“Lethargy bordering on sloth remains the cornerstone of our investment style.”
– Warren Buffett
A couple of weeks ago I was sitting at the dining table at home, staring at the wall and daydreaming. Faris, my five-year-old son, asked me what I was doing. “I’m not doing anything” I said. “Baba! That’s silly, you can never do nothing. Even if you’re just standing there you’re still standing and breathing,” he replied (an idea he attributes to his older brother). I’m not sure how philosophical he meant his remark to be, but it got me thinking.
At Mayar we often talk about sitting around doing nothing. As I’ve written in previous letters, our strategy leads to long periods of no activity punctuated by short bursts of hyperactivity, at least by our standards. But the reality is that when it comes to investing, we really are always doing something.
First, we’re always holding some asset. Even if we sold all the securities we hold in our portfolio we’d end up with cash, which is an asset. And second, when we don’t make any investment decisions, we are implicitly deciding to “hold” our existing portfolio.
Any portfolio we hold has what can be thought of as a “base rate” of return. This is the return that the underlying mix of assets (equities, bonds, cash, etc.) produces during a certain time period. Any changes we make to this mix between now and the end of that period will either add to or subtract from that base rate of return. Let us explore this a little bit.
“You can never do nothing, even if you’re just standing there you’re standing and you’re breathing.”
For the sake of simplicity, let’s assume that we can only hold cash or equities in our portfolio. Our portfolio’s base rate of return will depend on how much equities and cash we hold.
Equity markets have a base rate equal to the risk-free interest rate plus an equity risk premium on top of it. Historically that added up to approximately 8-9% per annum. This is the return that a “buy & hold” equity investor will generate. This return is not only satisfactory, it also turns out to be a very difficult hurdle to beat, which is why most active investors do not.
There are only two ways to do better than that (assuming no leverage):
- Hold cash sometimes with the hope that one can buy equities later at a lower price
- Choose a basket of stocks that produce higher returns than the overall market’s buy & hold return
Both are extremely hard to do. Cash earns almost nothing and exposes the investor to inflation risk. That’s a severe disadvantage compared to the equity buy & hold return. As a result, most of the time one should be fully invested in equities. History supports this conclusion.
Very occasionally though, one may have an insight that justifies holding some cash–as we do today–but even we at Mayar are guilty of overestimating the frequency of that in the past.
The second option we believe can be accomplished by having a much longer time horizon than the average equity market investor. This “time horizon arbitrage” gives investors with the right temperament the ability to buy quality companies at prices that produce market-beating long-term results at times when negative or uncertain short-term events cloud other investors’ lenses.
So, when we talk about doing “nothing”, what we really mean is that we cannot – at the moment – find opportunities that would, with a high degree of certainty, produce outcomes that are better than equities’ buy & hold return.
And we should expect that to often be the case. The investment field attracts thousands of intelligent and hard-working professionals which leads to efficiently-priced markets. We believe it would be arrogant of us to believe that we can do better than buy & hold all the time. A more realistic, though still tough, goal is to aim for a handful of smart insights every year and to only trade at those times.
Most investors don’t seem to have the patience and discipline to just sit tight most of the time and do “nothing”. Perhaps we’re just lazier than others. Or maybe we’ve just been comforted by the knowledge that we are operating in a field where doing “nothing” is so highly rewarded!
First published in Mayar Fund’s Letter to Partners – September 2018 (portions may have been redacted)