Podcast Series: Katsanelson at Planet MicroCap

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The Planet Micro Cap Podcast is hosted by Robert Kraft. The podcast’s main topic is interviewing though-leaders in the micro-cap space but from time to time other guests take part. This time I was thrilled to see that Kraft had interviewed Vitaliy Katsanelson.

For those of you who are avid readers of InvestingByTheBooks will know what we think of Katsanelson and his books. Both his first book Active Value Investing and his second The Little Book of Sideways Markets  are top-rated at the site.

For those who have read Katsanelsons books this episode is partly a repetition of how he views investing, but it also gives another angle as he discusses his own views of his books, how the last years have shaped him as an investor, his current view of the market, and his advice for young investors. He also mentions a 15-page article he hasn’t published yet about the pain and suffering he has experienced as an investor…

The Importance of Finding a James Montier

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A Recent Dinner

Yesterday a number of friends gathered at a seaside restaurant in sunny Stockholm for a pleasant dinner. This specific party consisted of persons from the financial sector that usually gather once a quarter to eat, drink a few beers and discuss financial literature. The theme for this specific occasion was books that had a decisive impact of how one looked at investing going forward, those books that in a major way changed how we think about our occupation.

For me a number of potential authors could have been viable choices: Philip Fisher, Ben Graham, Edwin Levère, Nassim Taleb and in later days Howard Marks. Still, in the end there were only two real contenders and they were Michael Mauboussin and James Montier, of which - at least in those early days – the latter became my largest inspiration. In all honesty, the time when they were the most influential was actually before they published the books that today make it to the top half of our site’s top list of the best investment books of all time. This is because, similarly to Marks’ brilliant The Most Important Thing, both Mauboussin and Montier later published books that consisted of a number of research notes that previously had a profound effect on my view of how investing functioned.

The Crash

The books that you appreciate the most are often those that inspire you at important junctions of your life – just as the best music of all times is always for some reason released in one’s youth. To understand the impact Montier had, we have to take a step back to the 1990’s and early 2000’s. I had gone to business school, picked up some of the practical tools of the trade through working in corporate finance and in fund management and then almost exactly at the peak of the TMT-bubble I joined one of Sweden’s largest asset managers as a global telecom operator, telecom equipment and media analyst. And then the downturn started.

This asset manager had been early in into technology and telecom stocks and also prudent enough to gradually scale down holdings in the more aggressive Internet-stocks as the craze continued and valuations became more and more detached from reality. Still we didn’t fully appreciate how much of the growth within telecom – which we saw as something much more tangible – was dependent on a temporary investment boom. I was too young to have a full systems understanding and we lost tons of money. That is, in reality we outperformed the market but we still lost our shirt and mostly so in my sectors. At one time our seasoned and very well known head of equities in frustration burst out saying “We will never own one single bloody telecom stock again!” Not what you want to hear as an aspiring young analyst.

As a side note, this head of equities quite early got us/me out of one of the positions I had inherited, namely a holding in Worldcom. I had met Bernie Ebbers and although he left a very questionable impression the stock was dirt cheep. It’s hard to argue against a PE-ratio of 7, but the stock just kept going down. At one point my boss told me, “There is something we don’t understand here. Get out.” What we didn’t understand at the time was of course that much of the earnings were fabricated to start with. Ebbers would end up in jail and the influential cheerleading telecoms analyst Jack Grubman at Salomon Smith Barney was to be banned from the profession for life. In this instance we saved most of our money but there were other positions were we weren’t as lucky.

As the saying goes, victory has a hundred fathers, but defeat is an orphan. It wasn’t at all that anyone at the firm I worked for blamed me for what was happening, but I still felt quite a bit disillusioned. The sell side hade 95% buy recommendations and kept those for most of the downturn so there wasn’t much help to be had from that direction. In retrospect I probably over-compensated my absent overview of events by digging even deeper into the intricacies of which equipment vendor that had the best DWDM-technology, which mobile operator price plan that was most competitive and so on.

On top of things I lacked a clear path to develop and take my game to the next level. I wanted to work with more than just a few sectors and it was also clear to me that what I knew about markets wasn’t sufficient. Obviously the stock market wasn’t the rational equilibrium that I had read about in school or the hysterical joyride I had participated in during the late 1990’s.

And Then Enters

At this time James Montier of Dresdner Kleinwort steps through our door. Today, he’s got thick hair and a knack for wearing Hawaii shirts, but by then he mostly looked like a football hooligan – albeit a fairly cultured one. This was definitely the regular sell side analyst.

The timing for someone to try to market the concept of behavioural finance as Montier did couldn’t have been more opportune. It was so obvious to many of us in the asset management industry that investment psychology played a huge part of how markets functioned.

Montier wasn’t alone in this at Dresdner Kleinwort. Around him he had the idiosyncratic economist Albert Edwards, the quant Andrew Lapthorne and sometimes the fellow strategist Dylan Grice - all distinctly different from each other and as a collective from other firms. They were slightly outlandish, thought like their customers and quite often criticized both how their clients and how the banks and sell side acted. I’m sure that the management at DrKW often must have thought of cutting these renegades loose at several times. But the clients loved it so they stayed on – money talks. Most of that crew later moved on to Societé Generale and today Montier is a strategist at GMO where he has worked with amongst others Jeremy Grantham, Ben Inker and Edward Chancellor.

The papers that Montier and Mauboussin wrote during the early 2000’s became one of the first stepping-stones for me to up my game, to take the next step in my intellectual development. It would be a stretch to say that the two of them were the reason for me becoming such a voracious reader of investment literature from then on; it was rather a parallel development in re-igniting my thinking in how to become a better investor. The self-improvement efforts actually some years later lead to an ambitious book manuscript in Swedish called Edge that no-one wanted to publish as it was “too advanced for the small Swedish private market and not academic enough to become a text book”. Honestly, it didn’t bother me too much as I by then was well on the way to the next level in a still ongoing process of constant learning.

