Winning The Loser’s Game – It’s Like Tennis

It’s that time of year when we review our investment performance over the last year and some of us realise that it would have been lot better if it was not for the few disasters in our share holdings. For example, this is what well known investor and ShareSoc director David Stredder tweeted before Xmas: “End of 2018 and most of this year has been pretty awful investing wise for me…ACSO, CRAW, BUR, SOM, OPM & JLH were all top 15 holdings and lost 50% or more. CRAW actually went bust. First signs of recovery in two of those and thankfully my top three holdings GAW, JDG & INL have all doubled and covered most my losses but shows investing cannot be fab returns every year. Often a roller coaster ride and must prepare yourself…Sell half on first bad news, slice profits, make friends, share bad and good times as happen to all of us. Enjoy the festive break”.

For those like me that cannot remember all the TIDMs of the several thousand listed companies, the failings were in Accesso, Crawshaw, Burford Capital, Somero, 1PM and John Lewis of Hungerford. The positives were Games Workshop, Judges Scientific and Inland Homes. As an aside I do wish investors would put the company name not just the TIDM (EPIC) code when referencing companies in tweets. A lot of the time I have no idea what they are talking about.

As in most years, I have also had failures. Patisserie was a wipe-out. It went bust after a massive fraud. Thankfully not one of my bigger holdings but I ignored two of the rules I gave in my book “Business Perspective Investing” – namely avoid Executive Chairmen, and directors who have too many roles. I lost money on a number of other newish holdings but not much because I did not hold on to the duds for long.

One of the keys to successful long-term investing is to simply minimise the number of failures while letting the rest of your investments prosper. It is important to realise that investment is a “loser’s game”. It is not the number of sound investments one makes that is important, but the number of mistakes that one avoids that affects the overall performance of your portfolio.

A good book on this subject which I first read some years ago is “Investment Policy – How to Win the Loser’s Game by Charles D. Ellis”. It covers investment strategy in essence but it also contains some simple lessons that are worth learning. He points out that investing is a loser’s game so far as even professional investors are concerned, let alone private investors. Most active fund managers underperform their benchmarks. A lot of the activity of investors in churning their portfolios actually reduces their performance. The more they change horses with the objective of picking a winning steed, the worse their performance gets as their new bets tend to be riskier than the previous holdings, i.e. newer holdings are just more speculative, not intrinsically better. That is why value investing as followed by many experienced investors can outperform.

But Charles Ellis supplied a very good analogy obtained from Dr. Simon Ramo who studied tennis players. He found that professional tennis players seemed to play a different game to amateurs. Professionals seldom make mistakes. Their games have long rallies until one player forces an error by placing a ball just out of reach. But amateurs tend to lose games by hitting the ball into the net or out of play, i.e. they make a lot of unforced errors. The amateur seldom beats his opponent, but more often beats himself. Professional tennis is a winner’s game while amateur tennis is a loser’s game.

In a recent review of my book by Roy Colbran in the UKSA newsletter he says “the book takes a somewhat unusual line in telling you more about things to avoid than things to look for”. Perhaps that is because I have learned from experience that avoiding failures is more important to achieve good overall returns. That means not just avoiding investing in duds to begin with, but cutting losses quickly when the share price goes the wrong way, and getting out at the first significant profit warning.

However, the contrary to many negative qualities in companies are positive qualities. If they are unexceptional in many regards, they can continue to churn out profits without a hiccup if the basic financial structure and business model are good ones. Compounding of returns does the rest. If they avoid risky new business ventures, unwise acquisitions or foreign adventures, that can be to the good.

The companies most to avoid are those where there might be massive returns but where the risks are high. Such companies as oil/gas exploration businesses or mine developers are often of that nature. Or new technology companies with good “stories” about the golden future.

There were a couple of good articles on this year’s investment failures in the Lex column of the FT on Christmas Eve. This is what Lex said about Aston Martin (AML): “Decrying ambitious ventures is relatively safe. Many flop. We gave Aston Martin the benefit of the doubt, instead”. But Lex concedes that the mistake was to be insufficiently cynical.

Lex also commented on Sirius Minerals (SXX) a favourite of many private investors but where Lex says equity holders are likely to be wiped out. Well at least I avoided those two and also avoided investing in any of the Woodford vehicles last year.

To return to the loser’s game theme, many private investors might do better to invest in an index tracker which will give consistent if not brilliant returns than in speculative stocks. At least they will avoid big losses that way. Otherwise the key is to minimise the risks by research and by having a diverse portfolio with holdings sized to match the riskiness of the company. As a result I only lost 0.7% of my portfolio value on Patisserie which has been well offset by the positive movements on my other holdings last year. It of course does emphasise the fact that if you are going to dabble in AIM stocks then you need to hold more than just a few while trying to avoid “diworsification”.

Not churning your portfolio is another way to avoid playing the loser’s game. And as Warren Buffett said “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” – in other words, he emphasised the importance of not losing rather than simply making wonderful investment decisions.

Those are enough good New Year resolutions for now.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )