For people who invest, their investment actions are usually guided by a philosophy of which investors themselves are consciously or unconsciously aware. It is like asking yourself to list out all items that are in your wallet now; unless you take a pause, open your wallet, one is usually not fully aware of what is in there. Similarly, it is a tall task to give a full answer to one’s investment philosophy. So, this blog piece is not meant to be a complete account, nor final or conclusive. As time goes by, as I age and gain more experience, I will likely abandon some beliefs that are stated below and form some that are new.
I first traded stocks when I was under 20 — I bought an A-share company listed in Shenzhen. Since then, I have invested in A-shares, Hong Kong–listed stocks, U.S. stocks, bonds, funds, real estates and other types of assets and financial contracts.
At Yale University was when I first learned investing in a systemic way. I had the great opportunity to learn directly from the Yale Endowment through its capstone course. I also had the fortune to work with Charles D. Ellis as his head teaching assistant and later to be the translator for his book The Index Revolution from English to Chinese and to publish the book in China. (Charles D. Ellis is the former Chairman of the Yale Endowment.)
Reflecting upon the past 10+ years, practicing investing, broadening investment knowledge, and making mistakes along the way, I always have a few thoughts on my mind. Here, let me list them out, and perhaps, call them my investment philosophy.
- Invest in Highest-Quality People
The most important thing in investing is people. High-quality people take us no time to manage. Good-quality people take us some time to manage. Low-quality people take far too much of our time to manage, leaving us no time to do other things.
The most important aspect of people is character. In challenging and confusing situations, the highest-quality people still stick to the truth and think independently. They are rational people with an enormous amount of knowledge. They are analytical and tend to make good judgement.
So, invest in the highest-quality management team we can find. Even if a business model is being challenged, even if a business moat is still not deep and wide enough, the highest-quality management team will find a way to deliver a high-quality business and let it thrive.
Also, invest with the highest-quality money manager we can find. Give them the freedom to pursue investment strategies as they see fit. The best manager does not need us to tell them when to invest, where to invest, or how to invest. (Those people are hard to come by, so in most cases we have to make some decisions regarding the “when,” “where” and “how.”)
- “Few Things are Forever”
De Beers’ slogan “A Diamond is Forever” probably does not apply to investing. In investing, “Few Things are Forever.” When I graduated college in 2010, value investing books (usually with pictures of Warren Buffett printed on their covers) could be seen on the front shelves of almost any bookstore — “value investing” was the only righteous road to investor salvation. Other investment ideas that were enshrined around 2010 include “small-cap premium” and “emerging markets opportunity.”
Looking back over the past decade, from 2010 to 2019, Berkshire Hathaway Inc. compounded at an IRR of 13.1%, underperforming the S&P 500 Index by 0.5% a year. The S&P 500 Value Index returned 12.2% a year, lagging the S&P 500 Growth Index by 2.6% a year. Fewer value investing books are now on the front shelves than 10 years ago.
The notion of “small-cap premium” fared no better. From 2010 to 2019, the S&P 600 Index (small-cap index) compounded at 13.4% a year while the S&P 500 Index (large-cap index) did 13.6% a year. The so-called “small-cap premium” became a 10-year “small-cap discount” of 0.2% a year.
The “emerging markets opportunity” idea suffered the most unexpected and tragic fate. For the past decade, including dividends, the MSCI Emerging Markets Index only earned about 3.7% a year, underperforming the S&P 500 Index by almost 10% a year. Investor could have done about as well if they decided to put their money with an online high-yield savings account!
In investing, things always change. Usually, by the time we arrived at a strong belief about something, such a belief was already obsolete and wrong.
- Only Play the Game I Can Win
Due to huge financial upsides, active investing attracts some of the world’s smartest people and has become probably the world’s most competitive field. Thousands of well-equipped and well-educated investors and traders are consistently looking for other peoples’ mistakes and looking to profit by exploiting them.
To borrow a quote of an unknown origin: “if you’re not at the table, you’re on the menu.” Same for investing. Unless you know you will win, you will lose.
Therefore, I must have crystal-clear visibility into my own scope of competence. I need to know what is within my reach and what is not, where my capability starts and where it ends. Most importantly, I must expand my scope of competence by active learning (for example, I taught myself coding).
On this point, I am a big believer that “differentiation” does not equal “moat.” “Differentiation” is not a good enough reason for one to win a game. Too many companies talk about their differentiated businesses. Too many managers talk about their differentiated investment approaches. To me, “differentiation” increasingly sounds like a lazy excuse to help not answer some of the most important questions in investing: do you really have a moat? Do you have an unfair advantage that other people for a reasonable amount of time will not be able to replicate or develop?
- Learn from Mistakes
I believe successes can be attributed to countless factors, but failures usually share some commonalities. The existence of luck in the formation of a success made it inherently difficult for a bystander to study the true drivers behind that success. However, behind failures are usually certain regrettable human actions that are worth our attention. Thus, it is hugely beneficial that I analyze my own investment mistakes, find patterns and try to avoid repeating them in the future.
- Beware of “Diversification”
Nobel Prize laureate Harry Markowitz once said “diversification is the only free lunch” in investing. Mathematically, that is correct. But diversification, if not done right, is the guaranteed path to mediocrity. Putting too many stocks into a portfolio is a sure way to make the portfolio behave like an index (and below the index, because of fees). If investors aim to replicate an index, diversification is fine; but for investors aiming to outperform an index, diversification has its side effects.