7 Immutable Laws of Investment from James Montier

I really like James Montier’s 7 Immutable Laws of Investing. The author is a member of the GMO asset allocation team. GMO is a privately held global investment management firm with $93 Billion in assets. Montier believes in a disciplined approach to investment with a particular interest in tail risk. Tail risk is defined by Investopedia as, “A form of portfolio risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution.”

Notice how many successful investors seem to believe in a disciplined approach?

1. Always insist on a margin of safety

There are a lot of rules that apply to this one. Never be “all in” any one investment. Even in poker that only occurs when a player is on the verge of bankruptcy. Diversify across many types and classes of investments. As King Solomon said, “Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land.” Hedge your positions. Do you have some tech stock? Hedge it with some bonds. Do you have some money in a small cap growth stock fund? Hedge it with some gold or dividend paying large cap shares. You get the idea. If you never have more than 2 or 3 percent of your net worth in any single investment, you will sleep better at night. One more thing to think about: be sure to keep some cash on hand just in case.

2. This time is never different

Montier observes, “Sir John Templeton defined “this time is different” as the four most dangerous words in investment. Whenever you hear talk of a new era, you should behave as Circe instructed Ulysses to when he and his crew approached the Sirens: have a friend tie you to a mast.” After the tech bubble of 2000 and the real estate crash of 2008 we shouldn’t need to be reminded that nothing goes up forever.

3. Be patient and wait for the fat pitch

Patience in investment, as in life, is a virtue. Don’t think in terms of annual or quarterly return on your investment. Look at the long term. Buy cheap and hold. Montier mentions Benjamin Graham’s deep value screen as an example of the fat pitch, “In order to pass this screen, stocks are required to have an earnings yield of twice the AAA bond yield, a dividend yield of at least two-thirds of the AAA bond yield, and total debt less then two-thirds of the tangible book value. Think like a catfish. Sit on the bottom and wait. Something tasty will show up.

4. Be contrarian

Your brain is wired to sell when your losses are at their greatest and buy when a market is nearing its peak. Your brain is wrong. Lord Nathan Mayer Rothschild (yes, he was one of those Rothschilds) observed, "Buy to the roar of cannon, sell to the sound of trumpets.” It was sound advice during the Napoleonic Wars and it is sound advice today.

5. Risk is the permanent loss of capital, never a number

The author sees three types of risk common in investment. To understand his definition of risk, consider, if you lose 50% of your money, you then must double your money to return to your starting point. Doubling your money is hard and takes a long time.

1) Valuation risk – you pay too much for an asset. If you are contrarian, you will avoid this trap.
2) Fundamental risk – there are underlying problems with the asset that you are buying (aka value traps); I bought GE thinking I purchased an undervalued industrial conglomerate. In fact nearly one half of their profits came from GE Capital which collapsed in 2008.
3) Financing risk – leverage: Making bets with borrowed money is great if you win. If you lose, expect a visit from Tony Soprano’s leg breakers.

6. Be leery of leverage

In this section the author expands on what he covers in financing risk. He considers most innovation in investment strategies to be nothing more than the discovery of a new way to use leverage. No money down real estate scams help lead us into the miseries of the housing crash. The author points to the junk bond debacle of the as example of the down side of leverage and quotes J.K. Galbraith on the subject, “The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.” If you hear the promotion of a get rich scheme based on borrowed money, Montier suggests that you run away.

7. Never invest in something you don’t understand

One of the most successful investors of the 20th century, John Templeton observed, “If you don’t understand what you’re investing in – don’t invest!” The author believes this is just plain old common sense. He contends that the financial industry intentionally makes things as complicated as possible to increase their commissions and fees.

The author believes American investors are ignoring his advice in a search for juiced returns in a market where bonds are held at artificially low rates of returns by the policies of the central banks of Europe and the Federal Reserve. He advises caution.

So, let’s be careful out there.

Thanks to the Big Picture blog for the link (below) to this excellent article. I encourage you to read it in its entirety at your leisure.

https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIDXQOKC%2bS4j0GSbBOTlmPaBq077Mz3ys9YPrV5AqoF%2bc5B4tXwvdcZNA7AKhLYcP8PVaZ2n4vsX6U1LALOAfBh5cgq3Q8EYyYeirezEiOl1tODvs33Qo8K%2f