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INVESTOR LETTER - DECEMBER 2019

INVESTOR LETTER - DECEMBER 2019

December 04, 2019
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We recently had a conversation with a potential client about our investment philosophy and why we invest the way we do. It was great to hear this person’s questions because most individual investors don’t have an investment philosophy beyond trying to get the best return.

During our conversation about our philosophy, we shared that we pursue factors of return that are persistent, pervasive, robust, implementable, and intuitive. The potential client asked what we meant by intuitive, and we thought all our clients might be interested in hearing our answer.

First off, let’s define what we mean by a factor of return. Academic and industry research has shown there are certain ways we can group securities with similar characteristics (i.e., factors), and then use those characteristics to find what parameters get rewarded (i.e., return). For example, we can group stocks into two categories based on size: In one group, we can put large market capitalization stocks, and in the other, we can put small market capitalization stocks. We can then look at how large stocks have historically performed versus small stocks and determine if we should invest in one group versus the other. Research has shown that small stocks outperform large stocks over the long term, and we call this the size factor of return.

We can easily apply our “philosophy test” by asking if the size factor is persistent (small stocks outperformed large over many different historical time periods), pervasive (small stocks historically outperformed large stocks in markets all over the world), robust (small stocks historically outperformed large stocks by a meaningful amount), implementable (it is easy to sort stocks based on size and it doesn’t cost much to buy small stocks) and intuitive (small stocks are risker than large stocks and investors should be rewarded for taking that risk).

Now, let’s consider an example of what isn’t intuitive. There are many ways to group stocks, so let’s group them by the first letter of the company’s name. Hypothetically, let’s say we did the research and found that investing in companies that begin with the letter “A” produced the best historical return versus all the other letters in the alphabet. To make our case, we might say that Apple, Amazon and Alphabet (the parent company of Google) are all part of the strategy, and they have all performed well over the past decade.

Yet grouping companies based on a letter doesn’t make sense, and, therefore, isn’t intuitive. Companies that begin with the letter “A” aren’t successful (or unsuccessful) because they named their company with that letter, and letters tell us nothing about the risk we are taking.

We want the bedrock of our investment philosophy to make practical sense and be supported by historical evidence. We are dealing with your life savings and how those savings can help you reach your life goals. We don’t want to leave your goals up to chance, a good sales story or some current trend.