‘Know thyself’... and avoid sinking your own ship

Christopher Dixon

Cooper Investors

In ancient times early cartographers would illustrate mythological sea monsters into the edges of their maps. The fantastical images of serpents and basilisks represented dangerous areas where ships had been lost, and unexplored territories through which mariners feared to sail. Says Thomas Sander of the Washington Map Society, “It was a way to say there’s bad stuff out there”.

There is wisdom here for investors.

In his book “Big Mistakes: The Best Investors and Their Worst Investments” author Michael Batnick chronicles a veritable hall of fame of legendary investors and where they stuffed up big time. In for the treatment are the likes of Jesse Livermore, Ben Graham, Stanley Druckenmiller, Jack Bogle, Warren Buffett and Charlie Munger.

All the classics are here - poor risk management, allowing ego to take over, an unwillingness to accept losses and move on. But arguably the most valuable area of learning and one which links the others together is that of understanding one’s own limitations. Get this nailed, stay disciplined and it seems the most grievous errors investors are prone to make should fade away.

One example given by Batnick is that of Michael Steinhardt, widely considered one of the best traders of all time. Yet his fund lost almost 1/3rd of its value in 1994. How did this happen?

Steinhardt was an expert stock trader, specialising in small and mid-cap equities. However, with great success (and significant fund flows) came overconfidence and in 1993 he launched a new fund that dabbled in overseas sovereign debt using complex derivatives. Despite having no expertise in this area, he pushed in hard with dire consequences, the fund losing 29% in 1994 after a near unblemished record up to that point. He retired the following year.

The importance of understanding and staying in your ‘Circles of Competence’ is crucial and arises from a core philosophical appreciation of Humility.

At Cooper Investors, Humility is a key cultural value that forms part of the CI Way. It’s a characteristic that we seek when hiring, that we aspire to as professional investors, and indeed something we’re tracked and measured upon during performance reviews. We love to analyse what we’re good at, and what we’re not. We want to be deeply intimate with our limitations, whilst also celebrating our strengths and focusing our efforts on getting better at what we’re already good at.

With an appreciation of the benefits of Humility and operating within our Circles of Competence, we not only avoid the pitfalls of over-reaching, but we also strive to find similar behaviours amongst the proprietorial management teams we invest alongside.

So, at CI we do one thing and one thing only: long-only equity investing. Further we only invest in companies with easy to articulate strategies, clear financial accounts, businesses that excel in one or two areas and when we can identify and discuss with management a pathway to realising value latency. 

We like companies that understand exactly what their ‘secret sauce’ is and when expanding their business maintain a very tight focus based on this. It might be something that appears incredibly simple – Costco’s membership-based retail model or the capital deployment process inside Halma or Constellation Software. Yet these companies appreciate the power and purity of simplicity, combined with an extreme suspicion of stepping outside what has made them successful.

Does this imply a restriction on innovation or a requirement to always ‘play it safe’? By no means. For our investment teams and the companies, we invest in we desire to see Humility combined with energy and a hunger for long term success that will of course necessitate taking a degree of risk. But like the medieval Captains who understood the dangers of sailing beyond sight of shore, investing inside the Circles of Competence means that necessary risks are considered, understood and taken on willingly.

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Christopher Dixon
Christopher Dixon
Portfolio Manager - Global Equities Funds
Cooper Investors

Chris has been co-PM of the CI Global Equities Fund since November 2011, focussing on European and Japanese companies. He has travelled extensively, living in four countries and investing across multiple asset classes over his 15 year career.

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