...from the hallowed halls...Quite a few times I have mentioned my opinion that normal equity returns will continue to exist but we may have to look harder to find them.
Yesterday's post on Vietnam, which ties in with looking harder, got me to thinking about something that theoretically takes on relevance if looking harder turns out to be correct.
If we allow that normal means a 10% annualized average return then in a simplistic world $100,000 invested on June 11, 2007 would be worth $235,794.76 on June 11, 2017.
What if, instead of putting $100,000 into a diversified portfolio one year ago you put it all into Potash Corp of Saskatchewan (POT)? Your 1368 shares would have been worth $301,726.08 based on yesterday's closing price which is almost $70,000 more than you would have hoped to have nine years from now.
In this obviously extreme example an argument could be made for selling the stock (paying the gain if held in a taxable account) and putting it in short term money or otherwise taking no risk for the next nine years. Selling the POT after a year and a day, paying the 15% and then averaging 3% per year would leave the original $100,000 at $343,886.48 in June 2017 when last June your target for that time was originally $235,794.
Before anyone adds 1+1 and gets eleven let me explain where I am going with this by way of yesterday's example with VOF.L. To recap, bought at $2.48, sold half in a few months at $4.73 and still have the other half now priced below $2.00.
If you accept the notion that finding normal equity returns will come about by looking in places that are less familiar to us then you can conclude that less familiar must include some countries/groups/themes/asset classes that are more volatile than buying a combo of SPY/EFA/IWM for your equity exposure.
Relative to less familiar there is nothing out of the ordinary with the sort of move VOF.L had. A diversified portfolio that includes these sorts of things could easily have a couple of things that go up 50-100% in what seems like a short period of time. I'm gonna say if you own something that goes up 100% in three or four months you need to at least consider selling some or all of it.
The psychology of taking a short term gain like this is you just got a few year's worth of return in a few months, you were lucky, take the gain. The reality of this sort of thing is that often big moves often go the other way when the momentum runs out of steam.
In hindsight, based on price, clearly, selling all of VOF.L would have been better. Too much sitting on things that go up 100% and then cut in half without any action prevents you from getting to where you need to be.
The point of this is that if normal returns are going to be more difficult to come by and you are willing to look for them in new (to you) places you will probably need to reorient your thinking about holding on to things. Go ahead and buy with the intention of holding if your so inclined to think that way (and I am) but be willing to take a large gain when the market gives it to you. A 2% weight in something that doubles in a few months adds 200 basis points for the year which is a lot if you are targeting a "normal" equity return.
To tie in the POT example if you can add 200 basis points in the manner above you are a little bit ahead and do not need to rush back in to something else.
It is unlikely that a portfolio will be chock full of VOF.Ls but future success may require having a few of them. If so, then the thinking will need to expand/evolve.
The picture (not mine) is of Hepner Hall at San Diego State University. In my four years there I only had one class in that building.
4 comments:
Good post, Roger, about VOF.L. Now, what do you do with the shares that you still hold? For example, if it doubles again, do you sell 1/2 of what you have left? Or, if it cuts in half from here, do you sell 1/2, sell it all, buy more, or ??? Thanks, JCarr
sorry but no single answer. two things before giving any answer is that my thinking is influenced by 2 things. i have mentally committed to this as a very long term hold and all that is left in there is the house's money.
My thoughts about what to do would differ if it doubled in four months again as opposed to 18 months. I have not bought more yet it has cut more than in half from the peak so buying on the way down, for me, for this, seems unlikely as I have not done it thus far.
over a ten year period I think Vietnam will outperform the US many times over and my very small holding allows for capturing that if it turns out to be correct.
Great post Roger. I, too, use similar thinking in my decisions on when to sell something that has risen parabolically. Not sure if it's original or not but I call it "Rubber Band Theory". In essence, the faster and higher you pull a rubber band the more painful it will be when it snaps back. So I keep an eye out for things that go vertical very quickly, no matter what the reason might be. I tend to take some (or all) off the table when that occurs.
Of course, the crux lies in the quantification and the magnitude of such stretches. I personally tend to look at the move in relation to a beta or standard deviation to guage how far outside "normal" the move might be. It's more art right now than science (but I am in the process of trying to put some hard numbers and a formula on it).
I like the way you framed the example with looking into the future and the "what comes next" aspect. I think that most investors are predisposed to believing they are going to get rich if they own something like Potash and it goes parabolic. Rather than thinking of it in terms of how it might help them reach their goals, it suddenly becomes "how it might make me rich" and all rationality disappears on the sell decision.
My 2 cents...
Jeff I would also add as a possible issue extrapolating/projecting monster returns into the future as being repeatable.
Over the long term an average investor can expect years of lagging and beating the market. One or two of those beats could reasonably be expected to be big. Get one of those early on and it possible creates an inflated sense of skill as opposed to knowing every once in a while you have a great year relative to the market.
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