I often discuss a study that was conducted by Fidelity between 2003 and 2013 with clients. In the study, Fidelity was looking at the client accounts that had the best returns. What Fidelity discovered surprises most people. The accounts with the best returns belong to people who had died or people who had forgotten they had accounts!

 

This is where it gets interesting. Many people, including many people who have written about the study, conclude that actively trading a securities portfolio does not add value or that passive strategies are better than active strategies. I believe these two conclusions miss the most important lessons. What you want to take away from the study is that:

1. Time horizons matter; and
2. Over a long enough time-horizon, a portfolio's return will converge with the return of the best performing securities in the portfolio.

 

The first takeaway is intuitive but often ignored. For example, when we think about Warren Buffet, we often think of the annual returns in his portfolio and not the fact that those returns have been compounding for more than 75 years.

 

The second takeaway is less intuitive for investors, so let's use an extreme example. Let's assume that an investor had $10,000 to invest in 1999. The investor buys a portfolio of ten securities and invests $1,000 in each of the ten securities. Now let's assume that nine of those securities go to zero, a -100% return, but the tenth security performs like Boyd Service Group (a sleepy Canadian listed owner of autobody repair shops), which was up more than 71x over the 21 years. Despite having nine absolute stinkers, this portfolio has appreciated from $10,000 in 1999 to $71,410 today. That is a compounded annual growth rate (CAGR) of 9.8%, which much closer to BYD's 22.5% CAGR than the -100% return delivered by nine of the ten securities in this example.

 

[A note for my compliance folks. Please note that I'm not recommending Boyd Service Group in the above example. I'm merely using the stock's historical returns in a quantitative example.]

 

So What's an Investor Todo?

 

I recommend that client equity portfolios focus on purchasing a small group of high-quality companies improving year-over-year. The phrase I use is "good companies that are getting better ." Additionally, each company should be exposed to at least one theme that we believe will persist for a long time.

 

This is the part that is the trickiest for investors. If you buy good companies that are improving, and each of these companies is exposed to a durable theme, you need to hold on to your position. You shouldn't sell the company because its stock price has increased. Said differently, you shouldn't sell a stock because you correctly identified it as a good company that is getting better. Said differently, if you bough a good company that is getting better you should expect its price to increase!

 

When to sell a stock is a more detailed discussion, but here is a peek at the criteria I use with investors:

• We would rather be short the stock. Articulated slightly differently, we no longer feel the company is improving.
• We have found another investment that gives us better exposure to the same theme.
• We identified a higher conviction theme that we believe will persist for a longer time.

 

Please reach out if you would like to discuss our investment process or working together.

 

Delli (delli@cibc.com)

 

Disclaimer: This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers, and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and a spread between the bid and ask prices if you purchase, sell, or hold the securities referred to above. © CIBC World Markets Inc. 2020

 

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