The Next Level

The topics that Montier covered were behavioural finance but extended broader to psychology, neurology and sociology – combining to cool sounding areas like neurofinance. That’s all very fine but the real trick was that he, with a lot of help from the quant team, turned these topics into practical processes and strategies for investors. I was handed investment tools that not all appreciated and that were applicable to a broad set of investment opportunities.

At times the texts presented some stock recommendations but their practicality really didn’t consist of bottom up stock picking. Rather the practical part was how to construct processes, investment methodologies, screens etc. and thereby either avoid falling into the behavioural traps described or instead benefit from others’ mistakes. The biases could be individual or based in crowd psychology and the bubbles that those create. Often the pieces took a psychological bias and connected it to a top down value investing strategy that the quant team a DrKW or Societé Generale then brought to life. It was using investment processes as a behavioural defense. As such Montier brought up topics that were supposed to help their clients to create tools that they themselves could use to sharpen their ability to manage money.

Today quant investors continuously scour academic research for new potential ways to get an upper hand but 15-20 years ago quants weren’t as prevalent as today and few ordinary portfolio managers read many books and certainly not many read academic research. What they do read is sell side research. James Montier read all the academic material and packaged it into a format that investors were used to read. In this way he was instrumental in introducing behavioural finance very early to a large part of the European investment community. With the interest sparked we could all then dig further and when Richard Thaler and Bob Shiller in later years received their Nobel prizes (as did Daniel Kahneman) I and many others could boost that we met those guys years ago.

Montier had a somewhat cynical style and the texts had a typical understated British humor that I grew very fond of. In my opinion Montier’s texts benefitted hugely from the fact that he continually had to meet investors and discuss what he had published. It was applied academia but it had to be packaged in an understandable way and above all, it had to be useful. The scarcest resource for a portfolio manager is his own time. Since the target audience was Europe’s largest institutional investors the language and the expected background knowledge suited me perfect.

The research pieces often had eye catching titles like Placebos, Booze and Glamour Stocks; CAPM is Crap (or, The Dead Parrot Lives!); Keep it Simple, Stupid; Spock or McCoy?; Part Man, Part Monkey; Brain Damage, Addicts and Pigeons; The Folly of Forecasting; Abu Graib: Lessons from Behavioural Finance and for Corporate Governance; ADHD, Time Horizons and Underperformance or Why Waste Your Time Listening to Company Management? Perhaps the most read analysis was called Seven Sins of Fund Management, banning his clients for making seven different stupid types of investment mistakes and then offering his take on alternative approaches.

Still, it might be that the sins text was beaten in popularity by a text called If It Makes You Happy. In it Montier draws on psychological research on happiness and presents his top 10 suggestions for improving this. The motivation being that “some of the most miserable people in the world seem to work in finance”. Most of the time I have been happy to work in finance – but then again I read Montier’s advice early on.

The Books

To date Montier has authored four books. The first called Behavioural Finance published in 2002 builds on a number of lectures that he held as a visiting professor at university. As I had grown used to the research pieces I at the time found it academic, dry and ultimately a disappointment. The second book called Behavioural Investing from 2007 and the third named Value Investing published in 2009 consist of most of the research pieces written by Montier at his time at Dresdner Kleinwort and Societé Generale. The texts are loosely grouped after subject. Then the quartet is finalized by The Little Book of Behavioural Investing from 2010 that summarizes the earlier work in a condensed and readable format.

Although the last book is probably more coherent and fluent than the others and certainly better edited it in my view lacks some of the sprawling energy of books number two and three. During those early years Montier was on a mission. When Behavioural Investing and Value Investing were released I had obviously already read all of the texts and they were rather like old friends but I still reread them and it had the added bonus that I could throw out a ton of research hard copies that I had saved. However, I still have a signed hard copy of Seven Sins of Fund Management saved somewhere in the attic.

During a period I wrote columns for one of the two dominating weekly Swedish business and investment magazines. It is probably true that half of these columns were based on concepts, ideas and examples that originated with either Montier or Mauboussin. Since the topics they had covered were largely timeless and universal a different geography, language and some water under the bridge made no difference - the ideas were as relevant as ever. I would argue that this goes for Montier’s books as well.

Role Models

Now, I’m sure that Montier would have a blast being called a role model or perhaps even more outrageous - virtuous. But, stay with me: in virtue ethics, as famously advocated by Aristotle, we should all be on a path towards our virtuous best selves that will do good deeds. Virtue ethics concentrates on how to become a better person. In this pursuit the truly virtuous persons are hugely important as role models and standard setters for what is good.

Being prosperous as an investor is also down to constant improvement. Charlie Munger and Warren Buffett have always stressed how important positive role models are for the improvement that is required for deserved success. Benjamin Franklin, Ben Graham and Lee Kuan Yew are some of their favorites. To me James Montier brought new insights and perspectives when I needed them to become a better investor. Hence, an intellectual role model at the right place and the right time for me. We can all benefit from one of those.

Kudos, James!

Mats Larsson, June 25, 2019

The Liquidity of a Plasma Market

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Focus on the Abnormal

In a classic 1999 paper called A Framework for Understanding Market Crisis financial risk manager Richard Bookstaber argued that we are analyzing financial risk in the wrong way. Financial risk models often remove the most extreme statistical outliers to create mathematically tidy and statistically convenient representations of risk arising from movements in asset prices.

