January 24, 2008
Dear Clients and Friends,
This letter is intended to remind you of our investing principles. We remain extremely focused on our research, our searching for potential opportunities, as well as research on potential stresses for your portfolios. Of course, the markets since July 2007 have been incredibly volatile. So far this year, and there are no guarantees for the future, we have typically outperformed the averages. We typically have had what would be considered to be above average, if not excellent returns, since our inception in 1995. Certainly, past performance is not necessarily indicative of future results. Nevertheless, we remain incredibly focused on your portfolios and our intent of capital preservation.
A Summary of our Investment Principles, Some Thoughts and Philosophies.
1. We take a long-term approach to investing. Our clients should not judge our performance for at least 3 to 5 years. We are value investors. We are typically buying investments that are being dumped by Wall Street. Since we are typically buying investments as they are dropping in price, our performance in the early years is often going to under perform other investments. We certainly suggest that our clients immediately judge us based on portfolio composition and philosophy. We welcome questions and comments on the investments and our approach. We are focused on portfolio positioning and not short-term portfolio performance.
2. Drops in share prices are welcome – We prefer to have the prices of shares we are accumulating to be dropping and not rising. If the share prices of any of these companies were to materially decline, we would probably look to increase our positions in these companies. We would welcome a market drop in the same fashion that a skier welcomes the winter snow. Peter Lynch notes in his book, ‘Beating the Street’ “A decline in stocks is not a surprising event; it’s a recurring event ‑ as normal as frigid air in Minnesota. If you live in a cold climate, you expect freezing temperatures, so when your outdoor thermometer drops below zero, you don’t think of this as the beginning of the next Ice Age. You put on your parka, throw salt on the walk, and remind yourself that by summertime it will be warm outside.” You can read our notes to Lynch’s ‘Beating The Street’ at this link Peterlynch.html .
3. We eat our own cooking. – We manage our portfolios and our family’s portfolios in the same manner as we manage yours.
4. We try to have as few positions in our portfolio as possible. We would ideally like to have 8 to 10 common stock positions. We try to keep portfolio activity to a minimum. We believe that less trading is preferred to frequent trading. On the other hand, our fixed income positions will often have greater trading frequency. Sometimes we feel a specific fixed income situation is a bargain at a certain price. We will be buyers, while we perceive that a bargain exists. At other times we will sell when we feel that the “bargain” has subsided.
5. We attempt to be tax efficient. We are always focused on tax efficiency. This is evident in our typical “buy and hold style”. Buying and holding gives us the ability to generate preferential long-term capital gains.
6. We will typically, but not always, outperform the stock averages in down years, and under perform the same averages when they have strong years. There is certainly no guarantee of this, but in our 13 years of investing client’s money, this is typically what has occurred. Warren Buffett discussed the General Market of 1959 on page 2 of his letter, “I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a “New Era” philosophy where trees really do grow to the sky.”
In Warren’s comments on year 1960, he mentioned something that we certainly believe in, “I would consider a year in which we declined 15% and the average declined 30% to be much superior to a year when we both advanced 20%. Over a period of time there are going to be good and bad years; there is nothing to be gained by getting enthused or depressed about the sequence in which they occur.”
7. Clients will often ask me to give a market prediction. My typical answer is that I have no clue what the stock market will do. The price of investments is a funny thing, and over the short term (short term being 3 years or less), anything can happen. In the book, “The Money Game”, Adam Smith pointed out when J. P. Morgan was asked what the market would do, he said, “It will fluctuate.” Warren Buffett mentioned in his 1958 letter, “I make no attempt to forecast the general market – my efforts are devoted to finding undervalued securities.”
8. In our letter sent a year ago we wrote, “It is very possible, and at some point expected, that we will have a year, or a period of years, where we not only under perform comparative indexes, but also lose money at the same time.”
9. We have discretion over the accounts we manage. We do not discuss investments with our clients prior to buying or selling them. We charge 1% of assets managed.
Random Notes and Quotes from our Website
The following are selected quotes from a very important section of our website. These are notes to one of the most important value investing books ever written. All quotes below are from Seth Klarman, author of the book, “Margin of Safety.” I urge you to spend the time to read these notes. You can access our full notes mentioned above by searching the term “Seth Klarman” at our website. https://www.rbcpa.com I have been re-reading these notes every few months since I read the book. Each time I review the notes, I feel as though I have gained a great deal of knowledge.
“Speculators are obsessed with predicting – guessing the direction of prices.”
