How to change your thinking on managing money – Piet Viljoen

In this fascinating talk at BNC#4, money manager Piet Viljoen suggests methods and principles to think about while managing your money, whether you’re an individual investor or allocating assets to a fund. This talk leads up to his debate with Cy Jacobs of 36ONE.

Excerpts from Piet Viljoen’s presentation at the BizNews Conference

Piet Viljoen on the most crucial thing when managing money

It’s to define what your investment philosophy and investment process will be. And each person will have a unique philosophy and process. The investment philosophy is what you do, what you believe in, what works for you. And as I say, that’s different for everyone. There isn’t a single correct investment philosophy, but it’s very important that for yourself you work out what works for you. You need to understand your own psychology, your psychological makeup, not when it’s a nice afternoon. Just before the hour I braai and that’s easy. People can make fairly rational decisions under those circumstances, but you need to know yourself when things are stressful, when the world is throwing darts at you. How do you make decisions? What do you fall back on? That is your investment philosophy, and that’s something that you need to think about very clearly. And then, as I said, for everyone, that’s unique. And there’s, you know, a lot of people who just try to copy Warren Buffett, but they don’t have his psychological makeup. And that ends in tears most of the time. So get to know yourself and work out what your investing philosophy is and write it down. The same with your process. Once you’ve defined what you want to do, you need to define how you’re going to go about doing this, and that is your investment process. Investing isn’t about picking a great stock. That’s not what investing is about. It’s also not about picking the ten or 20 best stocks either, because that’s virtually impossible. 

What investing is putting together a portfolio of assets that deliver satisfactory returns over a period of time for you. That is what investing is. And your investment process should define how you manage the risk you take when you invest. Because when you invest, you take a risk. Even if you invest in a money market fund, you are taking a risk. You’re taking some form of risk. And that is the key about the investment process. It is a risk management process. It’s not a stock picking process. Or let’s you know what the best asset is, decide what that is. It is about managing your risk. And again, this needs to be written down. How many stocks do you buy? How many of you own your portfolio? How liquid are these? And why do you want liquid or illiquidity? 

What’s, you know, what sort of industries you want to invest in and why? You need to think about these things. What is the vehicle in which you invest – the open-ended vehicle which can have outflows and inflows like a unit trust, which I happen to manage. That produces a different set of risks. You need to have liquidity at all times because clients can fund them. So I want my money back and you got to give it to them right away. If you invest in a closed end vehicle like a company like Warren Buffett with Berkshire Hathaway, then you don’t have to worry about phone calls from investors. You know, they can just sell their shares in the stock market and you can just carry on investing. So you need to think about those sorts of things and that’s your investing process. Again, I’ve seen a lot of people try to copy Warren Buffett’s investment process, but not in a closed end vehicle or in a company. And that often leads to tears. And as I said, you need to write these things down. You need to create a checklist because you make your mistakes when the stress is high.

On small pond syndrome and being the biggest fish in the smallest pond

That’s a very powerful thing to have in investing. To be the biggest fish in a small pond. Conversely, you want to fish where the fish are and not where the best fishermen are. Those are very important principles to bear in mind. So pick your fights. You don’t have to go up against Warren Buffett. You don’t have to go up against the best guys in the world. You can pick a different bond, a different fight. The third thing that I think is very important for everyone in this room to realise is that small investors can and should outperform the index. And the index can and will outperform large funds or fund managers. That’s the ranking of small investors, the index, and large fund managers. Why is that? Because of the breadth of assets a small fund or small investor can invest in – you can pick from a lot more things. The opportunities are much more varied and diverse.

Large funds are restricted to ten or 20 or 30 stocks on the stock exchange, on the JSE. They have no choice. They can buy the whole of 200 companies on the stock market. It will make no difference to their performance because their funds are so big. Hundred billion, 150 billion. You know, the average market cap and the stock exchange of the bottom 200 stocks is like two or 3 billion rand. It doesn’t touch the sides of the big guys. They cannot outperform the index and the numbers prove it. The large fund managers and large pools of capital underperformed the index. Small pools of capital and individuals outperform the index. That is the hierarchy. So that’s good news, the size of opportunity that determines this. But it’s also the risks that the fund manager is managing in the large investment house. That fund manager is not acting as a fiduciary. He is managing his career risk. He doesn’t want to be fired. And he is managing the marketing of the firm. Remember, asset management businesses are all remarkably scalable businesses. They generate fantastic returns as you scale up the size. And what happens in institutions is that fund managers, fund managers become marketing agents because it’s just so, so much more profitable. And they take them off the ball and their marketing and they’re not managing money. That’s an institutional imperative. So that’s why as a small investor, an individual investor, has this power. You have the power to pick from a diverse, wide range of assets, and that’s a very important power to have.

On how stocks actually get cheap

There’s another thing to really think about is, when you make an investment or buy stock. You need to think to yourself, why am I so lucky to be afforded this wonderful investment opportunity? How does this work? Because the market is a very efficient weighing mechanism. It takes a whole bunch of diverse opinions. Everybody that invests in the market buys and sells. It takes a whole bunch of diverse opinions. Weighs them up with an independent aggregation mechanism, the stock market itself, the auction method, and comes up with the value of a business. And that value is, over time, fairly accurate. And for a stock not to be not priced efficiently, you need either a diversity breakdown, diverse views, or views that conform and are not diverse. You need the aggregation mechanism, the market itself to not be functional. That’s when stocks get cheap. So you need to be on the lookout for those sorts of things. You know, the classic example of an efficient market is at the market, at the farmer’s market, where the, you know, the famous example where they have a cow and they ask people to guess the weight of the cow. And everybody comes to the market over the course of the week, guesses the weight of the cow, writes in a slip of paper, and puts it in the box. And at the end of the week, the farmer then awards the cow to the person who got the closest. But the most accurate estimate of the weight of that cow was obtained not by any one individual, but by adding up everybody’s numbers and dividing it by that by the number of entries. The average guess was the most accurate. That’s a diverse bunch of diverse opinions efficiently aggregated and came up with the right answer. Spot on and these people and farmers they didn’t really know a cow but the collective got the weight right and that’s the stock market. The stock market gets it right more often than not.

So when you are looking at investing, what you need to think to yourself is, why am I being offered this? Why do I think it’s cheap? And it either has to be because there’s a diversity breakdown or the aggregation mechanism is not working. So in what sort of situations do these things apply to things like selling? When you have an investor who has bought an asset on leverage using leverage and the bank says, I want my money back, and then they just ask to sell that asset. That’s an aggregation mechanism breaking down because there’s a facilitating place. There’s a force setting taking place there.

On the dangers of macro forecasting

Just stop it. Don’t worry about where interest rates are going. And what’s the rand going to do? And, is the economy growing by 2% or 3%? It doesn’t matter. Those things just don’t matter. If you want to do macro forecasting, invest on the basis of your macro focus, you have to get two things right. Number one, you’ve got to forecast that variable correctly, and that’s almost impossible. Nobody can do it consistently. All these economists’ surveys show you that, every year there’s a different winner of the best economist. So you have to get your forecast right. And the second thing that has to happen is you need to get right what happens in the market if your forecast is right, so if your forecast is GDP is going to grow by 3% next year, what does that do to the market? And that’s even harder to get right? It’s much easier to take the annual report of a company, look at its cash flows, understand its business dynamics, and make up your mind whether the stock is cheap or not. Because all you know about interest, is it’s going to go up and going to go down. If you hold the stock for long enough, during your holding period, interest rates will be high and or below. The rand will be weak and will be strong. All prices would be low. You just don’t know when. But all those things will happen. So forget about macro forecasting.

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