Unfortunately this creates a risk management approach that works really well when no risk management is needed but doesn’t work at all when risks are rampant, i.e. in a market crisis. Hence, financial risk models should throw out everything but the outliers and look to the structure of financial crises. It’s like markets can take two forms, one where the normal rules apply and another when there seems to be no rules.

Since 1999 a number of tail risk measures has been brought forward such as kurtosis and skew, maximum drawdown and a number of VaR-varieties. With about a decade passed since the great financial crisis the meaning of these figures is however gradually fading in the mind of people in financial markets. Many that have entered the industry the last few years have only seen good times. The VaR-number is nothing abstract; it’s the pain of watching your firm being shamed in media, the desperate outcry from customers over the phone line and the fear of loosing one’s job.

Much has changed in financial markets over the last two decades but unfortunately not allways to the better. Bookstaber’s understanding of how financial crises function is still highly relevant. In this text we will try to learn from one of the most experienced financial risk managers there is to see what can be said about today’s market situation.

 Apart from the already mentioned paper we draw on Bookstaber’s books A Demon of Our Own Design from 2007 and The End of Theory from 2017. The author is the Chief Risk Officer at the pension fund University of California Board of Regents. Earlier he has been both a PM and a risk manager at numerous leading hedge funds and investment banks. Few have longer experience of financial risk than Bookstaber.

Bipolar Markets

According to the traditional academic theory of financial markets, changes in market prices are caused by new information. The market price discounts all available information and only when there is an addition to this bank of data will the price adjust to a new equilibrium. Apart from the trading from a handful of dim witted, to the theory later added ‘noise traders’, that is it.

Obviously this bears little resemblance with how we see market prices behaving. Prices move around most of the time – sometimes violently. And often without any obvious new relevant news being released. Bookstaber brings forward the view that it is actually the market participants’ need for liquidity that dominates the trading of financial markets and subsequently the price movements. An investment bank needs to hedge a swap position, a mortgage desk needs to hedge its mortgage position and a fund manager who sells to meet liabilities are examples given by the author. It’s (mostly) a liquidity driven market, not an informational market.

Bookstaber’s market is a place where liquidity demanders meet liquidity suppliers. Liquidity demanders are demanders of immediacy - to them time is more important than price. Price levels are relevant but do not trump immediacy. Liquidity suppliers meet the liquidity demand and for them price matters more than time. They have a view of the market and take a position when prices deviate too much from what the liquidity suppler thinks the value is. By keeping capital available for investment at the right price and exposing himself to the risks of doing investments the liquidity supplier provides a valuable economic function that is rewarded by a financial return.

Between the two sits the market maker, the transaction intermediary who’s facilitating the trading. Market makers don’t want to take risk and trade with a very short horizon to make money on the bid-ask spread. The market price clears where the immediacy of liquidity demanders balance the price sensitivity of liquidity suppliers. If the immediacy of demanders increases and prices drop, suppliers step in with larger volumes. Liquidity suppliers and demanders serve each other well. In normal markets that is. Suddenly the behavior changes.

To describe how the market changes into something very different Bookstaber uses a magnificent metaphor from physics. In normal times mater is solid and clearly distinguished. “As energy increases, the constituents of matter blur. At low energy levels – room temperature – molecules and atoms are distinct and differentiated. As energy goes up, the molecules break apart and what is left are the basic building blocks of matter, the elements. As energy goes up even more, the atoms break apart and plasma is left. Everything is a defused blob of matter.” Matter is now an undifferentiated soup.

In normal times investors for example compare the PE-ratio of this stock to that stock, the credit risk of that bond to this bond, the potential future profitability of one company from another. Investors develop niches where they are comfortable to compete and sharpen their skill within their circle of competence. However, when the energy of the market goes up there is no time to look to the little things. It’s time to ditch broader segments like cyclical stocks and high yield bonds etc.

When the energy level goes up further all risk assets look the same, correlations go to one and there is a rush for cash, gold and government bonds. All risk assets go down together offering no normal diversification. What matters isn’t what characters assets used to have but who owns them and their immediate demand for liquidity. Risk assets are now an undifferentiated soup.

Critically, in this plasma market liquidity suppliers turn counter-economic. Normally, a lower price entice larger volumes, a larger supply of liquidity. Now a falling price triggers a flood of selling and despite the record low prices buyers are on strike – if they haven’t turned sellers themselves. The buyers might already have lost more than their board can stomach, they have gone through their stop-loss levels, they are busy denying media claims of their firm defaulting, some might have already lost their jobs and all their customers are withdrawing their money. The market maker is flooded with sell orders with no one to take the other side of the trade at almost any price.

Hence, there is an in advance unknowable tipping point where lower prices suddenly counter-economically entice even lower prices in a death spiral of escalating velocity. These tipping points are obvious in retrospect but always missed and misunderstood in real time. Somehow markets and their complexity seem to be beyond our ability to comprehend.

For me reading the chapter on the 1987 crisis in A Demon of Our Own Design was a revelation. Why are researchers still debating what triggered the downturn? It’s written out in black and white from someone who had the doubtful benefit of both a front row seat and the oversight and understanding to make sense of the event.

In short it was a combination of investor psychology, a mismatch in liquidity between the futures market and the cash equities market to act as a trigger and the widespread usage of portfolio insurance that created a self-enforcing negative loop of selling from liquidity demanders while the liquidity suppliers backed away. In his books Bookstaber gives his accounts of all the large market crises of the last three decades to try to make sense of the market dynamics.


Even though the volatility of the real economy has been declining for decades, as measured in the variability of economic growth, inflation and the like, the total risk of financial markets has instead increased. In can be argued that both the 2000/02 and the 2007/09 crises were generated from within the financial system and only later spread to the real economy. Shouldn’t behavior of financial prices and markets reflect the behavior of underlying assets?

