REFLECTIONS FROM LESSONS LEARNT OVER THE PAST 15 YEARS
TOP FIVE SUMMERHILL INVESTMENT PRINCIPLES
As the Summerhill team ends its 15th year in operation we decided to reflect on some of the key lessons learnt over that period of time. Investment management is one of the most humbling jobs anybody can have (probably second only to parenting). It is very interesting because just about every day you learn something new. However it is very humbling because regardless of how hard you work, mistakes can prove to be costly on many fronts. Ultimately you cannot change the past, but you can certainly learn from your mistakes and move forward accordingly. As Soren Kerkegaard said “Life can only be understood backwards; but it must be lived forwards.”
Looking back to the inception of the firm we have had to deal with some pretty interesting, even extraordinary, events such as:
The Great Financial Crisis that resulted in the failure of large financial institutions and markets declining over 50%.
The European Sovereign Debt Crisis that resulted in many European countries in need of an IMF bailout with many of their stock markets still well below prior-crisis peaks.
The Chinese slowdown which created the market correction of 2011 that saw the US market and the Canadian market fall 20% with a global decline in commodity prices
The realization in 2015 that absolutely nobody in the world can forecast the price of oil (or any other commodity for that matter)
The Bitcoin Bubble which is now considered to be the greatest bubble in all of history, surpassing the previous record holder which was the 1630s Tulip crisis.
The referendum in the UK which decided on leaving the European Union: Brexit
The normalization of corruption brought about by questionable world leaders
Loss of faith in vital institutions for democracy such as the government and the media
Over $17 trillion in global bonds with negative yields
The over tightening by the US Federal Reserve resulting in a very quick 20% decline in markets over a three month period in 2018.
The beginning of what could be the third impeachment process of the last 50 years in the US
Despite each of the aforementioned disruptions (some larger than others), markets, and the U.S. stock market in particular, have continued to progress higher making this bull market the longest on record. Profit margins are at peak levels. Jobs continue to be either outsourced or lost to technology but for the most part employment levels are high. Profitability has been extreme and to the benefit primarily of the 1%, leading to growing populist movements. The middle class keeps shrinking and in general the next generation feels that their future has been compromised by those that came before them. As much as we would love the party to continue, the realistic and rational thought is that inevitably, at some point, the pendulum must swing to incorporate those that have been left behind. It is not clear when that point will be. It is doubtful that during the French revolution the elite saw anybody coming for their heads until it was too late. But even if history does not repeat, the similarities are such that it behooves us to pay attention to all the possible dangers in our investment horizon. The number one lesson we have learnt throughout all the disruption above is that our clients prefer to not make a dollar, than to lose a dollar. Therefore capital preservation is absolutely our number one focus.
With that in mind, based on what we have witnessed over the past 15 years, the lesson is to never be afraid to move to the sidelines and hold on to your cash when trouble starts brewing. Inevitably, this means that we will be early when we do so. In other words we will hold on to our cash while the markets may well continue to climb. However, if we have a disciplined investment approach and risk becomes significantly higher towards the loss of funds, whether for geopolitical, economic or valuation issues, we must step aside as the key is to live to fight another day. In this case we have adopted our number one principle from two Warren Buffet rules: “RULE #1 DO NOT LOSE MONEY, RULE #2 REMEMBER RULE #1”.
In focusing on Warren’s famous rules for investors, we have over time determined that under no situation should we as investors speculate. This means if there are variables or inputs that are necessary for analyzing an investment that we have no way of predicting or accurately forecast, that investment must be avoided at all costs because it is in fact speculating, not investing. This was a valuable lesson both in 2011 when commodity prices collapsed as China slowed down their pace of investment; and in 2015 when it became apparent that absolutely nobody on the planet had forecast the price of oil accurately. Perhaps over the past 15 years this was the most humbling, but ultimately the most profitable lesson for our firm. It led to a highly defined strategy of investing only in companies where commodities were not the main variable and therefore earnings were more stable, predictable and easier to forecast. As a result, as a principle, we invest but we DO NOT SPECULATE.
The investment landscape offers all sorts of different opportunities in a variety of different asset classes. We keep things very simple by focusing only on publically listed securities and our number one objective is to invest in equities as long as we can be certain that they will offer a return that is above that of risk free bonds in order to compensate for the risk of investing. The most certain way to do that is twofold: do not pay more than what a company is worth and own only companies that have a sustainable competitive advantage within their industry. Many investment managers think they are diversifying by buying hundreds of securities. The fact is at any given time it is hard to believe that you will have hundreds of securities of sufficient quality to offer you attractive returns. Only ten stocks are required for adequate diversification according to many studies. Every stock owned should be in the portfolio because it has the potential to provide a better than average return. It is extremely important when investing to FOCUS ON QUALITY OVER QUANTITY.
It is always interesting to listen to anybody who invests in the markets. More often than not they are bragging about their winners. If you took everything you heard at face value you would think that these people had never made a bad investment in their life (and of course one wonders why they are not just hanging out in their 200 foot yacht on some tropical island). This is of course completely impossible. Even the greatest investors of all time, such as Warren Buffet and Charlie Munger, have made plenty of very costly errors. Unfortunately it is part of the investment process. You can research a company and an industry in the greatest of detail and things will still happen that will change the future prospects overnight: maybe it is a change in regulation, or a black swan event (a health issue caused by the product for example). In any event it is very important as investors to understand that you don’t know what you don’t know. Things change. We are human and despite the most rigorous investment process in place, we will make mistakes. The key is when making a mistake, cut your losses and run as soon as possible. This means that our investment strategy must instantly adjust to the new reality that is affecting the price of a stock and we must deal with it accordingly. Math will show you that you can recover from a minor loss but if you have a stock going down 80% the hole dug is so deep that it takes years to recover from it, if at all. It’s therefore crucial that as investors we RECOGNIZE MISTAKES QUICKLY AND CUT LOSSES ASAP.
We are living in interesting times where every business on earth is being disrupted by both new technologies and new generations with extremely different views from their parents about everything: corporations, governments and how the world should work in general. The last decade in particular has been extreme in the amount of change and how polarizing the world has evolved. As an investment management firm we operate in a world that is extremely competitive. Investment managers are a dime a dozen. Thousands of firms in North America alone are competing in the same, extremely mature, market. In that vein, it is important to differentiate oneself, and our clients are well versed in exactly how we are different in the services that we provide. Many different concepts form part of our investment process but what is vital is to always act with integrity, and we will always invest our own funds the same way that we invest our client’s money. The one key concept that the Summerhill Team never forgets is our one and most important principle which is to ALWAYS ACT IN THE BEST INTEREST OF OUR CLIENTS.
The past 15 years have been a remarkable period of growth for Summerhill. It has been an incredible learning process and looking back we can observe that the results over the past ten years have been remarkably better than the last 15 years, while the last five years have been even stronger than the last ten. This, for us, is the biggest indication that we continue to learn from our mistakes to the benefit of all our clients who today are enjoying leading risk adjusted performance. However, even when we are at the top of our game, investing remains a never ending learning proposition as the world keeps rapidly changing around us. We can never take this performance for granted and we continue to work hard on behalf of all our clients to ensure that our value proposition will never be jeopardized.
Lastly, it is extremely humbling to reflect on how the firm has grown and evolved over the years and done so without a marketing or sales department. The word of mouth referrals received from existing clients and friends are truly a great honour. It is something we will never take for granted and for which we are eternally grateful. The firm has become what it is today because of the trust and faith of our clients and friends and we promise to continue to do our best to deliver on these expectations for the multiple client generations that now form our client base.
The Summerhill Team