My 2023 Results
A bad strategy yields bitter fruit, but recognizing it has turned things around?
Apologies for the delay in posting 2023 results, I didn’t wait because of embarrassment (though I certainly was embarrassed), but because I was locked out of my substack account for well over a month1.
To recap how the year started, I left my job and returned to full time investing June 1st, the day after the S&P 500 closed at 4450. It ended the year at 4751, a gain of 6.7% in 7 months. During the same period my combined accounts lost -2%, after starting down -1% in first 6 months of 2023. For the entire year I finished down -2.7% vs. a 23.7% gain for the S&P 500, giving back a lot of the excess returns I had earned over the previous year and half.
This is my first down year and first year trailing the market, so it was very painful. The important questions are why did it happen, and how can I prevent it from happening again in the future?
Let’s review my investing approach. I typically focus on net-nets with impending catalysts, often called “special situations”. The emphasis on catalysts separates my approach from Walter Schloss. He would buy a huge basket of roughly one hundred net-nets and let things work out naturally over time. I run a focused portfolio and try to limit my holdings to my best five to ten ideas, with the belief I can generate higher returns than his mostly passive approach by cherry picking only the best ideas.
Walter’s approach meant that whenever a few net-nets did poorly his diversification meant that often those losses could be offset by gains from the rest of the large portfolio. My focused portfolio doesn’t give me the same luxury, if two of five holdings turn out as mistakes, the other three have to do well to make up for them. This increases variance, but given a typical holding period of under 6 months my down periods have rarely lasted long historically, and never for a full year. So what happened here?
Specifically my selection criteria was wrong. I focused on selecting mostly based on discount to NAV, the bigger the discount the “safer” its purchase and the higher its potential returns appeared. But this led to under-weighting another important criteria, board and shareholder composition. Turns out that without good shareholders, companies are less likely to do shareholder friendly things with excess capital (I hear you all saying “no duh”!).
The problem peaked at the end of November. Overall we were down nearly 10% for the year at that point, and I began to seriously consider whether we should continue managing money at that point. If I can’t generate positive returns (especially in a rising market) and beat the market each year I’m superfluous to an index fund and wasting client time and money.
At that point I finally accepted that I had focused too much on quantitative measures of risk and potential return, while not weighting soft factors like shareholder and board composition highly enough. Right then I committed to doing a better job of factoring in the soft factors and immediately sold nearly half of our positions that scored poorly on shareholder base, and reloaded into new opportunities with lower discounts to NAV but also with much better shareholder bases.
And the good news is, it worked (so far)! All accounts combined are up a little over +16% since December 1. My process feels back on track but I recognize it hasn’t even been 3 months (the S&P 500 is also up +11% in same time frame, so I’m only regaining lost ground slowly). This year will be the make or break year for the fund and my process. I continue to hone it to better focus research time on the best opportunities and improve research productivity. And promise to write up even more ideas now that I can login again;)
Advice to other Substack authors, don’t use email login. Instead give yourself a secure password and save it in keychain or your password manager. If your email address gets black-listed in Substack’s system you will wait for days for emails that never arrive and it’s very difficult to know whats happening or where to go for help.