Bookstaber describes how a combination of financial innovation, complexity and tight coupling creates unforeseen events that often cascade through the financial system as a crisis. The complexity arises as the agents in the system change their behavior depending on other’s behavior and events are often triggered by the use of derivatives. Due to the constant need for liquidity when using derivatives - and the often-high leverage - agents in the financial system are critically interdependent and the speed of the market trading gives little room for error or time for adjustment when things go wrong.

Time after time new financial products are launched without any real understanding of unintended consequences that can shock the system. Sometimes the risks are even deliberately ignored as the gains will fall to the banks’ personnel but they will not face the losses. Combine our normal-times-based risk models with the non-linear effects of a constant stream of newly invented derivatives plus complex organizations with plenty of politics’ aggravating decisions and you have an accident waiting to happen. That accidents occur in such a system is according to the author to be expected – they are so-called normal accidents that arise by the system’s design.

If we are to understand the market we should according to Bookstaber look beyond traditional economics and instead understand its four building blocks: 1) computational irreducibility – it is a system without mathematical shortcuts to describe it, 2) emergent phenomena – that the overall effect is different from the sum of the individual actions (nobody caused the economic crisis of 2007/09, but it still happened), 3) non-ergodicity – the concept that actions of one agent depend on and are shaped by history, context and the actions of other agents and 4) radical uncertainty – the fact that the system cannot be modeled by using historical events. The really important future developments will be unprecedented.

In effect Bookstaber is describing what others have called a complex adaptive system. When in time such a system reaches a tipping point, hurling it from one energy state to another, simply isn’t knowable in advance.

The key point if we want to understand how such a complex adaptive system behaves during a crisis is the state of the agents in the markets such as the liquidity providers and demanders; “what are their decision cycles; how much are they affected by market dislocations; and how critical is the market stress to their portfolio adjustments?”

Further with regards to the market makers; “what is their capacity for taking on inventory; and how long are they willing to hold these positions? And of the cycle of feedback: how are these answers affected by market dislocations; and how do they in turn further affect funding, leverage and balance sheets?” Some agents will be under more pressure than others. Which assets will they hold and are those who are under stress holding the same type of assets?

In the end the market reaction is determined by the volume of liquidity driven selling, the ability of market makers to take on inventory and the time and price level required for liquidity suppliers to take the other side of the trade.

What About Now?

Since we always regulate the previous crisis the leverage of the banking system is much lower today than in 2007. According to Bookstabber the next crisis will instead be one primarily concerned with liquidity. As a matter of fact, many of the rules that were designed to lower leverage risks have increased the liquidity risks of the financial system. Leverage is observable for those who know where to look but the liquidity of good times is not the same as that of bad times. Hence, the problem we might be facing in the next crisis is less observable.

Looking at today’s situation I would say that there are quite a few potential causes for economic misfortunes that come from outside the financial system. These are the things we tend to read about in the papers; the debt levels of some economically very significant states like Italy, Japan or China could cause problems in times of lower growth; the liquidity effects of quantitative tightening can turn out to be hard to manage; the more populist tendencies in global politics exemplified by events like Brexit and the flow of trade policy changes in the US-China battle for world supremacy; the monetary policy induced low growth caused by economic resources being locked in the many zombie companies that really should have been the subject of creative destruction long ago; or perhaps all the commentators are wrong and economic bull markets actually can die of old age.

Then there are the causes of trouble that hide inside the financial system. I’m bound to forget most of them and in reality what triggers a financial crisis tends to come from a direction where you are not looking. Still, a pair of distress candidates of mine would be firstly the fact that within corporate bonds the BBB-segment has ballooned to encompass half the investment grade market. Hence, the bonds with the highest credit risk have reached unprecedented size and the leverage of BBB-bonds in the US is also at historic record levels. If only parts of these securities would be downgraded this could totally dwarf the high yield market.

Further, even though the leverage of banks has moved in one direction – down – this doesn’t mean that leverage hasn’t moved elsewhere. The private debt market has seen a huge expansion the last decade. Not that this must lead to trouble, but booms in largely unregulated means to take on leverage has at least historically been good contenders for follow-on busts.

Irrespective of where the next crisis will originate there are also a number of factors present that can amplify the effects. The first category relates to Bookstaber’s liquidity demanders. Not unlike the portfolio insurance in the 1987 drawdown, the number of portfolio strategies and market functions that today sell when prices goes down are abundant. There are all the risk-parity and trend following strategies, there are the strategies that scale down position sizes as volatility goes up and the massive selling from delta hedging of derivatives when there are larger price movements. On top of this private clients usually run for the hills at the same time.

The second category of amplifiers has to do with the market making function of today. New regulation has made it forbiddingly expensive for bank market makers to hold inventory that would aid the provision of liquidity. Further the Volcker rule has almost made banks’ proprietary trading obsolete.

The order making is lightning fast and automated making the ‘coupling tighter’ than ever when it comes to market trading. Without much discussion on consequences a huge part of market trading has moved from underlying cash based markets, such as buying and selling stocks, to trading in ETF-units one layer up from the cash based markets. The effect of this is that the liquidity of normal trading of for example a credit-ETF can be great despite that the underlying securities – the corporate bonds - are hugely illiquid. Still, if the liquidity of the top layer would be exhausted in a crisis, the buying and selling drops down to the lower level where the size of the fire exit is made for ants, not a stampede of elephants.

