1. “We need to stop pretending that we can divine the future, and instead concentrate on understanding the present, and preparing for the unknown.” Montier makes the same point as others have repeatedly made in this series of blog posts: “Frankly the three blind mice have more credibility than any macroforecaster at seeing what is coming.” In addition to bets where possible future states are known and probabilities are known, there are bets which involve known states and unknown probabilities as well as bets which can be impacted by unknown future states where probabilities can’t be computed. Anyone who does not prepare for the unknown by recognizing it is unknown, is unwise. Montier adds: “To admit ignorance is actually liberating in the extreme. It frees you from all the needless fretting over the things you can’t control. Once you have said you don’t know, you can think about how you deal with this ignorance.”It should not be a surprise then that people like him are focused on making investments which do not require macro forecasting. Why not put capital to work in situations where the system which must be understood to make a profitable investment is orders of magnitude simpler? Why put capital at risk based on forecasts regarding the macro economy? Why not focus on understanding the intrinsic value of individual companies?
2. “Why do we persist in using forecasts in the investment process? The answer probably lies in behavior known as anchoring. That is in the face of uncertainty we will cling to any irrelevant number as support. So it is little wonder that investors cling to forecasts, despite their uselessness.” Montier is an expert on behavioral economics and knows that people will seek out and try to make bets based on forecasts despite the dismal track record of forecasters. He recognizes that fighting overconfidence is a constant battle for even the intelligent investor since being aware of a dysfunctional bias is not enough to keep you from falling prey to it. Nobel Prize winner Daniel Khaneman has written that despite devoting his life to behavioral economics he still suffers fallout from the same behavioral biases as everyone else.
3. “There is a simple, although not easy alternative [to forecasting]… Buy when an asset is cheap, and sell when an asset gets expensive…. Valuation is the primary determinant of long-term returns, and the closest thing we have to a law of gravity in finance.” One irony of value investing is that by focusing on the present moment and the intrinsic value of an individual stock, you best prepare yourself for the future which is impacted by macro phenomenon. Montier suggests blocking out the “noise peddlers” ranting about macro factors and instead focusing on intrinsic value.
3. “Process is the one aspect of investing that we can control. Yet all too often we focus on outcomes rather than process. Yet ironically, the best way of getting good outcomes is to follow a sound process.” Good outcomes are not necessarily the result of good processes. Similarly, bad outcomes do not necessarily result from a bad process. In probabilistic activities like investing, process will dominate outcomes over the long term, so the best approach is to focus on process not outcome.
5. “Always insist on a margin of safety.” The best hedge against mistakes and bad luck is to have a margin of safety. My thoughts on margin of safety are here: http://25iq.com/2013/01/02/charlie-munger-on-margin-of-safety-the-fourth-essential-filter/
6. “This time is never different.” If someone says to you that the rules (particularly in a financial context) have changed and that X is no longer important, hold tightly on to your wallet and extricate yourself from the situation. To not study history is to invite misfortune to haunt what you do.
7. “Be patient and wait for the fat pitch.” Montier has quoted Winnie the Pooh on this point: “Never underestimate the value of doing nothing.” The “fat pitch” is a bet which presents a small downside and a big upside with the odds being substantially in your favor. When you encounter such a bet, bet big. It’s that simple. The number of times you will encounter a fat pitch is small so you will need to be patent, spending most of your time doing nothing. Too many investors suffer from “action bias” says Montier.
8. “Be contrarian.” To achieve results which are better than the market you must by definition make a bet occasionally that is contrary to the view of the crowd, and you must be right about that bet. This must be true since the crowd is the market. This is not easy since “humans are prone to herd.” To be “greedy when others are fearful and fearful when others are greedy” means being occasionally contrarian, which is not a natural state for most people.
9. “Risk is the permanent loss of capital, never a number.” You can’t quantify the unquantifiable For example, the Value-at-Risk concept says Montier “cuts off the very part of the probability distribution (the extremes) that you most need to worry about.” He adds: “Regulators adopting Value-at-Risk is a little bit like asking children to mark their own homework.”
10. “Be leery of leverage.” As Charlie Munger has said: “I’ve seen more people fail because of liquor and leverage – leverage being borrowed money.” Montier adds: “Leverage can’t ever turn a bad investment good, but it can turn a good investment bad. When you are leveraged you can run into volatility that impairs your ability to stay in an investment which can result in “a permanent loss of capital.”
11. “Never invest in something you don’t understand.” My views on circle of competence are here: http://25iq.com/2012/12/22/charlie-munger-on-circle-of-competence-the-second-essential-filter/ Montier adds: “If something is too good to be true, it probably is.” Both the complexity and non-transparency of any investment are not an investor’s friend.
12. “One of the most useful things I’ve learned over the years is to remember that if you don’t know what is going to happen, don’t structure your portfolio as though you do!”