Category Archives: Strategy

It’s That Time of year – Window Dressing and Tax Selling

A Danish poet wrote a poem many years ago saying that the year contains sixteen months and five of those are November! A not so subtle hint that darkness and cloudy weather is becoming the norm at this time of year and that time tends to become more of a drag.

My mother and I are less pessimistic. In fact it is a month where we indulge in our disorders and celebrate them. For her Christmas comes early. And those 107 Santa Claus characters populating every shelf in the house? Well, they are just not enough. And so as soon as the stores make new ones available she acts swiftly and decisively. With skills carefully crafted and perfected over many years she picks out the most spectacular ones before anyone else can get to them – and thus fulfills her cravings.

I’m also like that at this time of year except my disorder is more related to stock purchases. I load up on stocks I have had my eyes set on and I even buy on margin (4% currently and I will most likely boost it to 10% as I have done in previous years). Doing so makes me tense but I simply refuse to let those crumbs lie on the floor without picking them up when they are thrown around so carelessly by money managers clinging on to their jobs. You might say I have a mean streak in me because I don’t believe in leaving money on the table for my fellow man but when I see mispricings before my eyes without acting on them, I become physically ill. The stomach ache from buying on margin I can handle but not that other pain. Also, stomach ache is the constant companion of the bargain hunter so I get a bit of extra practise at the same time!

So what makes some money managers become so generous all of a sudden? Why do they act like amateurs and let small investors eat their lunch?

Window dressing

Some investment funds mislead their clients by selling badly performing securities before the end of a reporting period – month, quarter or year – and use the money to buy a rising security instead or to hold cash to buy back the securities they sold when the new period begins. By listing the stocks they hold at the end of the period the fund wants to appear to have performed better than it actually has. It is a despicable practise but it is a well-known fact within the industry that it occurs and it is most prevalent during the months of November and December.

Here is another window dressing technique that I witnessed in real time as I had an interest in buying a related stock at the time: Check out Wilhelmsen Holding’s A stock movement, ticker WWI, on October 30th, the last day of the month. In the last half hour of trading that day the price jumped 10% from 154 to 170,5 on low volume ochestrated by one buyer, CSB, who had been buying heavily in the previous weeks. The related B share hardly moved and in the following days the price came down by the same amount. This maneuvre is not legal but nonetheless it can often be witnessed in several illiquid stocks, especially on Dec 31st. The purpose is to inflate performance numbers at a relatively small price. It seems silly and if you or I did that it would be akin to pissing in our pants to keep warm for a few seconds. But perhaps you would also be tempted by sub par investment decisions if you had clients or bosses to report to?

Tax selling

In an overall rising year selling losing stocks to cancel out part of the wins can lessen the tax burden. For this reason you will often see stocks that have underperformed reach their lows in November/early December.

Be on the other side of the trade

You could call both of the above light forms of ”forced selling”. Any time you can be on the other side of a trade that isn’t driven by company fundamentals you want to be in that position – supposing of course that you want to own the particular stock in the first place. Note that what I am talking about here is the general odds of the above happening – you never know with absolute certainty who you buy from or what their motives are.

The January effect and small cap losers

Part of the reason January is often particularly good to small cap stocks that performed badly the year before can be attributed to the above practises. The market tends to correct itself and smooth out ineffeciencies but strangely this one has persisted and I will continue the uncomfortable practise of buying on margin for three months of the year and then gradually become non-leveraged come February/March until evidence says the market has erradicated it.

This bet doesn’t always turn out favorably, of course. In fact as late as 2014 I was not treated with any respect whatsoever by Mr. Market when I went for a leveraged oil play that turned sour as the oil price decline worsened. I won’t know for sure whether my bet was sound but I believe it was and therefore I would do it again. Investing is at heart a mathmatical undertaking where you attempt to estimate the likelihood of different scenarios happening:

Expected value = (Intrinsic value of the company in Scenario A * likelihood percentage) + (Scenario B * likelihood) + (Scenario C * likelihood) etc…

Dance like a butterfly sting like a bee

The above is a quote by Muhammad Ali to describe his boxing style: Non-dogmatic and opportunistic. When you see an opening: Pounce. I think this flexible attitude can also be applied by the enterprising investor even though check lists and hard rules are also a fine way to guard oneself against permanent loss. But to completely shut oneself off from action when circumstances are especially favorable is also a mistake in my book – mistakes can also be ones of omission as Charlie Munger puts it.

There is only principle I will not bend ever and that is the idea of a large Margin of Safety. The gap between what I perceive the value to be and the market price needs to be large for me to consider an investment no matter the circumstances.

Ego Protection – a Source of Major Mistakes

“Take no thought of who is right or wrong or who is better than. Be not for or against.” – Bruce Lee

Imagine for just one moment that you and your ego are two separate entities. Ok? Now imagine yourself as a boxer and your ego as a punching ball. Is the image planted firmly in your mind? Good… Now punch!

Did it hurt? Unless you are Buddha or someone who dances in nirvana land on a regular basis the answer is probably yes. Separating ourselves from our ego is just not that easy to do. However, it is my thesis that if we become proficient at it good investment decisions will follow much more frequently than if we let ourselves become slaves of our irrational ego. The hopes and fears of our ego can block the view of what is actually true about a situation.

