It is only when the tied goes out that you learn who’s been swimming naked in 2008

The optimism of the last few years has now turned into panic.  The excesses in financial markers are now very clear, with more to come.  Hedge funds, banks, mutual funds, all manner of institutions, have been carried away by greed.  When a banker or manager earns a huge bonus by taking extra risk, he profits handsomely himself, but when he loses money for the investor, he has little invested personally and thus little to lose.  Individuals in markets are thus incentivised to take larger risks than necessary and to conduct more transactions than necessary.  As long as irrationally exuberant markets hid these risks, there was no problem.  “It is only when the tied goes out that you learn who’s been swimming naked.”

Given the wide level of uncertainty in the markets, I can understand investors’ reluctance to invest.  In financials, construction and property, there is need for caution, due to doubts over asset values and even over bank covenants.  While shares have appeared cheap in these sectors relative to the historic performance of the businesses, as mentioned in my last letter to you, there have been a huge number of fundraisings.  Many in the financial sector hold assets which they do not know how to value.  For most there is no market price and so they use “mark to model” methods, which basically is an educated guess.  Any businessman like you would love to value his inventory at the price he wanted to show the bank and ignore the market price!  A cautious approach to investing in this area, with deep research and insight, can provide long-term opportunities.  “Risk comes from not knowing what you are doing.”

Emerging markets have also suffered as investors have begun to lose confidence.  The same is true for many asset classes.  At the same time, much of the liquidity which speculators believed would last forever has dried up and private equity houses and hedge funds cannot keep borrowing unrealistic amounts and push up asset prices.  This means that some assets have now begun to be priced attractively.  It is by investing in these kinds of times, with an eye on long-term fundamentals, that great fortunes have been made.

The quarter ended 30^th April 2008 showed a marginal gain in the value of your investment.  Since that time, the markets have been very volatile.  Kurm has been able to sell some assets at or above their intrinsic values.  Particularly, exposure to the oil sector, and to Berkshire Hathaway, has been reduced so as to raise cash.  Kurm is well placed to take advantage of opportunities now available worldwide.  As I have said many times, remember: “Be fearful when others are greedy and greedy when others are fearful.”

As markets reached new highs there was a lot of bullish enthusiasm, now that prices have come down, there is a lot of bearish depression.   This is odd, as if prices come down, the investment should surely become more attractive.  Too often speculators consider the price movement alone and then suffer when they have not paid attention to the underlying business fundamentals, the value.   Investors seeking to preserve capital and grow it for future generations should seriously look at these times as times of great opportunity.  “Volatility is the friend of the long-term investor.”

The quotations in this letter, which are from Warren Buffett and Charlie Munger, two of the world’s greatest investors (and richest men), will, I hope, inspire courage in investors.  I look forward to writing to you in another three months.