In the last letter that I wrote to you, I quoted Charlie Munger, long-time partner of Warren Buffett. He said: “It is only when the tied goes out that you learn who’s been swimming naked.” The events in September have really given a tremendous instruction on risk. For many years, the financial industry and its professionals have been calculating risk using various models based on historical experience, but ignoring common sense and everyday experience. It was clear that some of the loans made were never going to be repaid. House prices had become unsustainably high – ask any young professional or newly married couple without parental support how difficult it was to find a home for a reasonable price in London or New York.
A large amount of consumption was funded by the release of equity from homes and a large proportion of financial services revenues came from the financial engineering of mortgages, generating exotic derivatives. Central banks allowed this all to continue, and, instead of deflating the assets bubbles caused by the huge amount of liquidity generated, actually kept interest rates low, which simply added to the problem. However, even during these times of euphoria and blindness, there were several dissident voices: Warren Buffett, whom I admire tremendously, said: “derivatives are financial weapons of mass destruction” back in 2003.
While this letter pertains to the results of Kurm Investments for the quarter ended 31st July 2008, it is impossible to ignore the events of September 2008. We have witnessed in one week the collapse of Lehman Brothers, Merrill Lynch sold to Bank of America, almost a nationalisaton of the insurer AIG, the UK government persuading Lloyds TSB to take over HBOS, and authorities in the UK, USA and elsewhere intervening in the financial markets by changing rules, providing guarantees and injecting liquidity. This is all after the US government took over Freddie Mac and Fannie Mae.
Risk arises when we really do not know what we are doing, but just become caught up in the euphoria of everyone else’s optimism, ignoring common sense and, most importantly, the fundamentals. The opposite is also true, in that when markets fall, sentiment changes and then great business sometimes sell for fabulous (cheap) prices. However, in the false urgency generated by panic, the average speculator sells, while the patient investor makes the moves which will build his fortune. “The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient.” This is the time to be patient.
While Kurm Investments has not been immune to the gyrations of markets, the overall portfolio has not suffered long-term damage in the underlying businesses. Kurm is invested directly, or indirectly, in businesses with strong balance sheets, good cash flows, and able, honest, managements. There has not been very much direct exposure to the financial sector. At the moment, markets around the world have thrown up tremendous opportunities. In the past few years it was hard to discover wonderful businesses selling with a margin of safety and we had to look very hard to find them. Today, even some well-known names are valued by the markets substantially below their long-term intrinsic values. Investments wisely made at times like these are seeds which will generate a great harvest in the not-too-distant future.
The views expressed and comments made on this website are not personal advice based on your circumstances. The purpose of this website is to provide information and analysis to help you make your own informed investment decisions. If you are not confident making your own investment decisions you should contact a firm which is authorised and regulated by the Financial Conduct Authority (such as Ashik Shah & Co. Ltd.) so that a qualified financial adviser, after considering your personal circumstances and investment objectives, can make personal recommendations of investments which are suitable for you. Whether you make your own investment decisions or prefer to follow the recommendations of a financial adviser you should always remember that your capital will be at risk and that investments can go down in value as well as up.