- December 14, 2020
- Posted by: CFA Society India
- Category:BLOG, Events
Speaker: Yen Liow, Managing Partner, Aravt Global LLC
Moderator: Paresh Thakker, CFA, Managing Partner, ValueQuest Capital LLP
Contributed By: Parvez Abbas, CFA, Member, Public Awareness Committee, CFA Society India
Investment is the art of competitive learning. The session started with the premise that the world does not need another investment firm. In North America, there are more than 3800 hedge funds and ~9000 long-only funds. If any new firm wants to enter this professional world, then what is their contribution. Aravt Capital focuses on Framework Investing. Framework Investing is taking the patterns of history and discerning them, looking for high performance strategies and applying them to current market context.
Yen has worked on the data set of US listed companies with market cap above $2BN for three times in the past 15 years to find companies that have generated extraordinary right and left tail performance and then deeply study those patterns. There are 90 companies that have compounded at >20% (~6x cash on cash return) over the past 20 years. If a 5-year period is considered, there are 645 companies that compounded for 20% (2.5x cash on cash return).
There are various ways to make money in the short term but very few in the long term. Through the analysis, Yen explained that he discovered three repeatable, scalable strategies that drove majority of long-term performance:
- Compounders at large: Companies that grow EPS more briskly than the broader market. Monopolies and oligopolies that compound earnings per share at 2x-3x the broader market for long periods of time and trade at reasonable prices. Overtime, earnings power is the only thing that drives return.
- A commodity framework – A demand shock that hits a fixed supply curve. China and India hitting the global supply chains.
- Quality Transitions – An M&A based framework which consolidates and improves the quality of an industry or a company.
One has to focus on how fast one can learn. That will determine how successful one can be. There is no shortcut to success. However, there are very long ways. There is no perfect way to invest and there are lots of strategies that work. All the great investors have vastly different strategies. Investing is like a sport. Just like any sport, one has to train hard to reach excellence. Barriers to entry are extremely low but barriers to excellence are extremely high.
As one ascends to higher and higher position, the decisions one has to make become harder and harder. That is because harder decisions are taken by leaders and other decisions are taken by people in the organization. The key is to have the right people and structure.
What makes a great investor 1) Great mind/taste (IQ) 2) Great temperament (EQ) 3) Huge work ethic. The three combined are necessary but not sufficient conditions to succeed in business. Yen explained the concept of 10x coined by him. If one doubles his ability (2x) on a key node of his capability, it will become 10x of his long term NPV. This will change throughout one’s career. For younger analysts, it may be accounting, basic finance knowledge and modelling skills. As one moves to advanced stages in career, it may be structural risk management, behavioral finance and idea generation. One must be cognizant of his training plan and look for that 10x.
The Mantra is to Decode, Simplify, Execute and Refine. Decode patterns and then simplify them. Simplify so these can be executed under market conditions. Then refine them as one gets feedback loops and adapt them to market situations and within one’s emotional framework.
Compounding is the most important force in the universe. It applies to the mind, capital, ability, mental models, context and experience. If one does not train and refine his learning style, then the great investments can also be overlooked even if they were right in front. For law of compounding to work, one needs to get it right early and then unleash time. The goal is to accelerate one’s pattern recognition and judgement.
Pattern recognition is exposure to statistically significant data sets to form causal relationships. Systematically breaking down the vast universe of investment opportunities to a finite set of ideas that one has a chance of generating sustainably superior returns. Judgement is exposure to decision points and feedback loops to refine within a mental model or framework of thought.
Investing is a future business and it is unknowable. Risk is always a function of price. Uncertainty is an inherent element of investing. Risk and uncertainty overlap but they are profoundly different concepts. As an investment professional, one has to differentiate between drawdown and permanent loss of capital. Yen explained that almost all of the 100+ stocks with 20% CAGR over rolling decades experienced a 50% decline over each decade. It is difficult to predict when they occur. The question is what one is going to do about it. One should be prepared physically, emotionally and mentally to respond to such situations.