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Category Archives: Aberdeen AM

Hugh Young’s 10 Golden Rules of Equity Investing

14 Friday Mar 2014

Posted by keanferdinand in Aberdeen AM

≈ 2 Comments

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Aberdeen, Aberdeen Asset Management, balance sheet, Equities, Hugh Young, Investing, Investment Rules, investment wisdom, Portfolio, Stocks

Hugh Young

Hugh Young, star portfolio manager and now managing director of Aberdeen Asset Management Asia Ltd, has developed a set of “golden rules” over his years of experience in investing in equities.

Compiled by the renowned asset management firm with their aim of passing down Young’s well-earned wisdom to the rest of their team, it has been released with the following statement: ‘None of the investment tenets that follow should surprise you and they all share one very distinct trait: a belief in common sense.’

Here are Hugh Young’s 10 Golden Rules of Equity Investing:

(1) Treatment of Minority Shareholders

When considering a company, the first question you need answered is ‘who controls it?’ The second is ‘do you trust them?’ Minority shareholders are just one of many company stakeholders (others include employees, the government, suppliers, bankers and major shareholders such as a founding family). While you should not, as a minority shareholder, expect priority over the other stakeholders, you should expect to be treated fairly.

And this depends on whether you can trust whoever controls the company to act in a fair manner. The controlling party need not be a shareholder. In the case of electric utilities, the respective government can often exercise considerable control over tariffs. Electricity prices are a socially-sensitive issue which politicians may sometimes pander to at the expense of minority shareholders. But it is also true, more often than not, that the controlling party is a shareholder, usually the founding family or a conglomerate.

It requires a certain amount of faith, but the best way to judge whether the controlling party will act fairly in the future is to see whether it has acted fairly in the past. Those that have a good track record of equitable treatment of minorities should be held in high regard. Until they slip up that is, though in my experience past behaviour is a pretty accurate predictor of future behaviour.

(2) Remember that Companies are About People Not Assets

A company is essentially a group of people with a common goal, namely to create the best possible product at the best possible price. This is what I call ‘quality’. Sure, companies need fixed assets but they are worthless without people. Once one thinks in these terms, one can appreciate that predicting the long-term performance of a company is all about assessing the quality of its people.

(3) Balance Sheet Strength is Critical

Companies fail largely because their businesses are poorly financed. A strong balance sheet tells you many things. Most importantly, it tells you that the company is very unlikely to fail. But balance sheet strength is not just about the liabilities. It’s also important to look at the assets. What a company does with its cash is very instructive. Does it have too much? Is it gambling with it by investing it in exotic financial instruments? Cash generation is paramount but, once generated, a company must invest it wisely, keep it safe or pass it to shareholders. A balance sheet is like a backbone; it tells you about the character of a company.

(4) Understand What You’re Buying

You don’t have to understand how silicon chips work to buy a silicon chip make, but you do have to understand what they are used for, as well as some of the basics of manufacturing process such as the inputs and costs. On the other hand, simple products like mortgages can be wrapped in businesses that are hard to understand. If there is something about a business that doesn’t make sense, such as how an industry with low barriers to entry creates profits well in excess of the cost of capital, walk away. As the old adage goes, if something looks too good to be true, it probably is.

(5) Be Wary of Over-ambition

It is often tempting for companies to expand capacity or even invest in areas outside their core area of expertise. One should be wary of such ambition, as it naturally means a reduction in focus on core capacity, let alone the implications for balance sheets. A focus on the top line tends to be great for stakeholders such as employees, suppliers and bankers, but rarely for minority shareholders.

(6) Think Long Term

Unless you need your money back soon, you should think long term and avoid getting caught up in the daily noise of markets. This is for two reasons. First, it makes sense to align your own investment time horizon with that of the companies in which you invest. You’ll find that all good companies – and even some bad ones – have a long term perspective. If a company builds a factory, for example, it expects to generate returns from it for at least ten years, as you should from its shares. The second reason is that short-term price movements are mostly inconsequential as they are largely about temporary loss (and gain) of capital. What you should be worried about is permanent loss of capital and this is all about assessing a company’s long-term business prospects.

(7) Benchmarks are Measuring Devices not Portfolio Construction Tools

The worst reason in the world to buy something is because somebody else did. This is essentially what you would be doing if you allowed your portfolio to mimic the benchmark index. A company’s weighting in the index tells you only what has happened in the past, not what will happen in the future. Furthermore, there is a lot of rubbish in most benchmarks that with a little hard work can be avoided. Successful investing requires thinking differently. This may at times feel uncomfortable but you should learn to embrace the feeling as a sign you’re on the right track. To put it in the simplest terms, to beat the benchmark you must deviate from it.

