Successful investing is all about getting the odds in your favour

By Kokkie Kooyman, Head of Sanlam Investments Global

What institutional investors can learn from Warren Buffet’s 50 years of success.

Speaking at the 2015 Sanlam Benchmark Symposium, Kokkie Kooyman, head of Sanlam Investments Global, opened his talk by asking “What would Warren Buffett do as an institutional investor, looking to maximise returns for his members?”

In answering this question, Kokkie highlighted several key learnings from Buffett’s years of success. In the 50 years since he took control of multinational conglomerate, Berkshire Hathaway, Buffett and business partner, Charlie Munger, have managed to compound growth in shareholder wealth at an astounding 19.5% per annum.

How did they do it?

#1 key insight: If you want to get the odds in your favour, you need to accurately determine the intrinsic value of a company/stock

There are several key steps to getting it right:

• Determining the intrinsic value of a company or stock is one of the trickiest things to accomplish. Most of us get it wrong. For Buffett, keeping it simple in quantifying intrinsic value is key, and eliminating the risks equally. As Buffett likes to say, “If there’s complexity, avoid it”.
• Make sure you have a sufficient margin of safety. In other words, leave room for error in your assumptions, i.e. invest at a price that is less than its intrinsic value. But never invest in a company just because it is cheap! And never over-pay. “Price is what you pay, value is what you get”.
• Never under-appreciate the long-term importance of individual company dynamics, let the quality compound for you at a low risk: Invest in quality companies with good track records of consistent generation of shareholder value and rational allocation of capital, ethical management, strong cash flows and healthy balance sheets.
• Work with people you can trust – this always gets the odds of success in your favour. Words of wisdom from Buffett’s business partner, Charlie Munger, are that “reputation and integrity are your most valuable assets – and can be lost in a heartbeat.” Warren Buffett also summarised this well when he commented: “… in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. If you don’t have the first, the other two will kill you.”

For Buffett, these are all critical factors. If you get the formula right, it will help you buy with certainty and hold on to your stocks for the long term. He has built his fortune by buying and holding great businesses for long periods of time.

“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Our favourite holding period is Forever” – Warren Buffett …

#2 key insight: Eliminate unnecessary risks by avoiding these common investor mistakes

• Short-term focus: Short-termism refers to a focus on short-term results at the expense of long-term interests. Investing is a long term game; don’t get distracted by short-term market movements. And remember that compound growth is an extraordinary concept that works best over time. Short-term thinking changes the odds against you.
• Timing the markets: You cannot time the markets; no-one knows when is a good time to invest. It is better to remain invested through the market ups and downs, which means you have to sit through both the good and the bad years. Also remember that selling during market downturns destroys value.
• Over-confidence: Over-confidence is an overly optimistic assessment of one’s abilities and can be detrimental to investors, because they believe they are better than they actually are. Many novice investors get lucky: the first few stocks they pick do extremely well. They start thinking they have a magic touch; or worse, they think they are smarter than everyone else. This often leads to disaster….

Therefore, the wise investor not only knows how to recognize signs of overconfidence in himself, he also knows how to apply the brakes when the signs become visible. In other words, he has learned at some point how to use reasoning to overrule his emotions.

• Basing investment decisions on macro-economic forecasts. The probability of accurately predicting macro- economic factors is very low. Attempting to do so will end up reducing your odds of success. Rather focus on the quality of the management of the stock you are looking at.
• Not knowing your limitations! Realise what you’re good at, keep it simple and stick to it. “You have to know your sweet spot…”.

By avoiding the above risks and mistakes mean that your returns compound at a much higher rate over time.  The trick to a higher rate of compounding capital is not to lose it:  generating and preserving wealth over time depends on your fund manager’s ability to compound wealth steadily  over the long term, and avoid large losses and periods of capital destruction. That’s the trick. Losses destroy the rate at which capital compounds.

Take-outs for trustees

# One: Test your fund manager to ensure that their processes take cognisance of the above common pitfalls and mistakes. They should have processes and structures in place to mitigate these. Like Buffett who relies on his ten filters for selecting a new idea, make sure your fund manager has the discipline to go through a series of processes that help mitigate the margin of error in making investment decisions; don’t take short cuts!

# Two: Understand what risk means for you and your fund manager. For Buffett, risk equals a lack of knowledge/ expertise in a certain area. Put simply, it’s something he doesn’t understand. His way of getting around this is to avoid risk altogether. Over the past 50 years, Buffett has consistently managed to get higher returns without taking on too much risk. Make sure your fund manager is operating within their circle of expertise.

# Three: Use your knowledge of member behaviour and behavioural biases to nudge members in the right direction, such as not making early withdrawals from retirement funds. You could also help educate members by communicating concepts such as the power of compounding to help encourage more beneficial decision making. Default investment options are also a powerful tool to help counter member inertia or apathy.

Phased retirement and “Lifestage solutions”
An understanding of how all these factors work together can help get the odds successfully in your favour, eliminate the risk factors and help make better investment decisions. This contributes to a blueprint for success and improved retirement outcomes for our retirement fund members.

Everybody wins.

Sanlam Life Assurance Company (Ltd) is a licensed financial services provider.