by Scott Pape - April 14th 2007
Being an investment adviser is a tough gig, given that clients place a lot of trust in your judgments.
True, surgeons have a tougher job – when they have a bad day it really is life or death.
Yet regardless of whether you deal with bodies or bounty, the same question arises – “Are you sure you know what you’re doing?”
When you’re asked this question it’s always prudent to follow the sage advice of Bing Crosby who sang “accentuate the positive, eliminate the negative”. Yet despite what anyone tells you, most long-term investors (and every trader) at some point will encounter a dog that will give their portfolio some fleas.
While no one likes taking a financial hit, these often expensive losses can be turned into financial lessons that make you into a better investor. Let me tell you about three expensive lessons that I’ve learned in my investment career.
First investment lesson
My first investment lesson occurred while I was still in short pants. My newspaper delivery empire was throwing off free cash flow at an alarming rate, owing to the fact that I had fixed costs that were being absorbed by my parent company (mum and dad). As such I devised a devious scheme to take this money and make a motza.
Scouring the investment returns of managed funds, I found a share fund that had produced stellar returns over the past three years, aptly titled the “special situations fund”.
I disregarded the fact that past performance is no indication of future performance. Nor did I concern myself with the fees that were being levied, or the trailing commissions and stamping fees I was paying to the adviser.
The “special situations” that the fund invested our money in were events that no one expected (or could predict for that matter) – droughts, floods, a CEO resigning, fluctuations in the gold price.
You name it and these guys bet on it. As luck would have it, the very moment I invested my money these “special situations” turned out to be “pretty bloody ordinary situations”.
In fact, the only special situation that happened to me as a result of investing in this fund occurred some 12 months down the track when 30 per cent of my capital had evaporated.
Still smarting from my loss, I decided that I would be more careful with my next investment.
Second investment lesson
As a teenage boy, with many moons to pass before I could achieve the holy grail of (legally) entering licensed premises, I deduced there would be certain cache in owning shares in Crown Casino – if nothing for the bragging rights with my mates.
Upon subscribing to the float I was entitled to a shareholder discount program, which of course was worthless to a prepubescent punter like me.
My reasoning was sound. People love to gamble, and Crown was set to be the biggest (and only) casino in Victoria. Mathematically speaking, the house always wins.
It was an exhilarating ride. After purchasing the shares for $1 they steadily climbed to $2.85 a couple of years later. Things were going well. Then we moved down the other side of the mountain, a slow painful process. Waiting at the bottom of the investment mountain was none other than the late Kerry Packer, who bought the casino for what many would argue today was a song.
The lesson was simple – it was never a good time to sell your company to Mr Packer. For a small shareholder, wealth could be made by piggybacking billionaires who had their own skin in the game – which was the forerunner to my shareholding in Publishing & Broadcasting Limited.
Third Investment lesson
My final investment lesson occurred only a few years ago – a time when I had been investing for well over 15 years, had spent years studying and achieving many grandiose letters after my name, and was working full-time as an investment adviser.
The stock market, not unlike a teenage girl, goes through many fads – private equity, gold stocks, mid-cap stars, and resource booms. In late December 2003 the latest fad was “listed investment companies” (LICs), which are best described as managed funds that trade like shares on the market.
Owing to my success in LICs such as the Australian Foundation and Investment Company, and Argo Investments, I saw this as a way to invest directly with fund managers.
These guys had a strong historical performance, and they bypass the trailing commissions that financial planners traditionally charged for unit trusts.
Clearly, I was not alone in my enthusiasm, as many of these LICs quickly raised hundreds of millions of dollars from retail investors.
It soon became apparent that this new breed of LICs was a markedly different beast to strong and reliable predecessors such as AFIC and Argo, which operate on an extremely low-cost basis to pass on benefits to shareholders.
These new guys were out to make money – for themselves, not shareholders.
Having raised hundreds of millions of dollars from retail investors, most of these funds locked away the ultimate trailing commission.
Sometimes these amount to more than 1.75 per cent of the fund’s assets each year for the next 20 years (which are often locked into a watertight management agreement not focused on performance), plus a 20 per cent “out performance fee” if they were lucky enough to beat the average market returns.
The final sting in the tail to many unsuspecting investors is that the cost of running the listed company – directors’ fees, share registry services, even printing costs – are taken out of shareholders’ pockets!
Not surprisingly many of these companies’ share prices today are languishing – in some cases less than what investors paid for them three years into a huge bull run.
A BETTER investment would have been the fund managers themselves (such as Hunter Hall Limited), rather than the products they shunted off to retail investors.
Elbert Hubbard once remarked that “a failure is a man who has blundered but is not capable of cashing in on the experience”.
Although each of these experiences were costly lessons, I have certainly cashed in on them and extracted full value for the future.
Today, I only invest my money with management that treats shareholders’ money as their own, and who have a strong track record (preferably over decades) in business.
Next time you sit down with your financial adviser (or your surgeon), ask them where they invest their money, and the last time they turned an investment lemon into lemonade.
Tread Your Own Path!
Photo: flickr.com/photos/slimjim/1095931082/in/set-72157600208179119
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