Last of the potential amplifiers, is the category of liquidity suppliers that range from those with minimal time horizons to those that measure their horizon in multiple years. A large part of today’s market liquidity is provided by high frequency traders. In normal times this helps boost liquidity. In more troubled times the evidence shows that the algorithms governing the high frequency trading simply make the HFT-funds exit the market. It’s like the old story of the banker lending you an umbrella…

Related, but working on a different time scale, is that due to the lengthy underperformance the assets under management in active value investing portfolios have been dwindling. Value investors are the quintessential liquidity providers that buy when prices have gone down too far and by this prevent the drawdown from being too severe. Now they are clearly decimated and quant based value ETFs will probably not be of much help as I would guess that they are held by end investors who will try to exit the market in times of trouble.

Much institutional money has the last decade been allocated to so-called alternative assets like unlisted real estate, private equity, hedge funds, and infrastructure. The good thing is that these assets don’t have daily pricing and therefore, at least on paper, are relatively unaffected by the first turbulent stages of a market crisis. The flip side of the coin is that with more funds in illiquid assets the forced selling of institutions due to for example cash calls related to collateral in currency hedging, the selling in what remains among liquid assets can turn out to be more indiscriminate and risk causing forced selling of assets that you really want to buy at the time. The Harvard and Yale endowments experienced this in 2008/09.

Now, private equity is also a potential liquidity supplier so more funds in PE could be of benefit. The problem here is the time lag, the period from the point that a PE-firm becomes interested is something to the time where a public stock company is bought out and taken private is several months. Hardly the liquidity provider to call on to stem an immediate market drawdown.

Nobody can predict when and from where the next large financial crisis will come, nor how it will spread through the financial system and the real economy. Despite this Bookstaber has made an important contribution in articulating and analyzing market functionality in a crisis situation and we are thanks to this at least in a position to clear away some of the fog in front of us.

Mats Larsson, March 5, 2019

Economic moats - A recipe for long-term outperformance

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“In business, I look for economic castles protected by unbreachable ‘moats’.”  - Warren Buffett

The greatest investor of all time - Warren Buffett -breaks down his investment criteria into the following four areas:

1. Circle of competence

2. Great long-term prospects

3. Competent management

4. A fair price

This text deals with the second point but also touches upon the third. In order for a business to have…

Kent Janér

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Investor profile at InvestingByTheBooks: The book The World’s 99 Greatest Investors: The Secret of Success provides a unique opportunity to learn form the most prominent investors globally. In the book they generously share their experiences, advice and insights and we are proud to present these excerpts. Magnus Angenfelt, previously a top ranked sell side analyst and hedge fund manager, will be presenting one investor per month. For those who cannot wait for the monthly columns, we strongly recommend you to buy the book. The investor himself writes the first section below and then Angenfelt describes the background of the investor and comments on his investment philosophy. Enjoy.

Successful investors have two important abilities. One is the ability to identify interesting and potentially profitable investments. This is grounded in a well thought-out analysis of macroeconomic developments, a stock, or some other investment. If the market valuation is too high or too low in relation to what the analysis indicates is correct, things become interesting. The probability of finding a good deal increases if you also understand the reasons for this disparity. If, on the other hand, there is no apparent reason for the disparity, there is a greater risk that the market is right, and you have missed something in your own evaluation. Financial prices assume predictions about the future, but predictions are considerably more uncertain that most of us would like to believe. Accepting and locking yourself into a particular scenario that appears to be reasonable right now is not a good way of handling insecurity. It is better to think in terms of a variety of possible future scenarios, weighing up the possibility of them occurring. The market price should then reflect a reasonably balanced assessment of these scenarios. Because new information is forever becoming available, you should adjust your weightings over time, and therefore also what you think a reasonable market price.

The other ability of successful investors is to identify and handle risk, which is mostly aimed at reducing the chances of catastrophic results from your investments. The worst possible result is so bad that you no longer can, may, or wish to make new investments. Rule number one is to never risk ending up in this situation. Further, it is important to understand which risks you are exposed to, and actively decide whether they are the ones you wish to carry, or if there are particular risks that should be insured or protected against. In many cases it can be wise, for the right price, to have a general insurance against unexpected events or macroeconomic shocks. Mathematical models can be very useful for measuring risk, but they should be combined with practical experience of financial markets. Excessive belief in models, which are of course simplifications of reality, can be downright dangerous. Good judgement and common sense are required, both of which are often underappreciated qualities.


If you as an investor want high riskadjusted returns over a long period of time in a changeable world, you will need to know about financial theory and understand macroeconomic structures and relationships, not to mention politics, including central bank policy-making. Without a certain understanding of these topics (which does not necessarily mean expert knowledge) there is a risk of becoming a one-trick pony, and making the same investment over and over again, despite the fact that reality has changed so that the factors and relationships which ensured success in the past are no longer valid.

Hard work and a passion for what you do are definitely important factors in success!

BORN Laisvall, Sweden 1961.

EDUCATION Janér graduated from the Stockholm School of Economics in 1984.

CAREER His first job after graduating was as a market maker in government bonds for Svenska Handelsbanken. After two years he switched to a similar role at Citicorp in London, working with British gilts. In 1989, Janér started working for the Swedish bank JP Bank with responsibility for bonds and the bank’s investment strategy. In 1998 he founded the hedge fund Nektar Asset Management, where he has been head of investments from the start, and is now also chairman of the board.

INVESTMENT PHILOSOPHY Janér runs Nektar, one of the decade’s most successful hedge funds in Europe. The fund is market neutral and looks for misvaluations between various financial instruments, which are advantageous from a risk perspective. The positions can also be based upon a macroeconomic theme (lower growth, higher inflation, higher volatility, etc.). The emphasis is on interest rate market. The fund usually holds several hundred positions and is characterized by relatively low risk.

