Tag Archives: failure

Review – The Art of Execution (@harriman, #investing)

The Art of Execution: How the world’s best investors get it wrong and still make millions (buy on Amazon.com)

by Lee Freeman-Shor, published 2015

A “valueprax” review always serves two purposes: to inform the reader, and to remind the writer. Find more reviews by visiting the Virtual Library.

Note: I received a promotional copy of this book from the publisher in exchange for sharing my thoughts AFTER reading it.

Professor Failure

What can we learn from failure? Aside from the fact that there’s an entire industry of business literature fetishizing the idea that it has much to teach us (as a kind of doppelgänger to the decades of success literature that took a person or business’s success as given and tried to look backward for an unmistakeable pattern that could’ve predicted it) I’m personally skeptical of what failure might teach. Life is complex and there is often little to separate the failure and the success but timing and luck in certain endeavors.

So, I approached Freeman-Shors book with some trepidation as the subtitle of the book suggests this is a study of failure. Au contraire, what we have here is actually a psychological or behavioral study, somewhat in the vein of Benjamin “you are your own worst enemy in investing” Graham, which studies not failure per se, but rather how investors respond differently to failure and thereby either seal their fate or redeem themselves.

A Behavioral Typology

The book recounts the investment results of several different groups of portfolio managers who were categorized, ex post facto, into various groups based upon how they reacted to adverse market conditions for stocks they invested in. The Rabbits rode most of their failed investments down to near-zero before bailing out and taking the loss. The Assassins had a prescribed set of rules for terminating a losing position (either a % stop-loss, or a maximum time duration spent in the investment such as a year or a quarter). The Hunters kept powder dry and determined ahead of time to buy more shares on a pullback (ie, planned dollar-cost averaging).

While I am suspicious of backward-looking rule fitting, I do think the author’s logic makes sense. What it boils down to is having a plan ahead of time for how you’d react to failure. The Rabbits biggest mistake is they had none whatsoever, while the Assassins managed to protect themselves from total drawdowns but perhaps missed opportunities to profit on volatility rebounds. The author seems most impressed with the Hunters, who habitually started at a less than 100% commitment of funds to a planned position and then added to their investment at lower prices when the market gave them an opportunity to do so.

Freeman-Shor’s point is that when the price falls on your investment you need to decide that something material has changed in the story or facts and you sell, or else you need to be ready to buy more (because if it was a good buy at $10, it’s a great buy at $5, etc.) but you can not just hang tight. That isn’t an investment strategy. This is why I put this book in the Benjamin Graham fold, the message is all about being rational ahead of time about how you’d react to the volatility of the market which is for all intents and purposes a given of the investing landscape.

Learning From Success, Too

The author goes over a couple other behavioral typologies, Raiders and Connoisseurs. I won’t spoil the whole book, it suffices to say that this section is worth studying as well because it can be just as nerve-wracking to try to figure out whether to take some profit or let a winner ride when you have one. Freeman-Shor gives some more thoughts based on his empirical observations of other money managers who have worked for him on when it’s best to do one or the other.

More helpfully, he summarizes the book with a winner’s and loser’s checklist.

The Winner’s Checklist includes:

  1. Best ideas only
  2. Position size matters
  3. Be greedy when winning
  4. Materially adapt when losing
  5. Only invest in liquid stocks

The last bit is probably most vital for a fund manager with redeemable capital.

The Loser’s Checklist includes:

  1. Invest in lots of ideas
  2. Invest a small amount in each idea
  3. Take small profits
  4. Stay in an investment idea and refuse to adapt when wrong
  5. Do not consider liquidity

Free e-Book With Purchase!

It is hard for me to decide in my own mind if this book is a 3.5 or a 4 on a 5-point scale. I think of a 5 as a classic, to be read over and over again, gleaning something new each time. This would be a book like Security Analysis or The Intelligent Investor. A 4 is a good book with a lot of value and a high likelihood of being referenced in the future, but not something I expect to get a new appreciation for each and every time I read it. A 3 is a book that may have been enjoyable overall and provided some new ideas but was overall not as interesting or recommendable.

While I enjoyed this book and did gain some insight from it, and I think the editorial choices in the book were bold, it’s closer to a 3 in my mind than a 4 just in terms of the writing and the ideas. I’ve found a lot of the content in other venues and might’ve rated it higher on my epiphany scale if this was one of the first investment books I ever read.

But something that really blew me away is that the publisher, Harriman House, seems to have figured out that people who buy paper books definitely appreciate having an e-Book copy for various reasons and decided to include a copy for free download (DRM-free!!) in the jacket of the book. This is huge. I read my copy on a recent cross-country flight and was really agonizing about which books from my reading stack wouldn’t make the trip for carry-on space reasons and then realized I could take this one with me on my iPad and preserve the space for something else. That’s a big value so I am going with a 4 as a result.