(8) Take Advantage of Irrational Behaviour

The efficient market hypothesis is nonsense. Markets are driven by humans, humans are irrational, thus markets are irrational. Occasionally, something happens and investors panic. You should take advantage of these instances, not join the stampede (or, if you are going to rush for the exit, be the first). Think of a 20% fall in a share price as you would a 20% sale at a department store, an opportunity to buy cheap.

(9) Do Your Own Research

In the case of the medical or engineering professions, for example, there is usually a precise standard for a given procedure. In the investment industry, while this may be true with respect to, say, ethics, when it comes to investment decisions, not following others is the key to success. Indeed, you want to be ahead of the herd, and this means doing your own research. Broker research has its uses, but it is no substitute for doing your own analysis and coming to your own conclusions. It’s about being accountable for your decisions as much as anything.

(10) Focus on Industries in Which it is Possible to have a Sustainable Competitive Advantage

Some industries produce more economic profit than others. How much economic profit a sector or industry tends to produce is often a function of how difficult it is to enter. High entry barriers can therefore provide a sustainable competitive advantage for incumbents. Take banking. Unlike retailing or steel manufacturing, there are all sorts of obstacles to starting a bank. Not only does one need licenses from one or more regulators, but one has to build up trust with depositors as well as a network of companies to lend to. As such, banks tend to produce excess returns on capital which can often be sustained over the long term. Assuming, that is, that they stick to the simple business of lending and deposit taking.

*Content published by Aberdeen Asset Management and strictly for information purposes only. The reader must make his/her own assessment of the relevance, accuracy and adequacy of the information contained in this document. No warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information, opinion or estimate contained in the content. 

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Investing like a Fund Manager

07 Monday Oct 2013

Posted by keanferdinand in Aberdeen AM

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Aberdeen, Asset Management, Channel NewsAsia, Financial Markets, Fund Manager, institutional portfolios, Investing, investment management, Investment Process, Money Mind, Peter Elston, Sir John Templeton

Peter Elston

Peter Elston, Head of Asia Pacific Strategy and Asset Allocation at Aberdeen Asset Management, was recently interviewed by Channel NewsAsia and featured on their program ‘Money Mind.’ The program gave viewers a glimpse of the asset management industry’s work process and the inner workings and thoughts of a fund manager.

Many retail investors and non-investment professionals often wonder how the professional investors and financial experts manage assets and capital. This interview with Elston offered certain insights at the thought processes of a professional fund manager and as well simple fundamental knowledge into how large institutional portfolios are managed.

Below are major points and takeaways of Money Mind’s interview with Peter Elston:

Quantify the Investment Process:

Like the legendary investor Sir John Templeton, Elston stresses that quantifying the investment process is extremely vital for investment management. Objectifying and quantifying decision parameters and gauges helps the investor to remain calm and disciplined to carry out important decision making. 18th Century philosopher David Hume once famously proclaimed that reason is the slave of human emotion, and modern day neuroscience studies seem to confirm this phenomena. When huge unexpected movements happen in financial markets, emotions tend to get the better of many investors – only the disciplined ones who have quantified their investment parameters will know how to respond and make decisions based on those parameters.

Elston has repeatedly mentioned throughout the interview that its all about “numbers, numbers, numbers” when being asked on how he responds to world events. The idea that he stresses is “to be as rational as possible in all possible circumstances.” This doesn’t necessarily mean that investors should automate and formulate algorithms, but it does mean that investors should have a cool and disciplined system that uses quantitative reasoning in light of irrational markets situations.

Be Sure to Profit from Fear or Greed: 

The shrewd investor must be positioned to profit from bouts of human emotions being manifested in the financial markets. Quantifying the investment process, as mentioned earlier, will help the investor execute this classic golden mantra and be well positioned to profit from fear or greed. Throughout history, humans have been known to overreact, and sometimes panic can manifest into huge amounts of selling pressure in the markets – further depressing asset prices. The intelligent investor will use these emotional floods repeatedly to his advantage.

Stress Test Your Portfolio and Perform Scenario Analysis:

It is extremely important to have an opinion on the overall situation of the portfolio’s position in light of major near future major events. Institutional investors and professional money managers often perform scenario analyses and stress-test their portfolios repeatedly based on those research and analyses. From there, they could come up with hedging strategies or rebalancing adjustments to optimize their portfolios and the positions of their assets.

Basic decision trees and path dependency frameworks can serve as aid tools to many investors. It is near impossible to predict the future, or the direction of interest rates, or the exact value of a currency pair within a certain time frame. However, what is extremely crucial is how one responds and reacts to what is transpiring! As what legendary investor George Soros proclaims: “It doesn’t matter if you don’t know what is going to happen, what is more important is how you respond to it.” Mapping out decision trees and setting down various probable courses of actions from there will give investors some form of idea (as well as the costs and benefits of those actions) into optimally positioning themselves against future events – whether positive or adverse.

If anyone wants to improve his or her investment performance, he or she ought to formalize their investment systems and perhaps adopt a similar framework and practices of the asset management industry as explained and shared above.

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