OTHER Janér made his name by being one of the most successful investors to take positions on the falling Swedish krona in 1992. Today, Nektar manages over $4 billion. Among the large number of international awards received over the years, for three years in a row Hedge Funds Reviews named Nektar the best market-neutral fund in Europe over the previous ten years. He is a member of the scientific advisory board of the Stockholm Institute for Financial Research, and his hobby is deep-sea fishing.

Source: Kent Janér; Nektar Asset Management.

Real Estate Primer: Part II

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Similarly to other financial companies like banks and insurance companies, but in contrast to most other companies, the layout of the financial accounts for real estate companies deviates from the standard company. We will exemplify by looking at the 2016 financial reports for Klövern and as…

Part I of this Real Estate Primer was published December 2, 2018

Stanley Druckenmiller

One of the "masters of universe" is Stanley Druckenmiller, who here is interviewed by Kirik Sokoloff in late september.

Its a great view/listen in many aspects, I am highlighting a few.


first 10 minutes is about private life

ca 10 min: Some history and background to his trackrecord, 30% cagr.

ca 16 min: Why algos is making his old system of using the markets price signals to make money

ca 22 min: On how he made money, build a thesis and make a small bet, and wait for price confirmation

ca 29 min: On FED

ca 37 min: On big tech

ca 41 min: On big bets & capital preservation

ca 50 min: Your most important job, is to know when you are hot or cold

ca 54 min: View of the us equity market

ca 1 hour 2 min: The rise of populism, wealth inequality

ca 1 hour 6 min: Stanleys book recommendation =>  Charles Murray, Coming Apart

ca 1 hour 8 min: US in the world

ca 1 hour 16 min: His philanthropy



Real Estate Primer: Part I

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Real estate is property consisting of land and buildings on it. Real estate companies are firms that engage in the acquisition, management, development and selling of real estate, generally for a commercial purpose. The ownership of a piece of real estate is by definition a very local undertaking and real estate companies are often classified by the regions where their properties…

Part II will be published within short!

Albert Frère

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Investor profile at InvestingByTheBooks: The book The World’s 99 Greatest Investors: The Secret of Success provides a unique opportunity to learn form the most prominent investors globally. In the book they generously share their experiences, advice and insights and we are proud to present these excerpts. Magnus Angenfelt, previously a top ranked sell side analyst and hedge fund manager, will be presenting one investor per month. For those who cannot wait for the monthly columns, we strongly recommend you to buy the book. The investor himself writes the first section below and then Angenfelt describes the background of the investor and comments on his investment philosophy. Enjoy.

·       Perform only those investments that you understand.

·       I suffer from insomnia when I am in debt.

·       Amat victoria curam – Victory favors those who take pains.

·       In every danger, an opportunity.

BORN Charleroi, Belgium 1926.

EDUCATION Dropped out of secondary school.

CAREER Aged 17, after his father died, he took over the running of the family’s nail merchant business. Aged 30 he began investing in steel factories which, when he sold them in late 1970s, became the foundation for his wealth. He continued to buy and sell, mainly Belgian national companies, and has today an empire of media, oil, and utilities.

INVESTMENT PHILOSOPHY Frère has displayed impeccable timing in his dealings. His strength and strategy predicting changes is business structure, political impact, and long evolutionary trends in industries. He was, for example, the pioneer in Europe on cross-border deals. He foresaw the single European market and the consolidation that would be one consequence of the EU. The valuation is not always the crucial point for him in making decisions, and he invests in both public and private companies. This investment strategy demands specific skills and contacts, and is not easy to apply. He is described by making money by exercising stone cold patience in a serene manner in connection to being a workaholic.

OTHER Frère keeps himself well out of the limelight. He rarely gives interviews (I thank him for granting me one!) or speaks in public. According to Forbes his wealth is an estimated $3.7 billion in 2013, which makes him the richest individual in Belgium. He is nicknamed The Warren Buffett of Belgium. At the age of 85 he made one of his biggest deals so far taking the investment conglomerate CNP private. He is a hunter, athlete, and lover of fine wine. Frère took up golf in his seventies.

 Sources: Albert Frère; Wikipedia; Forbes.

The Knowledge Project Podcast with Shane Parrish: Annie Duke

I am new to podcasts. But beeing a runner sometimes means knee problems, and you need to live life differently, or in my case, sit on a stationary bike.


But if you listen to a great podcast, you don’t mind.

This is a great interview by Shane Parris, and a nice written summary in the link as well.

It two hours long, which is very entertaining, and you soon forget that you are on a stationary bike.

Happy listening & have some skin in the game: https://fs.blog/annie-duke/

Stop reading and play some football!

So since you are at the investingbythebooks site, I guess you have read a few books. But besides reading books ... What else can you do to become a better investor, and not to read another book about value investing?

Lets compare with something else, for example football.  “A huge football fan that knows every tiny detail about the game. He knows exactly what is going on, what the players are doing right, what they are doing wrong. But if you put him on the field, he can't throw the ball because he never did it in his life before.”  It is one thing to know what you need to do, but it is another to execute. Only way to learn how to execute is to actually play the game, or in this case, actually invest your own money”

 Below is a text who is heavily inspired from Geoff Gannon, original here, https://www.gurufocus.com/news/144029/invest-with-style


1) Have Skin in the Game 

Buy stocks you pick yourself. Stocks you can only blame yourself for if they lose you money. The hard work isn’t just analyzing a company and handicapping the situation. It’s putting your own money — and your own ego — on the line.

2) You have to have skin in the game.

You have to risk taking a self-inflicted blow to your money and your mind.  The most important part of investing is trying, failing, experimenting, and adapting on your own. Watch yourself work under real world stress. And be brutally honest about what you see.

