Puzzle Financial Advice

The web page is intended as an extension of a document that I prepared for clients some years ago. http://www.puzzlefinancialadvice.com.au/Puzzle_investment_toolkit_140522.pdf  However, there is no definitive body of investment knowledge.  In the 24 years that I have been advising, the research-proven and accepted-theory of investment (and economic) knowledge has advanced considerably. And there-in is the first key piece of wisdom for investors - you will invariably be investing without 100% knowledge, but everyone is wise after the facts.

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Here are a list of strategies that work with significant probability over time. But first, let me emphasise that volatility is part of the journey. If you wish to have no volatility, invariably you will be limiting your medium-term returns - and missing great investment opportunities. http://puzzlefinancialadvice.com.au/Knowledge_base.htm#VolatilityVariability

• Value stocks out-perform growth stocks over most 5 and 10 year periods on broad average though obviously this has not been so from 2010-2020. Fama and French - early 1990s. http://www.investopedia.com/terms/f/famaandfrenchthreefactormodel.asp

• Before Fama and French's research, the best Modern Portfolio had to offer was that the most efficient portfolio was the index. Reference:   https://en.wikipedia.org/wiki/Capital_asset_pricing_model   In effect, Fama and French research disproved that. In effect, Fama and French's work showed that the concept of stock (or portfolio) beta is flawed.

• Fama and French also show that Small Value out-performs Large Value over most 5 and 10 year periods.

• During the first decade of the 2000s, the Low Beta effect was isolated, and was shown to be separate and independent from Fama and French's Value effect. The Low Beta affect https://en.wikipedia.org/wiki/Low-volatility_anomaly  is that over most 5 and 10 year periods, low volatility stocks out-perform higher volatility stocks. Again, this breaks the Capital Asset Pricing Model of the 1980s.

• Contrarian investing also can work very effectively. Kerr Neilson, founder of Platinum Asset Management ( https://www.platinum.com.au/kerr-neilson/ ), and one of the most proven long-term investors in Australia, is living proof of how effective contrarian investing can be.

  • Part of what is behind Contrarian Investing, is Behavioural Finance https://en.wikipedia.org/wiki/Behavioral_economics    One of the aspects of Behavioural Finance Theory, is that investors swing (as a herd) between over-pessimism and over-optimism. A corollary of this observation is that the most "unloved" part of the share market is probably (almost by definition) also the cheapest. So extreme negative sentiment is a positive inndicator pointing value investors to sections of the market that my perform best in future.

• Buy cheap stocks. If the Net Present Value or Discounted Cash Flow value of a company is substantially cheaper than the market capitalisation of the company, on average you likely to get a good return. This is the sort of approach Warren Buffett takes.

• Good stock picker without too much funds undermanagement.  This also tends to be a useful guide to strong future returns.

• Be smart about diversification.

  • Michael Kitces at the 2012 National Portfolio Construction Conference, pointed out that that, if you go back to the original paper written by Markowitz (on divesification https://www.puzzlefinancialadvice.com/basic-investment-theory ) , Markowitz does indeed firstly ask investors to identify “different assets” (preferably ones that as as uncorrelated as possible), but then to apply judgement and only diversify between asset classes that have a reasonable chance of getting a good investment result.

    • http://puzzlefinancialadvice.com.au/2017/Diversification/120826_Portfolio_Construction_conference_notes_Kitces_on_Diversification.pdf

    • But that is just common sense. Right?

    • At the same conference, Nick Bullman also agreed that at times, proper application of Modern Portfolio Theory sometimes leads to very concentrated portfolios. More discussion at the notes from that conference at the link above.

  • Warren Buffett said : “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” http://www.investopedia.com/ask/answers/031115/what-did-warren-buffett-mean-when-he-said-diversification-protection-against-ignorance-it-makes.asp

    • In Buffet's view, studying one or two industries in great depth, learning their ins and outs, and using that knowledge to profit on those industries is more lucrative than spreading a portfolio across a broad array of sectors so that gains from certain sectors offset losses from others.

    • http://puzzlefinancialadvice.com.au/2017/Diversification/171024_What_did_Warren_Buffett_mean_when_he_said_Diversification_is_protection_against_ignorance._Investopedia.pdf

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Another key thing that can be of major benefit to investors, is identifying areas of major risk to your capital. Some of the major danger indicators are:

• High cyclically adjusted Price/Earnings ratios.

• An economy with high private debt/GDP by historical standards – See Richard Thalers comments attached and also another Nobel laureate’s views here.  https://www.puzzlefinancialadvice.com/single-post/2017/10/12/100-year-future-assessment-from-Nobel-laureate

• A market or sector that is in a secular bear market.

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I will extend this discussion over time. So perhaps next time you visit, there might be more here. I will also expand on some of these points.

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Some references with interesting messages:-

• Bill Ferris - chair of Innovaton and Science Australia - on picking winners.

  • 'The six collaborative research centres (CRCs) established by the government were welcomed by Mr Ferris as an enlightened way of 'picking winners'. "That term gets used pejoratively, but I've spent a career in venture capital trying to avoid losers," he said.'

  • http://puzzlefinancialadvice.com.au/2017/AFR/170920_AFR_Bill_Ferris_five_steps_to_an_innovation_nation.pdf

• Sectoral approach to investing - a variation on contrarian investing.

  • 'One of the most straightforward approaches to buying stocks is to start by looking at share prices that are lower. Not every bombed out share is a bargain. Many stocks that drop significantly are permanently changed, and possibly on their way out the back door. At the same time the best time to buy a good business is when it is temporarily out of favour.'

  • http://puzzlefinancialadvice.com.au/2017/AFR/171018_AFR_ASX_sectors_that_offer_value_for_sharemarket_investors.pdf