Truly active investing is…

speculators

…dealing productively with risk and opportunities:

  • What stock opportunities to select that offer high upside potential for the risk taken (see section 3: Find Opportunities)
  • How to diversify a portfolio to try and avoid large synchronised losses (see section 4: Minimise Risk)
  • When to reduce exposure to a holding or to the market altogether (see section 5: Keep Aware)

Trying not to speculate

By favouring “bottom-up” investment thesis, that is, based on some fundamental knowledge of the stock (e.g. a company’s improving cost advantage or a technology disruption affecting a specific industry), rather than “top-down” bets (e.g. direction of some macro-economic variables) which are both a lot more complex to understand and more likely to have a systemic portfolio impact if wrongly forecast

Giving oneself a chance to benefit when proven right and survive when proven wrong

By keeping number of holdings low, carefully selecting stocks with high upside/downside risk ratio, and minimising the risk that several holdings fail at the same time for related reasons.

Focusing on absolute returns more than performance relative to an index

Over the long run, managing to deliver 10% return above cash deposit rate in good years and no worse than -5% in bad ones yields far better long-term outcomes than roughly matching the index each year. The objective is therefore not to try and beat the index every quarter so much as ensuring satisfactory absolute returns, which in turn will beat the index in the long run if not necessarily each quarter or even year.

A stock-picker’s guide to the galaxy

Don't Panic

The universe is a lot more complicated than you might think, even if you start from a position of thinking it’s pretty damn complicated in the first place

Stock-picking is an indistinguishable mix of skill and luck, just like poker, horse race betting, life, the universe and everything. There is no certainty, only probabilities. The best we can do is to tilt the odds in our favour as much we can and spread our bets in a way that they will never all fail at the same time and wipe us out.

Don’t panic

A 20-holding portfolio where 3 stocks lose over 30% of their value in a given year need not be of concern. In fact, if at the same time 6 holdings gain over 60% in value, then what you have is a great portfolio where the “randomness” factor has been well spread out across various types of investment thesis. Be concerned if all your holdings outperform by roughly the same amount. Highly correlated price behaviours can foreshadow major synchronised disappointments. Use the app (complemented by own research) to identify common factors driving your portfolio’s performance and use the mitigate function to diversify away from the source of risk concentration.

Once you know what the question is, you’ll know what the answer means

A stock scoring 10/10 is in no way an outright buy, just a stock highly worthy of your time. There simply is no information in a stock’s score, all the information resides in the story that underpins it. Why a stock is seen by the model as a 10/10 (is it super controversial, extremely cheap, or super-high quality/growth?), and what are the mitigating information (are brokers not keen, is there a major embedded macro bet, has the company passed peak margin, is there a key “bear” argument about to play out, etc)?

Protect me from knowing what I don’t need to know

The model calibration to long-term investing and the app’s automated portfolio alerts are here to shelter you from market noise and impulsive trading. Most of the time, it is better to let your portfolio run without intervention. When a discontinuity in overall markets or specific holdings performance arise that triggers an alert, just schedule some appropriate to time to reflect on the appropriate response. You won’t beat the algos for speed, so try not to trade on “smoking guns” (eg. the afternoon after a profit-warning). Do the work and trade on “loaded guns” (eg. taking the view that a profit warning is likely but not priced in).

Quotes from Douglas Adams’ Hitchhiker’s Guide to the Galaxy