Managing your own capital on a full-time basis is a constant process of learning and self-improvement that requires conviction in your views and the ability to shut out external noise and focus on what matters. If you get it right though, all the ups and downs are more than worth it.
I run Capital H as if it is an extension of my own investing, mainly because it essentially is, with the majority of the Fund comprised of my own capital. As a result, my approach is more akin to a private investor than a typical fund manager. So I felt these insights might be worth sharing with other private investors and SMSF trustees - and there are a lot of us - whose full-time job it is to manage your own capital. Keep in mind they are my views only. Hopefully, it provides some value, or sparks an idea or two.
1) Assess The Downside First
The majority of company analysis focuses on the upside potential of a company - how fast it is growing, how the margins are expanding, how impressive the management team are and how potential acquirers are looming. This is great and an essential part of your research but before looking at any of this you should assess the chances of permanent capital loss.
In practice, you’ll find that trying to precisely forecast growth rates and profitability is a very difficult task, even for the highly skilled analyst. What is easier, and much more in your control, is assessing the potential downside. If you can find investments where the price you are paying allows for minimal or even nil downside then chances are the upside will take care of itself.
This is similar to the premise of finding investments that have a built in ‘margin of safety’ - the gap between your assessed valuation and the market price of the stock. But protecting your downside should go beyond just looking for a moderate margin of safety. You should be looking for opportunities where the downside is as close to zero as possible. I can’t repeat it enough: protect your downside first and go from there.
2) Don’t Diversify, Concentrate.
‘Concentration’ means something different for everyone. To some, it may mean Charlie Munger, ‘100% in my best idea’ - type concentration. While to others 10% of a portfolio in one stock might be considered concentrated. The exact meaning of ‘concentrated’ is largely irrelevant as it depends on your skill level, goals, expectations, risk tolerance, investment horizon and myriad other factors.
But the key point is that backing yourself when you have high conviction in an investment is absolutely critical to generating outsized returns.
One of the things I believe in strongly, that may seem counterintuitive at first, is that betting big when an investment completely ticks all of your boxes is a risk reduction strategy. When something comes along and your extensive research suggests that the downside is nil with significant upside then you need to position size accordingly. These opportunities are very rare, maybe one a year if you're lucky, and betting small when you find one will simply sell yourself short in the long run.
Further, my view is that concentrating in a smaller number of attractively priced businesses that you know better than any other analyst in the market is a lower risk strategy than building a diversified portfolio in a larger number of companies that you know little about. In the latter scenario, you may as well just buy the index.
You’ll find that most of the great investors made the majority of their returns off a handful of investments. If (and only if) extensive research results in an investment ticking all of your boxes with minimal or nil assessed downside, act accordingly.
3) Be Optimistic But With A Bias Towards ‘No’
When you assess a new company or have an initial meeting with the management team, go in there with a bias towards saying no to investing. ‘No’ should be your default. The simple fact is that truly great investment opportunities are rare, you might get one come across your desk each year with a handful of ‘decent’ opportunities or trades thrown in along the way. The vast majority of companies you assess will not be worthy of your capital and it is your job to wait patiently for the rare one that comes along that you just can’t say no to.
This is the opposite of what many investors seem to do. They feel impatient to deploy capital and begin their research with a bias towards saying ‘yes’ to an investment. This is only compounded by the fact that the management team and their commentary to the market almost always has a positive bias - no company ever tells you “Now is probably not the right time to buy our shares.”
Lean towards saying no from the get-go and let your research determine whether you should change your mind. You’ll find the best investments are the ones that you just can’t say no to.
4) Aim High
For a fund manager with hundreds of millions, or even billions of dollars, under management, they are playing a very different game to you and I. For them, a ~20% p.a return over a medium to long-time frame is superstar status and will probably see them flooded with inflows. They have a fiduciary duty to their clients, set rules/mandates to abide by and a comprehensive list of business, marketing, compliance and administrative requirements to meet each and every week. It can be a demanding task and only the very best will manage all these obligations and still beat the market.
But you aren’t a fund manager. You have enormous advantages. You can move in and out of a stock without moving the market. You can set aside large chunks of time dedicated to researching just one company without any distractions (you’ll find fund managers find it difficult to do this, they have a portfolio of stocks to monitor and countless email invites for meetings and calls with numerous potential new investments). And perhaps most importantly, you don’t have clients breathing down your neck when you have a bad month or two.
Don’t get me wrong, fund managers do have numerous advantages over the rest of the market, namely access to research, company management, deal flow and infinite more resources than you do. But I guarantee you that some fund managers would kill for the advantages that you, as a private investor, have access to. Put simply, it is a whole lot easier to make 50% on $1m that it is on $100m.
And because of these advantages, it is my view that if you are managing a relatively small pool of capital (say <$5m), and willing to dedicate yourself full time to this, that you can expect - as an average over a long enough period - to generate returns that are in line or above some of the best fund managers in the industry, albeit on a much smaller capital base than what they are managing.
