Strategy

STRATEGY

At its core, our method is a value-based, stock picking approach. We try to maintain a high level of opportunism among a relatively large pool of ideas. While we seek some degree of diversification, diversification in itself is not a goal and is secondary to our objective of superior returns.

Conviction-based

Given the volatility inherent in the stock market and the trading of individual securities, we believe that it is important to base investment decisions on a solid ground that can resist the predictable swings in valuation. As conviction is not easy to reach in an ever-changing world, we seek to obtain it by:

1) Widening our investment opportunities (multi-channel) within the limits of our knowledge and  experience,

2) Following a time-tested discipline of rules that help us control our emotions when the going gets rough  (as it inevitably does) for us. Lack of confidence can result in reactive emotion-based decisions, such as  selling low in order to reduce painful losses.

Multi-channel

We have identified seven channels that allow us a broad range of investment alternatives:

Locomotives
High quality franchises with long-term stability and growth. superior management and governance, multiple/defendable growth prospects. We try to buy these on dips and hold them for the long-term. if successfully picked, they are good source of solid return with moderate investment efforts.

Rising Stars
Fast-growing companies in the process of establishing a major franchise and becoming locomotives. We hope to achieve a 3x return over a 3 to 5 year time frame.

Tradeable
They typically experience 2-4 valuation swings of 10 to 20% a year as they encounter bumps in the execution of their strategy. We try to predict these swings correctly.

M&A Arbitrage
Companies with a high probability of being taken over, or Companies with attractive arbitrage spread (post-offer announcement), or Acquiring companies making a transformative acquisition and conservatively understating potential synergies.

Volatility Investing
Our value-based investment style allows us to deviate from general market performance. As we are not under pressure to achieve constantly positive returns, we do not need to insure our portfolio against short-term losses. Such insurance (generally long VIX) is very expensive and we estimate its long-term annual cost at constant volatility to be approximately 30-40% of the insurance purchased. We tend to sell (short) this insurance in order to be at the receiving end of this 30-40% range. we try to sell insurance, when the hurricane hits, i.e. when the VIX exceeds 20.

Yield Enhancement
Seek to enhance our base returns by up to 5% a year by writing covered calls on core stocks at the high end of our valuation range which we do not want to sell for tax or other reasons. Similarly, we sell puts on core stocks at the low end of our valuation range. We seek to avoid “paying” for time premium and prefer to sell it, as we do by selling puts.

Algorithm
Stock prices fluctuate in the short term with a tendency to revert to mean. We attempt to capitalize on these short-term reversal processes with AI-based algorithms.

Disciplined

 
To keep things simple, investing success requires buying low and selling high. identifying what is low and what is high is indeed our daily task.

It is complicated by the fact that the market may disagree with our findings and leave us often lonely, at times poorer, and always emotionally engaged. It is essential for us to maintain a proper perspective, a grounding that volatility cannot shake easily. We achieve confidence by following a core of time tested set of rules that (somehow) generally work for us.

Investing Guidelines

Dealing with Losses: We generally do not establish stop losses, which we view as inducing buy high/sell low events. When the market does not cooperate with our investment idea, we ask ourselves on a regular basis: has something changed over than the price, since we made the investment? If not, we remain patient or might double down. In effect, we reassess the situation as if new and analyze what has changed if any. If we double down, and we regularly do so, we generally wait until at least a 10% price drop before doing so.

Dealing with Profits: We have no set guidelines. Profit taking is a function of tax (LT vs ST), perceived long-term appreciation potential and comparison with other investment opportunities. We like winners and tend to keep them instead of taking profit.

Portfolio Diversification: We have no set rules limiting what is allocated a channel or to a stock. We are mindful that the wealthiest people are initially 100% concentrated in the stock that made their fortune. If we see an overwhelming opportunity that we like better than most/all others, we go for it up to 30-40% of the portfolio as an initial stake, and potentially more if the investment outperforms. We have observed over time that the percentage of stock in the “locomotives” channel tends to increase as they gain in value and the rising stars morph into locomotives. We are agnostic with regard to how the return is obtained, as long as it is achieved. We appreciate that some investments will be riskier than others: we require more conviction from them to adjust for the increased risk.

Shorts: We use shorts in pair trades, or individually when we see excessive valuations. Our total short stock position (excludes short volatility) generally is less than 20% of the gross portfolio.

Time-tested Rules: We believe that key to successful investing is to invest “within yourself”, i.e. with comfort with the tolerated risk profile and the acceptable time frame. Over time, we have honed certain rules adapted to our investment style. These rules tend to work regularly or at least give us the conviction essential to controlling our destructive emotions. We know we cannot invest perfectly and we will make errors every day, as we miss selling at the highest point or buying at the lowest point. We also believe that the more certain the potential gain is, the least knowledge we have about the timing of this potential gain. In 2007, we knew for sure that the market would recover: we just did not know when, and we also did not know if we had already reached the bottom or had more to lose. Indeed, it was a great time to invest. We just had to reset the investing timeframe to a proper range. Anecdotally, we list below some of our other guiding rules

To establish a position, we need to feel at least a 3/1 win potential, i.e. 3 times more chances to see a the price rise, rather than a price fall. When the odds are 50-50, we lighten up some. When the odds are 1/3, we sell.

Am I acting emotionally or rationally? When I fear, is there a way to reduce the fear, i.e. double down, stretch the time horizon, do a “redeeming” trade, i.e. have a plan to enter a winning trade at a losing time. When I feel great, shouldn’t I sell? After a peak is achieved and investors are happy, they are even more reluctant to lose their gain, they lose their thirst and as such tend to accelerate the down swings. When making investment decisions, to feel happy generally leads to bad choices, to feel anxious leads to good choices. No pain, no gain.

Experiencing interim losses is normal when seeking superior returns. The tolerable losses are generally proportional to the potential gains, as proven by the mathematical martingale law.

In summary, we believe that high conviction and disregard for interim losses give us some comparative edge in achieving our goals of superior returns.