What I Learned About Investing In 2008 : Lesson 1 - Patience

The Australian Stock Market has had a terrible year based on almost any measure you care to name. The All Ordinaries and major S&P ASX indexes are all down significantly from the beginning of the year and some market pundits are saying we still haven't reached bottom - but I guess we wont know when the bottom is until it has passed. World stock market indexes have fared little better and in some cases even worse.

It's approaching the time of year when I like to reflect upon my investment activities over the past year and consider what the coming year may hold. It's a great opportunity to take a couple of steps back and look at the year's events and my participation in and reaction to them from a safe distance. Time can sometimes give us a better perspective from which to consider our actions.

With that in mind, I thought I'd share some thoughts on what investment lessons I've learned from the tumultuous year that has been 2008. Before I started writing this, it was going to be a single post. But as I started writing, the words just stated to flow to I think I'll spread this over a number of posts.

Value Investing Takes Patience.

I like to consider myself a value investor or even a contrarian investor. However, in recent years (with the exception perhaps of 2008) this has taken more and more patience. Value investing opportunities become very scarce. I was accumulating cash, my trigger finger was becoming itchy but there just weren't any decent targets to take aim at.

Then the sub-prime mortgage came along and suddenly some of the shares on my watchlist were getting cheaper. To put things in perspective, the All Ordinaries had been as high as six and a half thousand in 2007 and fell to around five thousand in the first quarter of 2008 and looked like staging a recovery from that point.

I didn't want to miss the buying opportunity so I started buying. While I didn't spend all of my cash, in retrospect a think I spent too much, too early, leaving less in reserve for the opportunities which would emerge later in the year.

I think I fell for the old "this time it's different" line. You know the one where everyone tells you that there's been some sort of fundamental shift in how sharemarkets work. Think back to the dot-com boom (and bust). It 's happened many times over - the stock market crash of 1929, tulip mania - the list goes on.

Stock market commentators were saying that higher prices were justified. They said there was a great weight of superannuation money driving asset prices and that this was an ongoing and long term trend which would support shares prices. They said that industrialization of China had lead to a resources "super cycle" - everything was different now!

Even though I considered myself a skeptic, I was worried that the market would recover from this hiccup and carry on it's merry way, leaving me behind. I felt I needed to take advantage of the "relative" value in share prices, even though I didn't consider it absolute value.

Investing is a long term game. Even though the last bull market was a long one, history told us that it had to end. It also told us that the longer the bull market and higher it goes, the longer and deeper the bear market that follows it. Benjamin Graham, author of The Intelligent Investor and Security Analysis recommended buying blue chip stocks at no more than two thirds of their most recent highs. This was to protect investors from the market's inevitable manic depressive behavior. He believed there would always be another opportunity - that the market would always over-correct on both the upside and the downside.

Once again, Ben has been proven right. The Australian Stock Market has shown how quickly things can turn ugly. I should have had more patience in waiting for that value to emerge.

Institutional Transactions - Week Ending 19/12/2008

This week has been a relatively quiet one for institutional investors - at least among the money managers that I keep an eye on. I guess everything is winding down before Christmas. And with the the performance of the Australian stock market (and global financial markets for that matter) this year, I suspect this is a year that some of those in the industry would prefer to forget.

Some Of The More Interesting Substantial Shareholder Notices This Week.

452 Capital Pty Ltd bought some more Consolidated Media Holdings Limited shares (ASX:CMJ) to go to over 7% this week following an announcement at the end October that they held 5%. They joined Perpetual, among others, as substantial shareholders of the company. Consolidated Media Holdings is the old Publishing And Broadcasting, without the gaming assets plus a few other 'minor' tweaks.

Australian Value Investor Maple Brown Abbott Limited has sold down its stake in Metcash Limited (ASX:MTS) again after selling shares in September and October this Year. Maple Brown Abbott join 452 Capital Pty Limited and Lazard Asset Management in heading for the exits in recent months. I don't follow Metcash at all, but I noticed from the share price graph that the stock price has been rising in recent months.

Perpetual has been active in the market again this week. The have been buyers of Consolidated Media Holdings Limited, Billabong (ASX:BBG), Incitec Pivot (ASX:IPL), CVC Ltd and sellers of Skilled Group (ASX:SKE), Crown Ltd (ASX:CWN) and Norfolk Group (NFK).

