Rudi's View | Dec 12 2006
By Rudi Filapek-Vandyck
In what is without any doubt one of the best investment stories ever written, Hong Kong based strategist and market commentator Marc Faber tells the story of an imaginary eccentric uncle who prefers to live on a sparsely inhabited island, without any access to modern media or communication devices.
The uncle is, however, a clever investor who knows that ultimately money will flow from overvalued assets into undervalued assets as the world is governed by investment cycles. If his timing is correct he’ll be able to buy in cheaply and sell at elevated prices and then buy in cheaply elsewhere again.
Once every ten years he leaves the island, spends a whole week in catching up with events and developments in the rest of the world and makes his investment decisions for the next decade. Smart as he is the uncle manages to pick the right place to be in each of the past few decades: Japan in the eighties, US technology in the nineties. He’d probably have picked Chinese property and shares in early 2000 in combination with resources elsewhere.
It goes without saying that the uncle who started investing with a small amount of money only will die as one of the richest people on the planet. The obvious question that comes to mind then is can this be done? Is successful investing really that simple?
The criticism that too many investors, including fund managers, try to chase returns by swapping assets too often is not new. The theme is bound to resurface again at the end of a calendar year during which most hedge funds are believed to have underperformed major share price indices across the globe.
It would seem that FNArena’s Market Sentiment Indicator has added its own contribution to the public debate this year. FNArena received its first invitation to provide a list of so-called top stocks for the year ahead in 2004. The list, published in the December edition of monthly magazine The New Investor, beat the S&P/ASX200 index that year by more than 5%. The calculation was done on the assumption that an imaginary investor would have equally spread his investment funds between all the stocks mentioned on the list.
The list itself was compiled by simply calculating the Buy, Hold and Sell recommendations for each stock from eleven stock brokers in Australia. Those with the most Buys, and the least Sells, made it to the list.
We repeated the exercise the following year. The second list, published by the Australasian Investment Review, was again compiled via the same methodology. And again, on the same assumption of an imaginary portfolio equally spread between all the stocks on the list, Australia’s leading stock index was beaten by circa 5%.
In both cases the basic premise was that money was invested once and left untouched for the next twelve months. This also implies that any costs, although not taken into account in the calculation, would have been low.
In hindsight one could argue we had created our own eccentric uncle story. Only in our case he would leave his island towards the end of each year, have a quick look into the consensus views by the market experts and change his portfolio accordingly. Every year our uncle would beat the index by 5% at little costs and with no extra effort throughout the year.
Can successful investing really be this simple?
At the time when we drew up this year’s list we’d already come to the conclusion that our method, even though successful two years in a row, was too heavily skewed towards large cap stocks. Large caps receive more coverage from equity brokers and are thus more likely to outmuscle mid caps and smaller stocks in a beauty contest simply based upon the amount of Buy recommendations.
So we came up with the idea of creating our own Market Sentiment Indicator which would make the contest between large cap stocks and the rest of the Australian share market a more equal playing field. The indicator translates all recommendations for a given stock into a figure between 1 and minus 1. We set the minimum amount of coverage at four experts out of a maximum of ten.
The list was published in early January instead of the usual mid-December and WHK Group had a share split towards the end of the year. It contained the following stocks: News Corp (NWS), Oil Search (OSH), BHP Billiton (BHP), Brambles (BIL), James Hardie (JHX), Macquarie Bank (MBL), CSL (CSL), Macquarie Communications Infra (MCG), Babcock & Brown (BNB), Perseverance (PSV), Roc Oil (ROC), Excel Coal (EXL), SAI Global (SAI), STW Communications (SGN) and WHK Group (WHG).
Adding up all the total returns and dividing it by 15 gives us an average return of 21.82% which is –again- a little more than 5% higher than the performance of the S&P/ASX200 index over the period (dividends included).
We feel lucky we fine tuned our methodology in the third year as our traditional method didn’t perform so well this year. We’re still finalising our return calculations, with the likes of Macquarie Infrastructure (MIG) and Alinta (AAN) giving us headaches, but it would seem the traditionally chosen 15 stocks could not keep pace with the S&P/ASX200 index this year.
For 2007 our eccentric uncle has chosen the following ten stocks:
Emeco (EHL), News Corp (NWS), ResMed (RMD), Rio Tinto (RIO), Macquarie Bank (MBL), BHP Billiton (BHP), Oil Search (OSH), Boom Logistics (BOL), Spark Infra Group (SKICA) and Domino’s Pizza Australia NZ (DMP).
It’ll be interesting to see when our uncle returns from his island in twelve months from now if his picks for the year have again done better than Australia’s major share index.
After all, what are the chances he will again have outperformed the market by 5%?