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Be unmoved by market moves – 3rd quarter, 2013

October 05, 2013

As is customary in our commentaries, we won’t talk about our short-term investment results. We make the daring assumption that you invest with us because you’re interested in compounding your wealth over the long term. We don’t pay attention to relative results in any given month or quarter and we don’t subscribe to the notion that short-term price movements have any correlation to longer-term investment value. The industry’s convention of focusing on such short-sighted, random and highly variable performance increments could easily be made fun of but instead, let’s happily treat this as opportunity for the pursuer of longer-term value.

The one-sided view 

Investment success seems to be defined exclusively by fund returns. Oddly, investors rarely ask what risks were taken to achieve them. 

Throughout history, many funds have significantly outperformed over one and even five years on a single sector or macro call. Or the majority of their big gains have resulted from a lone holding’s stratospheric rise. These funds attract a lot of money and their portfolio managers attain celebrity status for their foresight, yet hardly anyone ever stops to ask about the risks taken to get there. What if those portfolio managers were wrong? If one decision caused great success, couldn’t one decision also cause great failure? 

There are countless approaches to getting from point A to point B. Think of the border at Niagara Falls, which can be crossed in different ways. You can walk, bike or drive over the bridge. You can try swimming across. Kayaking? Heck, last year a guy even did it by tightrope. If we all make it across, we’ve all achieved the same outcome despite having taken divergent paths. Let’s not forget about those afraid of tightropes, water and bridges who may never get to point B because of their excessive risk aversion. Also keep in mind the people who take risks that increase their chances of never getting to point B and for which they’re unaware because they remain solely focused on the outcome instead of the journey. Centering on a fund’s return without asking how it arrived at it is akin to being indifferent as to whether you cross Niagara Falls by car or tightrope. 

By the way, point B is that place in the future where you need enough money for retirement, or to send your kids to school or to donate to charity. If history is a guide, we’ll slip up many times getting you to point B but our investment approach works to help ensure no individual mistakes are catastrophic. 

Our report card 

The best way to understand where your returns come from is to look at your investments from their beginning. Which names made, or lost, you money? 

EdgePoint Global Portfolio has owned 92 securities since inception. Some names we still hold; others have been sold off completely. Thus far, nine of them (or 10%) have lost money. Here’s the full list* in descending order by their results with the losing names highlighted in grey: 

*Excluding derivatives and one name in which we’re currently building a position. Cumulative since inception (November 17, 2008) holding period returns in C$ as at September 30, 2013, including dividends. 

Not to claim that losing only 10% of the time is good. Perhaps it indicates we were too risk averse. More obvious is: 

  • the diversity in the names that have been profitable 

  • that no strong correlation exists among the winners. Similarly, the losers are equally dispersed 

  • to date, no one stock has had a disproportionate impact, good or bad. 90% of the names each impacted returns by less than 5% of the portfolio’s cumulative results. No one company detracted more than 3%. Of the remaining 10%, positive returns are spread fairly evenly 

We go to great lengths to help make certain that EdgePoint Portfolios are a relatively concentrated collection of distinct ideas. Each investment is based on a well-researched proprietary idea. We hold an eclectic list of businesses and take comfort knowing our returns aren’t derived from making one or two big calls. After all, our internal partners have some $65 million in our investments. This personal stake creates a clear alignment of interests between us and our investors.

Here’s the list of all businesses ever owned* in EdgePoint Canadian Portfolio (some of which we still hold) in descending order by their results with the losing names highlighted in grey: 

*Excluding derivatives and one name in which we’re currently building a position. Cumulative since inception (November 17, 2008) holding period returns in C$ as at September 30, 2013, including dividends. 

Names in which we’re flat or up represent approximately 80% of the total holdings and are also diverse. 

  • 96% of the names each impacted returns by less than 5% of the portfolio’s cumulative results 

  • No one company detracted more than 3% 

  • Of the remaining 4%, positive returns are spread fairly evenly 

One of the benefits of owning an eclectic collection of companies is that losing money on one name doesn’t necessarily mean the entire portfolio suffers as the other uncorrelated names can compensate. 