The usual response to the above would be to ask: if we pursue higher returns shouldn’t we also expect to take on more risk? My answer to that is no, higher expected returns, in this case, do not necessarily require taking on a greater level of risk, but it should be expected to require a significantly greater investment of time and effort.
5) Be Willing To Invest The Time
If your goal is to generate outsized returns as an active private investor then you really need to be willing to invest the time and energy in the pursuit. This is a full-time job. You are up against the best and brightest who are all trying to find investment opportunities before you do. Perhaps even more challenging is the fact that you're up against people who genuinely love this. Personally, this is a passion, I’ve just been lucky enough to turn it into a career. I’ll read ten-year-old annual reports on a Sunday night with a smile on my face. Loving what you do is an incredible advantage over the competition when it comes to your ability to outwork others.
If you're one of the lucky ones who genuinely enjoys doing this - and since you're reading Livewire right now, the chances are high that you are - then invest the time that is needed in order to achieve your goals. The correlation between time, effort and results in this game are high.
That said, there is absolutely nothing wrong with doing this on a part-time basis or just as a hobby, but be realistic when setting your expectations in line with the amount of effort you can invest in this pursuit.
6) Do It For The Love Of It
Being a self-directed or private investor is incredibly rewarding and enjoyable. Success in this venture can completely change your lifestyle for the positive. But it is also hard work with a lot of ups and downs that some people handle better than others. Everybody should actively engage in learning, understanding and to some extent managing their own investments but only set out to do this full time if you genuinely enjoy the process.
A few extra percentage points a year aren’t worth it if it causes you undue stress or emotional hardship. Investing should be a net benefit to your lifestyle and relationships. What most won’t tell you is that if you want to do this right you need to be willing and able to commit a sizeable portion of your week, each and every week, to research and due diligence. If you can’t or choose not to do this then you may be better off using that time to find skilled, well-incentivised managers to outsource and do it for you. And despite the claim that index funds have destroyed active management, there are still many high-quality investment managers who would be fantastic stewards of your capital, and chances are they contribute right here on Livewire so you won’t have to search too far.
And what if you do a have love for this? Then the time and energy required to do this successfully will be more than compensated in the financial and emotional rewards that you will receive in return.
Commit yourself to a continual process of self-improvement and ongoing learning and be ready to play the long game.
Founder of Capital H Management and Portfolio Manager of the Capital H Inception Fund. Previously worked for Pie Funds and Bligh Capital.
Good stuff Harley! A perspective not much talked about in this forum. First and last lines sum it up for me; the attitude if not the process. Spent half my life working for the man and while I can’t rule out doing it again, the money I make on accrued capital is more important than wages. I don’t outdo wages every year but the entire experience of investing is cumulative- consciously so. Take the good with the bad, learn from both and become a better investor. I would add that amateur investors tend to focus on the story (too much), while professionals focus on the numbers, at least in the first instance. If you are not comfortable with financial analysis, forget it. You’ll always be reliant on the opinion of others. Just pick one of them to do the job for you. I like your investing principles and will keep them for future reference and reassurance; probably when the market is tanking. Thanks for your insight. Ron
As a retiree in my 70's (lifetime working in financial services admin roles) and now having self managed a small precious little bundle of capital over the last 4 years, which I can not afford to loose but also simply must earn me well above bank td rates, I have found this commentary of yours to be excellent Harley. I am new to Livewire and my initial reaction is very positive. Some of the stuff I get is very noisy, and sage well constructed guidance such as you have provided above is truly valuable to investors like me. Because I have subscribed and followed a number of stock tipping services over the years (mainly small cap based), I have learned a lot and had my wins and losses but overall, given what has happened in our market over that time, to date I am still not quite in positive territory. Looking back, the main weakness has been trying to build a collection of too many well spread winners and not backing my best decisions long enough or big enough, and not abandoning my bad choices early enough. Prime examples of the former in my case would be HUB; ORE; and S32; and of the latter, PDN and RXL. Lots of time, effort, and mistakes, but I find it really engaging and enjoyable in spite of the disappointments. Last 12 months has seen me perform much better as I have moved more towards more established less spectacular stocks which can provide both income and growth prospects (AHG; ALU; SIQ; IPH)
Good stuff Harley - it is re-assuring reading your article as I have only recently adopted much the same approach over the last twelve months after concentrating too heavily on TLS for a big kill 18 months ago and I came unstuck badly badly. My main problem at this point is forcing myself not to "deploy capital" just because it seems to be sitting there and not doing anything. Your points will help me to fine-tune my approach. And you are right in saying that it takes up a lot of time each day - but I have to offset that with the 25% return I've achieved in the current financial year. I am a 70 yo self-funded retiree. Thank You for the advice.