3) Keep an Investment Diary

Take some time every day or at the least once a week and just write down whatever thoughts you have. Stocks you are looking at. Months from now and years from now, your memory of what you were feeling and what you read in that journal won't match. And you may not recognize the person who wrote those things. You'll have changed as an investor without realizing it.

4) Keep an Investment Bucket List

If you had to put your family’s money into five stocks before you died, which five stocks would they be? Study companies regardless of their stock price. Keep a list of your favorite companies. Imagine the following limitations:

· You have to invest all of your family's net worth in stocks.

· You can never sell a stock once you buy it.

· You can only buy five stocks between now and the day you die.

It’s amazing how quickly this exercise will force you to distill your thinking.

5) Work more

When authors list Warren Buffett's investing secrets they don't mention that he read every book on investing in the Omaha public library by the age of 11. That he owned stocks in high school. That he took a train down to Washington and knocked on GEICO's door. That he went to annual meetings of companies he knew Graham owned stock in even though he was only a student and Graham himself wasn’t going. Which brings me to the Buffett did that you can do too: 1. Work an absurd amount. 2. Become an expert .

6) Become an expert

Become an expert. You've studied some different stocks now. You've had a taste of Indian stocks, U.S. stocks, Japanese stocks, micro caps, big caps, net-nets, hidden champions, etc. What interested you? What stock was the most fun to research? What did you think you really "got"?  Think about what area you might want to learn more about.  Then become an expert in that area. Pretty soon, you'll develop your own investing style.

7) Invest with Style

Do you buy turnarounds? Hidden champions?  Wide moats?  Brands?  Companies with surplus cash? Family controlled companies? Food and beverage companies? Companies with mind share?  With cutting edge tech?  With a lack of change?  Young companies?  Old companies? Low cost operators? Stocks in industries with little price competition?  Stocks with an activist banging at the gates?

8) One example – of someone with an investment style…

One example of  investment style”, watch an interview — any interview — with Tom Russo, for example he gave three lectures at Columbia. He is a buy and hold investor. He is a global investor. He likes brands. He likes food and beverage companies. And he likes family controlled companies. He wants a high return on capital and the ability to reinvest that capital for many, many years to come. He cares about price. But he’s a lot more flexible on price than most value investors. Just Google him.

To summarize, grow your own style, and play some football!

Selling and Selling Short

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“Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you would come out as a winner […].” /Charles Ellis

When it comes to investing in portfolios of individual stocks, it doesn’t matter if your benchmark is an index or an absolute return number; there are still two basic ways to beat that target…

Insurance Primer

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Life presents us all with a wide variety of risks. This gives us a choice to either accept the consequences of those risks, should they materialize, or to try to protect ourselves from these consequences and by this reduce the exposure to various perils. Insurance companies protect against the financial risks of both retail customers and those of corporations. Those who…

Warren Buffett’s only public investment thesis

Although Warren Buffett is open and transparent about most things he never discusses the details of his investment theses. That is too bad since that is probably what most of us investors are interested in. But there is actually one investment case that he has described publicly. And it is not any investment, but his favourite and probably most important investment, Geico.

Warren wrote the article when he was 21 years old and working as a security broker at his father’s investment firm Buffett-Falk & Co. He had just received his degree from Columbia where he studied under his mentor Benjamin Graham.

What struck me is that, contrary to public perception about his old strategy, Warren was investing in a fast growing company with competitive advantages. Although he paid a value multiple of 8 times earnings, Geico was clearly not a cigar-butt or liquidation play. On the contrary, Warren discusses the advantages the company has compared to its competitors. Another thing that struck me is that he only mentions management and insider ownership briefly. That is a factor that he has focused more on as he has developed. That said, the quality of the analysis is high and impressive given his young age. Already at 21, he was good at making difficult things sound simple.

Enjoy the read: The Security I Like Best

Carl Icahn

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Investor profile at InvestingByTheBooks: The book The World’s 99 Greatest Investors: The Secret of Success provides a unique opportunity to learn form the most prominent investors globally. In the book they generously share their experiences, advice and insights and we are proud to present these excerpts. Magnus Angenfelt, previously a top ranked sell side analyst and hedge fund manager, will be presenting one investor per month. For those who cannot wait for the monthly columns, we strongly recommend you to buy the book. The investor himself writes the first section below and then Angenfelt describes the background of the investor and comments on his investment philosophy. Enjoy.

There are no words in our vocabulary that define the common quality that all very successful people share, but the closest words would be ‘passion’ or ‘obsession’ relating to what they do. A second quality these people share is a lack of hubris when achieving a great victory in a game or investment. When they are victorious they do not believe they are geniuses, rather they understand how much luck is involved. As Rudyard Kipling put it, ‘if you can meet with Triumph and Disaster and treat those two impostors just the same’.

A third quality that I believe all great investors share is the ability to recognize the difference between a ‘secular’ and ‘cyclical’ change in companies they have carefully studied. If a company they have studied and believe in is down because of a cyclical change, successful investors use the opportunity to purchase as much as they can as quickly as they can. They do not care and are not influenced or frightened by market conditions, etc. However, if a company is in trouble due to ‘secular’ change, successful investors will take their losses and back away.

The ability to recognize secular and cyclical cycles cannot be taught, in my opinion. Rather, it is an instinct or talent that has been honed over many years of arduous work. In other words, the great investors, just like the great champions in other fields, can divorce themselves from their emotions and just play the game.

BORN New York, USA 1936.

EDUCATION He studied philosophy at Princeton University in 1957 and at the New York University School of Medicine, but he left without graduating.