Notes – Original Issue Discount (OID) Tax Implications, Lessons Learned (#taxes, #investing)

In the process of carrying out the KV Pharmaceuticals capital structure arbitrage trade of 2012, I got caught with my pants down a bit as I didn’t think to sell the convertible notes before they stopped trading. As a result, I missed an opportunity to lock in a capital loss for tax purposes at the time, which would’ve helped shield some of the income I made on the puts and thus made the trade as a whole more tax efficient.

Instead, I got a double-whammy of tax inefficiency for my ignorance, a chicken that finally came home to roost in tax FY2013 as the CPA assisting me with my tax preparation informed me that I ended up owing an additional sum beyond amounts withheld in prior periods due to Original Issue Discount (OID) interest income related to my defunct KV Pharmaceuticals play!

At first I was shocked and dismayed– the company went into bankruptcy and the securities were eventually removed from my account entirely earlier this year. How could I owe taxes when I never earned any cash interest and will never get back even a penny from the securities I stupidly held onto?

I talked about it with my CPA (who double-checked with his partner) and then spoke to a rep at TD Ameritrade and the matter is decisively not going to turn out in my favor. I learned that when a bond goes into default it often switches from cash interest basis to accrual interest basis in the eyes of the IRS, and like any good group of thugs they want their blood now, not later. In other words, I owe federal income tax on “accrued interest” I not only never received but never will receive. Because the securities were removed from my account in 2014 and not 2013, it looks like I accrued interest income due to me even though we clearly know right now that I’ll never get it.

Instead, I get a stepped up cost basis on the securities (in the amount equal to the accrued interest not received) so when I finally report the loss for FY2014 taxes, it’ll be a total loss of X + Y instead of just X. I get to shield additional future income with the X + Y amount but I paid real cash up front for the privilege.

If I had known better, I would’ve executed this trade such that the gains and losses all occurred in the same period in 2012. I also probably wouldn’t have gotten into a trade in the first place whose money-making mechanics I generally understood but about whose technical execution and tax implications I was grossly ignorant.

Another expensive lesson learned!

Review – Good To Great (#business, #investing)

Good To Great: Why some companies make the leap and others don’t (buy on Amazon.com)

by Jim Collins, published 2001

A “valueprax” review always serves two purposes: to inform the reader, and to remind the writer. Find more reviews by visiting the Virtual Library

The G2G Model

“Good To Great” seeks to answer the question, “Why do some good companies become great companies in terms of their market-beating stock performance, while competitors stagnate or decline?” After a deep dive into varied data sources with a team of tens of university researchers, Collins and his team arrived at an answer:

  1. Level 5 Leadership
  2. First Who… Then What
  3. Confront The Brutal Facts (Yet Never Lose Faith)
  4. The Hedgehog Concept (Simplicity Within The Three Circles)
  5. A Culture Of Discipline
  6. Technology Accelerators

The first two items capture the importance of “disciplined people”, the second two items refer to “disciplined thought” and the final pair embodies “disciplined action”. The concepts are further categorized, with the first three components representing the “build up”, the ducks that must be gotten into a row before the second category holding the last three components, “breakthrough”, can take place. The entire package is wrapped up in the physical metaphor of the “flywheel”, something an organization pushes on and pushes on until suddenly it rolls forward and gains momentum on its own.

This book found its way onto my radar several times so I finally decided to read it. I’d heard it mentioned as a good business book in many places but first took the idea of reading it seriously when I saw Geoff Gannon mention it as part of an essential “Value Investing 101” reading list. I didn’t actually follow through on the initial impulse until I took a “leadership science” course recently in which this book was emphasized as worth covering.

I found G2G to be almost exactly what I expected– a rather breathless, New Age-y, pseudo-philosophical and kinda-scientific handbook to basic principles of organizational management and business success.  The recommendations contained within range from the seemingly reasonable to the somewhat suspect and the author and his research team take great pains to make the case that they have built their findings on an empirical foundation but I found the “We had no theories or preconceived notions, we just looked at what the numbers said” reasoning scary. This is actually the opposite of science, you’re supposed to have some theories and then look at whether the data confirms or denies them. Data by itself can’t tell you anything and deriving theory from data patterns is the essence of fallacious pattern-fitting.

Those caveats out of the way, the book is still hard to argue with. Why would an egotistical maniac for a leader be a good thing in anything but a tyrannical political regime, for example? How would having “the wrong people on the bus” be a benefit to an organization? What would be the value in having an undisciplined culture of people who refuse to see reality for what it is?

What I found most interesting about the book is the way in which all the principles laid out essentially tend to work toward the common goal of creating a controlled decision-making structure for a business organization to protect it from the undue influence of big egos and wandering identities alike. In other words, the principles primarily address the psychological risks of business organizations connected to cult-like dependency on great leaders, tendency toward self-delusional thinking and the urge to try everything or take the easy way out rather than focus on obvious strengths. This approach has many corollaries to the value investing framework of Benjamin Graham who ultimately saw investor psychology as the biggest obstacle to investor performance.

