of my total investment capital as cash.

There are, however, exceptions to this rule. If stocks have seen a market-wide decline, presenting plenty of investment opportunities, it may be wise to be fully invested to make the most of these bargains.

Portfolio Management Simplified

Obviously there is no one-size-fits-all strategy to invest well. Investors need some investing experience to personalise their own portfolio management according to their goals and needs. However, these three strategies can act as a framework for how to manage an investment portfolio.

Why Value Investing Has Worked – and Some Key Takeaways

Insights on why value investing (essentially investing in stocks with low valuations) has worked in the stock market over long periods of time but has struggled in the last decade or so.

Around 1.5 years ago, I read a piece of fascinating research from O’Shaughnessy Asset Management (OSAM) and the pseudonymous financial blogger, Jesse Livermore. The research provided insights on why value investing (essentially investing in stocks with low valuations) has worked in the stock market over long periods of time but has struggled in the last decade or so.

I want to share the paper’s main findings and my takeaways, because value investing is popular among many stock market participants.

Value’s success

The research found that stocks in the value category saw their earnings fall in the short run. The market was somewhat correct in giving such stocks a low valuation in the first place. I say “somewhat correct” because the market was excessively pessimistic. Value stocks eventually outperformed the market because their earnings recovered to a point where their initial purchase prices looked cheap – it was the initial excessively-pessimistic pricing and subsequent recovery in earnings that led to the value factor’s ability to deliver market-beating returns.

So the market was right in the short run, in the sense that value stocks will see a downturn in their businesses. But the market was also wrong in the sense that it was too pessimistic on the long-run ability of the businesses of value stocks to eventually recover. OSAM and Livermore’s research also showed that the value factor’s poor performance in the last decade or so can be attributed to the disappearance of the subsequent recovery in earnings of value stocks. The reason for the disappearance of the earnings-recovery was not covered in the paper.

My takeaways

First, investors can gain an enormous and lasting edge over the market simply by adopting a longer time horizon and having the courage and optimism to see past dark clouds on the horizon. The Motley Fool’s co-founder and chairman, David Gardner, spoke about the concept of “Dark Clouds I Can See Through” in an insightful podcast of his. The idea behind seeing past dark clouds on the horizon is that if you’re able to look past the prevailing pessimism about a situation, and if you’re right in your optimism, there’s success to be found on the other side when the clouds clear. OSAM and Livermore showed this empirically when they broke down the exact drivers behind the past successes of the value factor – investors who had the ability to “see” the subsequent recovery in earnings of value stocks were able to profit from the market’s short-term pessimism.

Second, I think it’s now more important than ever for investors to not buy value stocks blindly. The underlying mechanism behind the value factor’s past successes has been shown to be the initial overly-pessimistic pricing and the subsequent earnings recovery of value stocks. The recent struggles of the value factor, however, has been due to the inability of value stocks to produce an earnings recovery. To succeed with value stocks, I think investors should have a robust framework for analysing companies in the value category and think carefully about the probability of their businesses’ abilities to produce growth in the future.