In other news, Manhattan Software passed 50% ownership of MYOB Limited. This is after the MYOB board capitulated and recommended a revised, conditional offer from Manhattan at a little over $1.15 per share. The offer is conditional on acceptances reaching 90% at which point the rest of the shares can be compulsorily acquired (the details of the offer are a little hard to explain in a concise manner here, so have a look at the announcement on the Australian Stock Exchange website if you want exact details). The directors, who control nearly 30% of MYOB stock have said they will accept the higher offer. After reaching 50% this week and including the board's almost 30%, Manhattan Software must be close to 80% - just 10% away from taking MYOB private.

Watching What Fund Managers Are Buying And Selling

Buying Australian shares has taken nerves of steel in recent times. All of the major Australian stock market indexes have spent most of the year in a decline that has ranged anywhere from a steady fall to alarming drop depending on the prevailing mood in world financial markets.

Australian investors need all the help they can get. Could keeping an eye on what the professional fund managers are buying provide you with some clues as to how to invest your money? While institutional investors don't always get it right I think watching what shares the managed funds are buying and selling can be a useful exercise.

I tend to use this information in one of two ways.

Identifying Investment Opportunities:

The first way I use this information is as a way of finding new shares to invest in. I should stress at this point that just because a fund manager is buying shares in a particular company, does not mean I would automatically go out and but that stock. Investing money in something just because a leading fund manager is buying is not a good way to make money, in my opinion.

What I tend to do is research the company in more detail and apply my own quality and valuation criteria to it. Look at earnings and dividends. Does it have low debt? Does income cover the interest on borrowings with a sufficient margin? Does it have a good return on invested capital? And so on...

In most cases, I cant make a compelling case to buy shares in the company and I move on to the next opportunity. It doesn't mean the stock wont go up - it just means that I can't find any reason to buy based on fundamentals.

Because of the resources available to most institutional investors, they are more likely to spot opportunities before I do. In this way, a number of situations have come to my attention which I would otherwise have missed. It's normally after a sudden share price drop that a situation like this presents itself.

As Part Of My Investment Research:

The other way I use this information is as a kind of a sanity check when I'm doing my research. When investigating an investment opportunity, I normally have a look to see who the substantial shareholders are and who has been buying or selling lately. While it's not normally a deciding factor, if I see that one of the better Australian fund managers has been buying, it would strengthen the case. Conversely, if I see that some of the best performing managed funds have been selling, it would raise a red flag and cause me to dig a little deeper. But, just because they are selling, doesn't automatically mean the company is a poor investment. You don't know why they are selling.

How To Find The best Fund Managers:

This is a difficult question. If you're going to spend time watching a professional you'll need to make sure it's someone worthwhile. Perhaps the best indicator is the fund managers performance over an extended period of time - preferably through both bull and bear markets. Look for consistent performance as measured against an index like the All Ordinaries or the ASX 100 (or some other appropriate sharemarket index) or against other managers with a similar risk profile.

The other thing to look at - and I think this is just as important as performance, if not more so - is their investment style. Do they buy growth stocks or are they a contrarian investor? My value investing bias leads me to monitor fund managers like Maple Brown Abott or Investors Mutual or one of the other value investors. The important thing is to make sure their style matches your idea of what makes a good investment.

Benefits Of Following Fund Managers:

As I said earlier, these guys have more resources than you do. They're likely to have looked of lots of companies before buying and hopefully they've done their homework. And while this doesn't mean you should automatically follow them, it can give you ideas or add weight to an idea you already have.

Disadvantages Of Following Fund Managers:

I will stress again that you should not mindlessly follow the actions of one or more institutional investors, buying and selling whatever shares they do. You're not privy to the reasons behind a given transaction. Remember the decision was made in the context of an entire share portfolio. Depending on their investment strategy, it may be part of an broader asset allocation policy. Or it could be a high risk purchase of a distressed security in an industry where the manager has special expertise. Or any of more than a dozen other reasons.

The other problem is when they sell. They wont give you a call or send you an email to tell you they're about to sell. And if they're a big investor and they sell a large quantity of stock, the share price could be dragged right down by the selling pressure. You could then be stuck with an unloved company which was bought for reasons which may no longer be apparent.

If you take a long term approach to wealth creation you can afford to be patient. The Australian stock market will continue to throw up bargains so you can afford to be picky. Keeping an eye on the fund managers can be good sport but don't get carried away.