What follows is a portion from the monthly client letter I send out to investors at T11.
The seeds planted in 2014 are already bearing fruit in the form of significant gains to begin 2015. Throughout the years I have been a part of enough January jubilation, if you will, to realize that while a strong start to the year is certainly the best possible outcome, the market is fickle mistress that can quickly decide that castration may be the next best course.
To reiterate the review for December, the market of 2014 did afford a great deal of opportunity in terms of situations that were simply not being recognized. Discovery of those situations followed by the strength of conviction to take a substantial position has dictated our gains to begin the year.
There are a number of factors at work that lead me to the belief that we will see a minimal amount of turnover in the portfolios over the next eleven months. The evolution of a bull market dictates that in the middle of the cycle attractive opportunities become scarce due to the recognition of what is occurring by investors. That recognition disallows an investor from receiving an appropriate amount of reward for the risk they are taking. The situation for investors moves into a balanced phase that very obviously creates volatility in returns as an investor decides to settle for less than ideal circumstances expressed through the act of taking on investments that can be best described as “discovered.”
It is only through imbalance that significant returns are possible. The counter-intuitive nature of the markets dictate that balance is an adverse circumstance that should be summarily avoided. However, it is all too common that investors find comfort in the intuitive act of investing into a balanced situation.
In the current phase of the bull market there are very few perfectly imbalanced situations. I like to think that our portfolio is an amalgamation of the most attractive imbalanced investment situations remaining in the marketplace. Of course, I come across a handful of potentially imbalanced investment situations every month. There are degrees to imbalance, however, that cause those situations to be filtered out. In reality, I scan through literally hundreds of names per month. Over the course of the year, that number jumps into the thousands. In 2014, five of those thousands of candidates made it onto the big screen instead of being discarded onto the cutting room floor, to borrow a phrase from Hollywood.
In fact, each successive year from 2012 on has caused a more discriminating process of allowing for investments to actually make into the portfolios. As an obvious example, in 2013 we saw nine new positions make it into the portfolios. In 2014, it dropped to five. I expect in 2015 for that number to drop to between two to three new names.
This steady drop in the number of opportunities I have been willing to take on as the bull market has progressed tells me that I am doing my job correctly by sticking to the very basic tenet of investment: When you are able to command a significant degree of return in exchange for an insignificant degree of risk, then your money should be put to work in that instrument. It is only natural that as a bull market continues to advance the potential for significant returns diminish while insignificant risk becomes a rarity.
It is all too common that investors will approach a bull market through the reverse pyramid method of allocation. As a bull market begins, the approach is one of timidity that disallows all but a few chosen opportunities to make it into one's portfolio. As the bull market progresses, those ideas grow simply as a result of comfort in what is taking place as opposed to sound analysis of situations leading to appropriate discovery of asymmetry in any particular equity issue. By the time a bull market reaches maturity the average investor portfolio looks like a Chinese buffet featuring investments of all shapes, sizes and colors.
I reject this mentality towards investment, believing that as a bull market progresses an investor should become more selective. Leading me to 2015, which, as previously stated, will be a year of minimal turnover in the portfolios.
The enemy of good is better. For the time being, I am content in leaving good enough alone.
Regards,
Ali Meshkati