I don’t have the time or interest to confirm this hypothesis but I did wonder how many of the market-beating performances cataloged were due primarily to financial leverage used by the organization in question, above and beyond the positive effects of their organizational structure.

A science is possible in all realms of human inquiry into the state of nature. Man and his business organizations are a part of nature and thus they fall under the rubric of potential scientific inquiry. I don’t think we’re there yet with most of what passes for business “research” and management or organizational science, but here and there the truth peeks out. “Good To Great” probably offers some clues but it’s hard to know precisely what is the wheat and what is the chaff here. Clearly if you inverted all of the recommendations of the book and tried to operate a business that way you’d meet your demise rather quickly, but that is not the same thing as saying that the recommendations as stated will lead in the other direction to greatness, or that they necessarily explain the above-average market return of these public companies.

I took a lot of notes in the margin and highlighted things that “sounded good” to me but on revisiting them I am not sure how many are as truly useful as they first seemed when I read them. I think the biggest takeaway I had from the book was the importance of questioning everything, not only as a philosophical notion but also as a practical business tool for identifying problems AND solutions.

Hailing The New Year

In early 2013 I penned a personal reflection on what I had accomplished in 2012, and what I had hoped to see happen in the new year.

I didn’t actually accomplish much with regards to the specific goal I outlined for myself in that post, looking back on it now. My hope was to spend more time “practicing investing”, specifically in the sense of looking at lots of ideas and trying to value things.

In addition, while not a stated goal I did not make even half as much progress reading new material over the course of the year as compared to the year prior in 2012. In fact, I had planned not to in order to free up more time to spend on “doing” rather than “thinking about doing” investing.

My excuses were two. First, and this reason looms largest in my mind though it’s in objective actuality the least potent, the market continued to run up in 2013. Value dried up, the marginal effort expended yielded consequently less marginal return so I just threw in the towel and decided not to bother with it. We know this is a weak excuse because plenty of people, including value investors, managed to crank out stellar returns this year past, though some of this was on legacy positions made in 2012 and held through 2013 and I did notice my pen wasn’t the only dry one in 2013– many of my value blogger friends suddenly cut down on their blog output, while many others gave up blogging to get real jobs as money managers. From rags to riches, a sign of the times?

My second excuse is that while I had significant free time, even during the course of my “normal” daily professional responsibilities, to think about and act on my value investing interests and portfolio management duties, in 2013 the demands of my day job were much more significant as was the total opportunity to learn and grow as a businessman in the industry and more generally speaking. This dominated my time so that I did not grow as much as an investor, but I nonetheless grew as a businessperson and productive individual and ultimately I think what I learned in terms of the problems (and solutions) of a real operating business, as well as my ability to effect change, will have significant effects on my future investment returns. They clearly had significant effects on my short term investment returns this year! One small portfolio I tend to was essentially flat and uninvested, my personal portfolio grew by single digits, mostly uninvested and mostly through the churning of the JNet portfolio and the other larger portfolios I watch over grew mostly because legacy bond positions had increased in price and I decided it was time to take money off the table there (I traded some JNets around the margins, too).

I didn’t accomplish what I wanted to, but I did accomplish other things so all in all I was satisfied with how 2013 went.

Looking ahead, I’ve decided the most important thing I can accomplish in 2014 is to master the art of focus. To that end, I am going to look for a way to disabuse myself of the portfolio management responsibilities I so eagerly sought out in 2012-2013, in order to completely free my time, attention and anxiety to be applied to my daily professional opportunities. The enterprise is much greater in scope and I can have a much more leveraged effect here. This is a real opportunity to harness competitive advantage and the power of the division of labor to better myself and provide a meaningful chance for someone more talented to do better than I can.

I’ll content myself with “playing Buffett” in my personal portfolio and enjoy the satisfaction of cheering from the sidelines on everything else. That way I can be myself in everything else I do.

If I can accomplish this, I forecast 2014, and beyond, will be very good for me.

Concerns of Meaningless Peons (#poverty, #inadequacy, #values)

The following is a running list of observed concerns and conditions of individuals which would suggest they may be living the lives of meaningless peons, updated as observational faculties permit:

  1. Owning less than an acre of land
  2. Not contemplating life from an Eames chair
  3. Emotionally invested in professional sports
  4. Arguing economics on the internet with idiots trying to vouchsafe wanton criminality in sophistry
  5. Leasing everything, owning nothing
  6. Primary pastimes revolves around drinking with your friends and Facebooking your exploits
  7. Fretting about how to get your child into a “good” public school

Note: the composer of the above list may be guilty of some or even all of the infractions mentioned.