Investment discipline

TAMRIS’s disciplines were designed to operate within a total asset, life cycle wealth management framework.

The TAMRIS consultancy’s underlying equity investment discipline is long term, contrarian, value biased, globally diversified, in other words, universal value. In no way does it require the managers it assesses to follow a specific investment discipline. The information provided here is purely for information purposes.

It is universally accepted that equity investments are long term because of the short term risks to earnings, dividends and share prices. In other words do not buy if you are going to have to sell after a fall.

You buy and hold an investment as long as it offers value, irrespective of the short term share price performance. Why? Because if you are buying the earnings the short term price movement is immaterial.
Investments with larger equity risk premiums are viewed as “higher risk investments” . It may take time for the market to buy and for the value to be reflected in the valuation.
Long term does not mean buy and hold. Once value is discounted by the share price an investment needs to be sold. Long term does not mean you can invest at any price and prosper and should not be used to justify such.
Long term means aversion to “market timing”. If you wait for conditions to improve before buying you will have already missed out on a large rise in a market, while waiting for a market to fall before you sell implies you can get out at the right price.
Long term implies discipline. If strategy is influenced by sentiment you risk investing in highly valued markets to the exclusion of under valued markets. In other words, buying high and selling low.

A long term investment philosophy realises that the future is uncertain. By the time you recognise a problem in an economy or market it is often too late to get out. If an investment has not been made for valid considerations, you will end up in a position where you should not be and, which, you will most likely end up exiting at a loss.

A contrarian investment discipline is one which has an aversion to buying over valued assets, where returns have been strong and where prices reflect the good news of the past rather than the risk of the future.

It favours investments where news has been bad and returns have been poor. It believes that this strategy reduces risk and enhances return.

Such a stance is influenced by the long term damage that buying at the top of a market can have on long term stock market returns.

Operating a contrarian style means over weighting under valued and under weighting over valued markets. If you do not have assets in rising markets you cannot realise value.

Contrarian investment strategies are exposed to short term performance risk as under weight markets continue to rise and over weight markets may continue to fall. More damage is done to a portfolio by selling a market which has under performed in favour of buying an investment which has performed well.

Value investors should not be constrained by index composition in their allocation for the simple reason that the index is not weighted by value but by market cap and relative demand. Indeed rationale long term investors should over weight value, which may also mean significant allocations to small and medium sized companies.

A benefit of value investing is that buying into bad news often affords a margin of safety. This means you can accept further falls in earnings or share price without affecting your ability to earn a comparable long term return relative to the market. Likewise, when selling, you are selling into good news. Value investors should not be forced sellers nor forced buyers.

While smaller companies are illiquid compared to larger companies, are more exposed to the domestic economic cycle than larger companies, the long term return for holding smaller companies has been significantly above that of larger companies.

Even during periods of significant larger company out performance, for example, during the 1990s, earnings growth on the Russell 2000 (December 1993 to December 2000) exceeded earnings growth on the S&P 500.

Lower relative demand for smaller companies is due partly to the fact that institutions are unable to trade smaller companies with the ease of larger stocks. The market cap of a larger company can equal the entire market cap of the smaller company index.

Another reason for the smaller and medium sized company valuation difference is investor preferences. Smaller companies are “higher risk” investments requiring a higher equity risk premium in order to equate demand with supply. In this sense an efficient market rewards risk takers.

Value actually means higher return/lower risk, not higher risk/higher return. However, value is not a constant but a transient state and areas such as smaller companies can become over valued and hence become higher risk/lower return vehicles.

Long term economic growth determines earnings, which determines stock market returns. At certain points of the domestic stock market and economic cycle, equities become over valued. An investor should therefore be free to allocate to areas of value in global markets.

The best value is found in early economic cycles and/or markets where there has been a significant financial or economic shock. Global diversification increases the opportunities for buying low and selling high. If you can take advantage of these buying and selling opportunities within a structured allocation framework, you can reduce risk and enhance return.

If markets are efficient, then all markets should be priced to cover the perceived risks of the return, that is, there should be value in all markets. Investors should therefore be investing globally, irrespective. There should in reality be no significant additional long term risk of investing in global markets.

Unfortunately many investors do not truly understand the rationale for global investment. Periods of significant out performance of global markets are taken as a rationale for investment, while under performance is taken as a reason for disinvestment; buying high, selling low.

Modern portfolio theory looks at the benefits of static global allocations primarily in terms of the risk reduction benefits of covariance. Most investors over long periods of time will feel short changed if they have under performed the domestic market, even if the ride has been smoother overall. They want performance above their benchmark, the domestic index and quite rightly so.

The universe of value is wide; global and emerging global markets, growth, emerging growth, value, large, medium and small companies.

The relationship between the components of the universe determines the efficient allocation to market components based on relative risk/return relationships.

Growth stocks, technology stocks and larger companies can all at times have significant relative value, while small caps and value can all at times be relatively over valued. No relationship is constant.

The standard argument for diversification is risk reduction, whereas in fact diversification is a return management platform. Diversification of allocation should add value while blind (MVO constructs), fixed allocations designed to reduce portfolio risk and enhance long term returns may reduce return and increase risk. All allocation should have a valuation determinant, a fact ignored in most global diversification.

TAMRIS’s own relative valuation frameworks were developed to manage the universe of relative value. These structures provided a disciplined framework for buying low and selling high.

Think long term, buy low and sell high and keep your head while others around you are losing theirs. If you want to enhance return you have to allocate to areas of value and risk and to manage risk and return you need to manage allocation to areas of relative valuation.