Iceland could do no wrong in 2007. An island of 330,000 people, it had one of the highest per capita incomes in the world. It had produced several billionaires. The International Monetary Fund and the World Bank held up Iceland as an example of how to run an economy.
By March of 2009, just over one year later, all three of its banks had failed, its currency had lost 50% of its value versus the U.S. Dollar and its stock market was down 50% in its local currency and down 67% in terms of U.S. Dollars.
Asset managers exposed to Iceland in 2008 and 2009 got their heads handed to them.
Our day-to-day investment operations consist of two primary activities: stock selection and portfolio construction. We look for undervalued equities in the stock selection element of our business. In doing so, we analyze business models, assess management teams, and figure out what the business is worth relative to its publicly-quoted price. We’ve been doing this for nearly three decades now. We’ve analyzed thousands of companies.
In the portfolio construction element of our business, we assess what we call shared exposures. A shared exposure is anything that affects the value of two or more of our investments.
We are invested in three Brazilian financial services companies at the moment. The management teams and business models of these companies are not shared exposures because they are different and unique for each company. The Brazilian economy and the Brazilian financial services industry are shared exposures for these investments because they each affect the underlying value of all three investments simultaneously. If the Brazilian economy turns south, it will affect the value of all three investments. Our portfolio construction activities - that is, determining exactly which of the undervalued stocks we find that actually go into the portfolio - focus on finding and analyzing shared exposures in the portfolio.
This is a critical element of our investment operation. The relative priority of our portfolio construction activities has steadily grown as we have gained experience in the asset management business. Today, portfolio construction is every bit as important and adds just as much to our returns as the stock selection element of our business.
The market is sometimes slow to respond to incoming data that doesn’t fit neatly into an existing narrative. A bridge built with planks consisting of better theories than those that exist in the market is a well-built bridge.
A well-built plank does not always have immediate utility. It is time well spent, in our view, to nevertheless build those planks with no immediate utility but with enormous long-term potential. Those types of planks are the homeruns of the future.
Planks should be firmly secured to the bridge for future use. A well-written document are the nails and glue that secures the plank to the bridge. The act of writing not only focuses the mind, but creates a document that preserves the moment for a lifetime of use.
The best investment managers with great track records almost always surround themselves with like-minded plank builders. Networking with like-minded plank builders is a wonderful way to extend your bridge further than you could ever build it on your own. You build your planks. They build theirs. You then exchange planks.
A final way to accelerate bridge building is to train others in the art of building planks. Proteges once enlightened in the art of plank building sometimes build better planks than the mentor. Mentoring pays big dividends.