“Value investors pay attention to financial reality in making their investment decisions.”
“Investing is serious business, not entertainment.”
“The river may overflow its banks only once or twice in a century, but you still buy flood insurance.”
“Value investing is the discipline of buying securities at a significant discount from their current underlying values and holding them until more of their value is realized. The element of the bargain is the key to the process.”
“The greatest challenge for value investors is maintaining the required discipline. Being a value investor usually means standing apart from the crowd, challenging conventional wisdom, and opposing the prevailing investment winds. It can be a lonely undertaking. A value investor may experience poor, even horrendous, performance compared with that of other investors or the market as a whole during prolonged periods of market overvaluation.”
“Value investors are students of the game; they learn from every pitch, those at which they swing and those they let pass by. They are not influenced by the way others are performing; they are motivated only by their own results. He discusses that value investors have “infinite patience.”
“A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.”
“Diversify your holdings and hedge when it is financially attractive to do so.”
“A market downturn is the true test of an investment philosophy.”
“All investors must come to terms with the relentless continuity of the investment process.”
“I recommend that you adopt a value-investment philosophy and either find an investment professional with a record of value-investment success or commit the requisite time and attention to investing on your own.”
Some Other Timely Quotes
“Investing isn’t simply about being sure you are right, but about making sure you are protected if you are wrong.” Jason Zweig
“What you have to do in this environment of heavy research and abundance of value players, is to be able to analyze and capture the appearance of value, within companies that are herd followed and owned by value investors, yet at the same time, when you dig deep, these same companies do not carry typical value traits. Another way of saying this would be to “capitalize when value investors lose sight of the ball, or get lazy.” Ronald R. Redfield cpa,pfs 10/07.
“Value Investors must be over-weighted in patience.” Seth Klarman
“Doubt – The only human activity capable of controlling the use of power in a positive way. Doubt is central to understanding.” Author – Unknown
“Investing should only be done with a long-term outlook. The need for liquidity in the short term is important, and one needs to make sure that short term money is invested in short term, liquid instruments. Don’t be fooled by someone telling you the instrument is short term and liquid. Make sure you understand what you are investing in.” Ronald R. Redfield cpa,pfs 9/06
“We do trade fixed income positions with frequency if necessary. We are always looking for bargains.” Ronald R. Redfield cpa,pfs 9/06
“I invest like I shop. I look for quality, but bargains.” Ronald R. Redfield cpa,pfs 9/06
“During the meeting we stressed our sole reliance on long term investing. We used hall of fame baseball player, Rod Carew as an example. Rod had a lifetime batting average of .328. It was fairly predictable over the course of an ordinary season, Rod would hit over .270. With that said, I would “invest” in most years during his prime that he would bat over .270. That is called “waiting for the fat pitch.” If someone were to ask me to wager that he would bat over .270 in his next 20 at bats, I would typically not make that bet. Anything can happen over the short term. For example a sickness or plain old fashioned slump. Rod typically batted over 500 times during the year. Hence, the long term would be considered at least 500 at bats. The short term would be the 20 at bats. Hence, I would “invest” a great deal of money, if given the opportunity to “invest” well below Rod’s expected batting average for a single season. This gives the investor a “margin of safety.” Ronald R. Redfield cpa,pfs 9/06
“Once you select an investment adviser, give him a fair chance. For the first five years the Dallas football franchise, under Coach Tom Landry, had losing seasons. Upset about negative fan reaction, one club official approached owner Clint Murchison about the unrest of the fans. Clint told the official to give Coach Landry a ten-year contract, as that should keep the fans quiet.” Bennett W. Goodspeed ( author of “The Tao Jones Averages.”)
A Welcome Addition
John O’Shaughnessy, CPA has been a wonderful addition to our investment management practice. We introduced you to John in our July 2007 letter. His research, his fresh ideas, our frequent investment and business discussions, have been an excellent benefit to our firm and to the management of your portfolios. Please feel free to contact John either by phone or email, if you would like to hear some of his views. John’s email is [email protected] . We are eager to hear from you in regards to sharing ideas, hearing your thoughts or concerns.
Thank you very much for reading this long, yet hopefully informative note. We greatly appreciate the confidence our clients have placed in us. Should you have any questions, concerns, or if I have not been clear in any respect, John or I would be happy to hear from you. Our concerns are the ultimate goals of preservation of your capital and above average investment returns for your money you have placed with our firm.
Very truly yours,