CAREER Icahn began his career on Wall Street in 1961 as a registered representative with Dreyfus & Company. Aged 32 he bought a seat on the New York Stock Exchange and started Icahn & Co. Inc., a brokerage firm that focused on risk arbitrage and options trading. In 1978, he began taking substantial controlling positions in individual companies. Today, he is chairman of Icahn Enterprises, a diversified publicly listed holding company engaged in a variety of businesses, including investments, metals, real estate, and consumer goods.

INVESTMENT PHILOSOPHY Icahn is the most successful and famous stock market activist in the world, but his roots are in contrarian value investing. His strategy is to invest in beaten-down assets that nobody else wants, usually out of bankruptcy, then fix them up and sell them when they are back in favour. When studying a firm’s structure and operations to explore the reasons for any disconnect between the company’s stock price and the true value of its assets, ‘for the most part the reason for this disconnect is management’, as he explains it. To take the steps necessary to seek to unlock value he uses tender offers, proxy contests, and demands for management accountability. When valuing companies, he looks at replacement cost, break-up value, cash flow and earnings power, and also liquidation value.

He operates with almost all market instruments – including long and short equities and bonds, bank debt and other corporate obligations, options, swaps, etc. He regards consensus thinking as generally wrong. ‘If you go with a trend, the momentum always falls apart on you’ says Icahn. In contrast to the general view about activists, he is more of a long-term investor. The focus is on capital structure, management, and finding the best long-term owner for the assets.

OTHER Icahn Enterprices has revenues around $20billion and almost $30 billion in assets. In 2008, Icahn launched the Icahn Report, which campaigns for shareholder rights and encourages them to shake up the management and boards of underperforming companies. He has through his different vehicles taken positions in various corporations over the years and very seldom failed to wring out changes and higher valuation. Some of the most famous battles were RJR Nabisco, Texaco, TWA, Phillips Petroleum, Western Union, Gulf & Western, Viacom, Blockbuster, Time Warner, Yahoo, Motorola and recently Dell. In the fight over Time Warner, where he owned about 3.3 %, he unveiled a 343-page proposal calling for the break-up of the company. In 2013 his net worth was estimated by Forbes to be $20.3 billion, making him the eighteen richest man in the world. He has been an active participant in a variety of philanthropic endeavors through Icahn Charitable Foundation, which mainly focuses on child welfare, education, and medicine. 

Sources: Carl Icahn; Icahn Enterprises L.P.; Icahn Enterprises; the Icahn Report; Wikipedia.

The Market and Corporate Governance

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Who is “the Market”? Or rather, how does the stock market work? Why does it react as it does? Why is our stock valued as it is? What do investors really want out of us? Board directors and executive managers at times have a strained relation to a stock market they view as short-sighted, moody and that infringes on their valuable time. Many are genuinely unsure of what makes this unruly monster tick and others…

Bank Primer

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Financials is one of the really big global sectors in equity markets. In fact, measured in market capitalization it’s the largest one. It’s also a more diverse sector than many perhaps realize hosting a number of different business models. In the GICS framework the sector is made up of four industry groups, namely banks, diversified financials, insurance and real estate. Each industry…

The Zurich Axioms

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The Zurich Axioms by Gunter, Max

1.      On Risk: Worry is not a sickness but a sign of health. If you are not worried, you are not risking enough.

·       Always play for meaningful stakes

·       Resist the allure of diversification

2.      On Greed: Always take your profit too soon.

·       Decide in advance what gain you want from a venture, and when you get it, get out.

3.      On Hope: When the ship starts to sink, don’t pray. Jump.

·       Accept small losses cheerfully as a fact of life. Expect to experience several while awaiting a large gain.

4.      On Forecasts: Human behavior cannot be predicted. Distrust anyone who claims to know the future, however dimly. 

5.      On Patterns: Chaos is not dangerous until it begins to look orderly.

·       Beware the historian’s trap.

·       Beware the chartist’s illusion.

·       Beware the correlation and causality delusions.

·       Beware the gambler’s fallacy.

6.      On Mobility: Avoid putting down roots. They impede motion.

·       Do not become trapped in a souring venture because of sentiments like loyalty or nostalgia.

·       Never hesitate to abandon a venture if something more attractive comes into view.

7.      On Intuition: A hunch can be trusted if it can be explained.

·       Never confuse a hunch with hope.

8.      On Religion and the Occult: It is unlikely that God’s plan for the universe includes making you rich.

·       If astrology worked, all astrologers would be rich.

·       A superstition need not be exorcised. It can be enjoyed, provided it is kept in its place.

9.      On Optimism and Pessimism: Optimism means expecting the best, but confidence means knowing how you will handle the worst. Never make a move if you are merely optimistic.

10.   On Consensus: Disregard the majority opinion. It is probably wrong.

·       Never follow speculative fads. Often, the best time to buy something is when nobody else wants it.

11.   On Stubbornness: If it doesn’t pay off the first time, forget it.

·       Never try to save a bad investment by averaging down.

12.   On Planning: Long-range plans engender the dangerous belief that the future is under control. It is important never to take your own long-range plans, or other people’s, seriously.

·       Shun long-term investments.

Mats Larsson, September 27 2018


P.S. Please see the review of the book The Zurich Axioms for more color on the philosophy presented. Or read the book.

Post-Merger Integration

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The historic evidence is quite clear, listed corporations’ acquisitions on average destroy value for their shareholders. And companies that make large and infrequent acquisitions are especially efficient in transferring their hard earned wealth to the purchased company’s shareholders. Basically, all the value of the generated synergies and then some - on average – accrue to the...

Mr. Buffett Miscalculates

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How does one get the most bang for the buck? - The most future benefit out of ones present scarce resources? How does one decide between different options? In finance the way is often to compare the return on the various uses of ones capital and then select the one(s) with the highest return on equity, return on capital employed, return on capital invested, internal rate of...