Ego taking over the control
Ok, so we have done a thorough analysis on a company and have decided to invest. The stock goes up and we feel quite good about our stock picking skills. It still has a long way to go before it reaches its intrinsic value (according to our analysis) but nonetheless we decide to lock in the gains and sell on the grounds that “no one ever lost money from taking a profit” – a surprisingly common saying even among professionals who ought to know better. In reality we have committed a crime against our wallet in order to satisfy our ego’s need to book a win. In that moment we gave in to shortsighted sugar craving when it would have been wiser to develop the patience and thick skin and toughness of a Mongolian warrior waiting through the long and cold winters for the prey to arrive – ie. for the stock to finally reach its fair value. Easy thing to say, not always easy to do – hence the spiritual warrior metaphor.

Other examples
The same is true when we exit a stock that has fallen because our ego cannot stand to see the red figures in our account. When we start buying at absurdly high prices for fear of missing out on a rally everybody and their neighbor is seemingly a part of. Or when we become so attached to a stock that we keep holding on to it even though the fundamentals have changed in a major way so that the intrinsic value is now below the price of the stock. (Note, I’m not talking about the minor inevitable bumps that all companies experience on a regular basis. Selling on minor bad news can be costly when it comes to transaction costs in and out of a stock. I’m talking about game changers that fundamentally change the future prospects of a company.)

Being too attached to a stock
This last example can be especially difficult to deal with if we have put in lots and lots of time studying a company and now feel we need to get paid for that time. Unfortunately, the market is completely insensitive to our petty needs! It doesn’t deal with what is fair or unfair, only with what is true about the intrinsic value – or rather, it fluctuates around it, usually with a pull in that direction, like a yo-yo always returning to home. Another danger of being attached to a stock we have bought is that we can become so blinded by the upside that we don’t analyze news in a cool and unbiased fashion but instead shift the truth of the situation and instead see it in the light that we prefer.

Why do it?
Obviously, all of the above can be devastating to long term returns. So why do you, me – everybody! – do it so often? I think there are a few things that can come into play – and it isn’t at all impossible to cut down on their frequency.

1) We don’t separate ourselves from our ego

When we are not monitoring our own thought processes in an unbiased, “from the outside” sort of way and instead go on autopilot and react to situations in a non-reflecting way, our ego can easily dominate our actions. To prevent that it can be helpful to view our ego and ourselves as separate entities like in the exercise above. Daily meditation can be very powerful in this respect, as in every other part of our life. The Buddhist nun Pema Chödrön has described her view of meditation as the image of “sitting in a garden, watching children play with an attitude of nothing left to do”. With children being a metaphor for our thoughts – ie. watching them in a calm and free way without interfering – and becoming like water:

Within the finance world there are many proponents of meditation, which isn’t surprising given how much people are burdened with constant streams of information. One is top fund manager Ray Dalio, who attributes all of his success to this practice, which he has been at every day for 43 years.

2) Protecting our ego is more important to us than spotting mistakes

When protecting our ego from getting hurt becomes more important than making money we are in a bad situation as investors. The result is that we travel the comfortable road we are used to, which is to make sure we blame mistakes on external factors rather than looking inwards. And here I’m not talking about mistakes as being equal to having losing positions and winning positions being mistake free. That is “after the fact”-thinking, which is worthless and something to toss out the window. We act on the information we have in the moment we make the decision. We cannot look into the future so a mistake is not necessarily the same as an outcome that turns against our particular stock. What I am instead talking about is our reactions to events. That is what needs to be scrutinized, not our results – I don’t believe anything can be learned by studying our results.

3) Analytical work makes our heads cooler

It is much easier to react with a cool head if we have done the analytical work. If we don’t know the approximate value of something through analysis (and here I’m not talking about analysts estimates…) we can be swayed easily like the wind whenever a talking head says something in the news or whenever there is a minor positive/negative company event that doesn’t really do much for the long term value but we react by buying or selling nonetheless.

A note on intrinsic value
Now, I know I talk about intrinsic value – the present value of all expected future net cash flows – as if a number exists that could be agreed upon by all analysts. And if we all had godlike, omniscient knowledge of all available information and were able to calculate the millions of possible outcomes, yes, such a number would exist. But as investors we don’t live in theory land and so the intrinsic value of a stock will always be based on fallible estimates and is therefore not a number set in stone. However, it is the closest thing we have to uncovering the true value of a stock and therefore we have no choice but to rely on our own estimates more than anything else. If we give in and trust the volatile price movements of Mr. Market more than our own estimates, we become speculators instead of investors. And 99% of speculators don’t win.

There is, of course, great uncertainty when performing discounted cash flow analyses. The future is usually very hard to predict. But that doesn’t mean we shouldn’t try. If not for anything else but to see how the value is affected by different outcomes. And that means we can better interpret the results as they appear.

Ego – peace not war!

Is ego all bad and something that needs to be destroyed in order to achieve good results? No.The ego can often tell us where we want to go. But it needs to be supervised. We need to make sure that it isn’t taking charge of the ship that is us. Because it is a very bad captain.

But, we are humans – not machines. Our ego will take charge from time to time and it will lead us into making bad decisions in the future. The way to reduce the damage is to become aware of the ego’s influence the moment it takes over. Not an easy task, but one that can reap huge rewards the more we work on it. Ignoring it is not the answer. Instead we ought to monitor it like a mild grandfather watching his grandchild play!

I’d love to hear your experiences…