Is passive investing enough?
The gist
Steve Clapham went into the City at the time of the Big Bang (in the 1980s when there was an explosion in UK finance) where he became an investment analyst, then moved to a hedge fund and then was a Partner and Head of Research at two multi-billion pound funds. He now runs Behind The Balance Sheet.
His job was to pick stocks that were badly mispriced.
To find a new stock, he had to spend 6 weeks on that work - and only doing that. Stock picking (done well) takes so much time.
Even so, he thinks there are strong arguments to pick stocks rather than index funds - but only if you're interested in the subject matter.
Steve argues that you can see a company like Google is a good company so you can invest on that basis - but only if you can understand its valuation properly. Maybe it's over-priced?
The problem is there are lots of great companies which are already expensive so aren't great investment choices. Understanding valuation is key.
The growth in the stock market in the last 40 years has been driven by lowering interest rates, he argues.
But rates have increased loads in the last couple of years and we now have endemic inflation.
On top of that, valuations aren’t going to go up like they have in the last few decades because margins are already extremely high in companies.
Steve questions if the market can keep growing at 8% a year. Sure, it's done it for a century but for that reason, mathematically, it becomes much harder to do in the next century.
This is why he thinks the next period will be different - that beating index funds or the market will become much more common.
What does Steve suggest?
There's a key difference between professional investors and private investors - they've got a much shorter time horizon. Professions are under daily scrutiny.
If a professional's investments go down in the short term then it can have devastating consequences on their job and career, e.g. their investors might pull their money.
This can happen even if the investor's choices are good for the long term. And this difference in time horizon gives private investors an advantage, says Steve.
Steve uses combinations of different ways to value companies rather than just one methodology.
He thinks the best way to make money is to understand the difference between a business’s perception and real value.
Start small, he says. Don’t put all your investments in single stocks - keep some money in index funds.
How many stocks should you invest in? This is a really personal decision - you need to ask yourself, what will keep you awake at night? The fewer stocks you have the greater the volatility, because when one goes down a lot, it has a greater effect on your portfolio, all other things being equal.
Plus, there's often hidden correlation - when one stock goes down, another does.
He wouldn’t recommend having less than 15 stocks as a private investor.
Don’t go all-in on individual stocks because you’re going to lose money and make mistakes, he says.
If you are really interested in doing this, one way to think about it is experimenting with some fun money - not investing more than, say, 10% of your investment portfolio in single stocks. That's what Damo does btw...
Book recommendations from Steve
Richard Oldfield's Simple But Not Easy.
Warren Buffett's Letters To Shareholders.
Howard Marks's The Most important Thing.
