Case Study: Why quality is key for long term investment strategies
30 August 2018
Global investment company Magellan Group stands by a strong set of principles when it comes to investing. Their carefully considered strategies have resulted in long term success, underpinned largely by the importance of quality investments. The below snippet from their Annual Investor Report provides an insight into their thinking and highlights the importance of quality when creating an investment portfolio.
Renowned investor Sir John Templeton was perhaps best known for saying: “Bull markets are born on pessimism, grown on scepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” In our view, only conservative investors sleep well. Implicit in conservative investing is the focus on the conservation of capital.
As Warren Buffett has said, there are two rules in investing:
1. Don’t lose money.
2. Don’t forget the first rule.
At Magellan, we believe in the fiduciary concept of the ‘prudent man rule’ in managing money for our clients (and ourselves). This rule was conceived in the 19th century when a Massachusetts judge suggested trustees should “observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.”
We have often stated that clients should be aware that we will not be overly concerned if we under-perform a market benchmark in the short term. Given our approach is to build a portfolio of a small number of outstanding businesses (which, by definition, is substantially different in composition from any broad equity-market index), the probability of this occurring is a near certainty.
All our investments are made in accordance with our investment philosophy; to invest in outstanding businesses that have attractive underlying business economics because they are protected by sustainable long-term competitive advantages or, in Buffett’s words, an “economic moat”. In our opinion, investing in terrific businesses at appropriate prices is a low risk investment style and will produce more certain investment returns over time than many other approaches.
Buffett wrote in his 1992 letter to shareholders: “Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher 5, 10 and 20 years from now.” This test sounds easy, but it is hard to put into practice as there are only a relatively small number of companies in the world whose earnings are almost certain to grow significantly in coming years. We believe that many companies are entering the most disruptive business environment since the start of the industrial revolution.
So now it is even harder to find such businesses. We will clearly need to be on our game in the years ahead. Sir Frank Lowy, the founder of Westfield, once gave me some sage advice on the key to being successful: “Be paranoid”; that is, spend more time on thinking about what can go wrong than what will go right.
Our investment objectives are clear. We seek to deliver very satisfactory investment returns over the medium to long term while minimising the risk of a permanent capital loss. We are happy to be judged on absolute returns over time and our record at minimising the risk of a permanent capital loss. We recognise that some people are fascinated with comparing investment returns over short periods of time with a share-market index, such as the MSCI World Index.
If you look at our returns after fees over three years on a rolling monthly basis, which we think is the minimum time frame you should consider when assessing whether or not a manager is adding value over time, our global equity strategy has outperformed the MSCI World Index consistently since inception; in fact, more than 90% of the time. This places Magellan right at the top of its peer group of global equity managers on the basis of consistency of outperformance.
We feel strongly that people cannot retire on ‘relative investment returns’. Only by generating investment returns that exceed the rate of inflation by a reasonable margin will investors meaningfully increase their wealth over time. We are satisfied with the investment results that we have delivered to date.
Source: Magellan Group, taken from their Annual Investor Report 2018 – by Hamish Douglass (CEO and CIO)
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