Investment manager GMO's chief investment strategist Jeremy Grantham released his quarterly letter to investors recently that ran over 15 pages across three sections.
Grantham is well-known for going against the grain, often being branded a perma-bear for his dreary forecasts for equities, mainly for developed markets, but he prefers to call himself a realist.
Putting it down to his long-term view and his belief prices always revert to the mean over the long term, Grantham warned of overvaluation of equities before the tech bubble and the housing crash but also asked investors to pick up stocks when he felt they had become cheap enough right at the bottom in March 2009.
His quarterly letters to investors are laced with insights that are based on a common-sense approach to investing, a critical-thinking view of the economy helped a lot with historical perspective, and market-outlook calls that have proved correct a lot of times, especially at inflection points.
In part 1 of the most recent, "longest" letter, titled Investment Advice from Your Uncle Polonius, borrowing the latter character from Shakespeare's Hamlet, he outlined 10 pieces of advice "for individual investors setting out on dangerous investment voyages". Here are excerpts.
Believe in history: History repeats and repeats, and forget it at your peril. All bubbles break, all investment frenzies pass away. You absolutely must ignore the vested interests of the industry and the inevitable cheerleaders who will assure you that this time it's a new high plateau or a permanently higher level of productivity… The market is gloriously inefficient and wanders far from fair price but eventually, after breaking your heart and your patience (and, for professionals, those of their clients too), it will go back to fair value. Your task is to survive until that happens.
"Neither a lender nor a borrower be": If you borrow to invest, it will interfere with your survivability. Unleveraged portfolios cannot be stopped out, leveraged portfolios can. Leverage reduces the investor's critical asset: patience… It encourages financial aggressiveness, recklessness, and greed. It increases your returns over and over until, suddenly, it ruins you. For individuals, it allows you to have today what you really can't afford until tomorrow.
Don't put all of your treasure in one boat: This is about as obvious as any investment advice could be. It was learned by merchants literally thousands of years ago. Several different investments, the more the merrier, will give your portfolio resilience, the ability to withstand shocks. Clearly, the more investments you have and the more different they are, the more likely you are to survive those critical periods when your big bets move against you.
Be patient and focus on the long term: Wait for the good cards. If you've waited and waited some more until finally a very cheap market appears, this will be your margin of safety. Now all you have to do is withstand the pain as the very good investment becomes exceptional. Individual stocks usually recover, entire markets always do. If you've followed the previous rules, you will outlast the bad news.
Recognize your advantages over the professionals: By far the biggest problem for professionals in investing is dealing with career and business risk: protecting your own job as an agent. The second curse of professional investing is over-management caused by the need to be seen to be busy, to be earning your keep. The individual is far better-positioned to wait patiently for the right pitch while paying no regard to what others are doing, which is almost impossible for professionals.
Try to contain natural optimism: Optimism has probably been a positive survival characteristic. Our species is optimistic, and successful people are probably more optimistic than average. But optimism comes with a downside, especially for investors: optimists don't like to hear bad news… In a real stock bubble like that of 2000, bearish news in the U.S. will be greeted like news of the bubonic plague; bearish professionals will be fired just to avoid the dissonance of hearing the bear case, and this is an example where the better the case is made, the more unpleasantness it will elicit. Here again it is easier for an individual to stay cool than it is for a professional who is surrounded by hot news all day long (and sometimes irate clients too). Not easy, but easier.
But on rare occasions, try hard to be brave: You can make bigger bets than professionals can when extreme opportunities present themselves because, for them, the biggest risk that comes from temporary setbacks--extreme loss of clients and business--does not exist for you. So, if the numbers tell you it's a real outlier of a mispriced market, grit your teeth and go for it.
Resist the crowd: cherish numbers only: We can agree that in real life as opposed to theoretical life, this is the hardest advice to take: the enthusiasm of a crowd is hard to resist. Watching neighbors get rich at the end of a bubble while you sit it out patiently is pure torture. The best way to resist is to do your own simple measurements of value, or find a reliable source (and check their calculations from time to time). Then hero-worship the numbers and try to ignore everything else. Ignore especially short-term news: the ebb and flow of economic and political news is irrelevant. Stock values are based on their entire future value of dividends and earnings going out many decades into the future. Shorter-term economic dips have no appreciable long-term effect on individual companies, let alone the broad asset classes that you should concentrate on. Leave those complexities to the professionals, who will on average lose money trying to decipher them.
In the end it's quite simple. really: Let me give you some encouraging data. GMO predicts asset class returns in a simple and apparently robust way: we assume profit margins and price earnings ratios will move back to long-term average in 7 years from whatever level they are today. We have done this since 1994 and have completed 40 quarterly forecasts. (We started with 10-year forecasts and moved to 7 years more recently.) Well, we have won all 40 in that every one of them has been usefully above random and some have been, well, surprisingly accurate. These estimates are not about nuances or PhDs. They are about ignoring the crowd, working out simple ratios, and being patient. (But, if you are a professional, they would also be about colossal business risk.). For now, look at the latest of our 10-year forecasts that ended last December 31 (Exhibit 1). And take heart. These forecasts were done with a robust but simple methodology. The problem is that though they may be simple to produce, they are hard for professionals to implement. Some of you individual investors, however, may find it much easier.
"This above all: to thine own self be true": …To be at all effective investing as an individual, it is utterly imperative that you know your limitations as well as your strengths and weaknesses. If you can be patient and ignore the crowd, you will likely win. But to imagine you can, and to then adopt a flawed approach that allows you to be seduced or intimidated by the crowd into jumping in late or getting out early is to guarantee a pure disaster. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely must not manage your own money. There are no Investors Anonymous meetings to attend. There are, though, two perfectly reasonable alternatives: either hire a manager who has those skills--remembering that it's even harder for professionals to stay aloof from the crowd--or pick a sensible, globally diversified index of stocks and bonds, put your money in, and try never to look at it again until you retire. Even then, look only to see how much money you can prudently take out. On the other hand, if you have patience, a decent pain threshold, an ability to withstand herd mentality, perhaps one credit of college level math, and a reputation for common sense, then go for it. In my opinion, you hold enough cards and will beat most professionals (which is sadly, but realistically, a relatively modest hurdle) and may even do very well indeed.
Read the full letter here.