Imagine a speciality product like a precious metals fund that returns 12% annually for five years. Isn’t that just one idea generating most of the ups and downs? One fund dependant on a solitary thesis? When that one idea stops working, point B can start to look further and further away. It’s a crazy way to invest, especially when you don’t have to. So we don’t. 

What is risk? 

I should check that we're all on the same page with regards to how we define risk. In reality, the greatest risk is running out of money before you die. You can help to avoid this possibility by following a common-sense investment approach. This includes assessing the potential for permanent loss of capital, when something you invest in never recovers from a drop in value. That’s what we think about. Big mistakes like that get you closer to experiencing the ultimate risk! 

Other "investors" have devised mystical definitions of risk, such as volatility. But markets have been and always will be volatile. It simply comes with the territory and can actually signal opportunity. Don't lose sight of the forest for the trees by getting caught up in any way of thinking about risk other than as the potential for permanent loss of capital. 

Markets will go down 

As you’re probably aware, markets will go down. The only question is when and by how much. 

Remember, the market is simply a collection of businesses (stocks). Stocks move based on myriad factors, few of which relate to long-term business fundamentals. For the last five years, markets have been very emotional and thus volatile. More recently, we’ve been climbing a wall of worry, which means every day a few more investors feel less fearful about the future and the markets inch higher. The newly confident pay higher prices for the stocks they buy than those investors before them. 

Of course, this climb also works in reverse. One or more issues will captivate investors as they replace the complacency they feel from a rising market with the anxiety that’s part and parcel of a falling market. The value of the businesses you own might be the same ten years from now, but the stock prices of those businesses can fluctuate wildly in the meantime. 

The real question is what you’ll do the next time the market drops by 5% or 15%. Your actions at that point will determine your likelihood of getting to point B. If a business’s fundamentals haven’t changed, does the price other investors are willing to pay for it in the short term impact its long-term value? Of course not. The price at which others are willing to transact isn’t relevant to the business itself. A change in that price doesn’t increase or decrease that business's market share, customers, costs, margins, sales, employees or earnings a decade from now. 

If you have a view, as we do, on what a company can be worth in the future, the short-term movements of its stock create little information, but plenty of opportunity! Recognizing that the markets will go down yet having an idea about the long-term value of the businesses we own provides wonderful serenity, peace of mind we hope our investment partners also enjoy when they think about the markets and investing. 

Only two reasons endure for rejecting the reality of market slumps: 

  1. You’ve invested too much, and/or 

  2. You don't know the underlying worth of the businesses you own. 

Although we're not allowed to promise investment returns (nor would we), we can without a doubt promise volatility. And remember, volatility isn't risk. Since our inception in 2008, we've seen three significant market dips. Now, look at the negative returns of our portfolios over those same periods: 

EdgePoint Global PortfolioDeclineEdgePoint Canadian PortfolioDecline
January 6, 2009 – March 9, 2009-22% January 6, 2009 – March 9, 2009-14%
April 29, 2010 – August 24, 2010-16% April 26, 2010 – July 5, 2010-11%
May 10, 2011 – August 8, 2011-20% July 5, 2011 – October 4, 2011-17%
Standard performance
We’re mandated to include standard performance here only because Geoff references since inception returns. If it were up to us, we wouldn’t bother. We measure investment success over periods of ten years or more and place little value in the short-term investment results shown.

Annualized returns as at September 30, 2013:

EdgePoint Global Portfolio, Series A
YTD: 31.15%; 1-year: 36.07%; 3-year: 15.88%; since inception: 17.23%

EdgePoint Canadian Portfolio, Series A
YTD: 18.67%; 1-year: 21.75%; 3-year: 8.92%; since inception: 17.43%

Even though it experienced these noteworthy declines, EdgePoint Global Portfolio is still up 117% cumulatively since inception. 

Similarly, EdgePoint Canadian Portfolio is up 119% cumulatively since inception notwithstanding three relatively major downturns. 

This data proves that volatility is somewhat irrelevant. Down markets don’t impair performance; in fact, over the long term, they generally help. Down markets are simply an opportunity to purchase businesses at even better prices. Long-term business fundamentals are eventually reflected in stock prices. If you buy a company and have an idea about its future that isn’t widely shared, you’ll probably be successful over time no matter the market environment in which you invested. Remember, embracing price movements with the right attitude and investment approach is the best way to get to point B.