Long-Term Investing: Simple, But Not Easy

“Will Our Heroes Be Able…?”

Nino Manfredi was one of the most prominent Italian actors from the mid-twentieth century to the early 2000s. During his long career he was in dozens of films. A versatile and incisive interpreter, he alternated comic and dramatic roles with remarkable effectiveness. Manfredi was one of the most appreciated and beloved actors in Italian cinema, a cinematographic genre that arose in Italy during the 1950s and developed over the following two decades. That period also saw the emergence of figures such as Vittorio Gassman, Marcello Mastroianni, Alberto Sordi, and Ugo Tognazzi, to name the best internationally known actors in this genre.

In 1968, Nino Manfredi costarred in the comedy, “Riusciranno i nostri eroi a ritrovare l’amico misteriosamente scomparso in Africa?” (Will Our Heroes Be Able to Find Their Friend Who Has Mysteriously Disappeared in Africa?), directed by Ettore Scola. The comedy tells the story of a pompous, adventure-seeking businessman (Alberto Sordi) who journeys through Africa with a clumsy employee (Bernard Blier) to find his reportedly-dead brother-in-law (Nino Manfredi). After months of travel filled with adventures, they encounter a village where the missing brother-in-law has taken refuge. He has become the village sorcerer who claims to invoke the rain with esoteric rites.

Financial Bricolage

As in the movie, today’s world is teeming with self-proclaimed sorcerers, shamans, and gurus in many fields. You only need watch YouTube to see how many financial prophets profess to be able to read the future of markets in their crystal ball. Like the brother-in-law from the movie, they all claim to be rainmakers able to deliver showers of money thanks to arcane magic formulas.

To tell the truth, those who deal with money do a strange job, one that plays on a basic misunderstanding of the difference between expectations and reality. Many people see in their financial advisor a kind of sorcerer, a repository of truths unknown to mere mortals, who is able to multiply money and vaporize risks. Whether driven by anxiety, fear or greed, or even just the need to feel reassured, people entrust their life savings, their expectations and hopes for their own and their children’s future to a financial advisor, but in many cases, with sound planning and proper financial education, they could often define and achieve their goals on their own.

Recently, Irene, a young neighbor of mine, realized that her financial goals did not coincide with the suggestions from her advisor, whom she has blindly trusted for years. She decided to try to establish a more hands-on relationship with her savings by focusing on her needs, without distorted or unattainable ambitions, and start managing her own finances. She turned to me for some advice.

I explained to her that investing is simple, but that doesn’t make it easy. Simple because, as suggested by many great investors, you “only” need to do the following three things:

1. Identify quality titles;
2. Buy these titles at the lowest possible price; and
3. Keep them for the long term.

But is it easy? No. For me, each step presents challenges that are increasingly difficult, with the third step being the most difficult. Let’s take a look at the difficulties –huge, daily, and often discouraging– you might encounter at each of these steps.

Identify Quality Titles

There is no doubt that to build an efficient and sustainable portfolio over time, you must start by selecting quality titles. I invest mainly in closed-end funds (“CEFs”), for which I developed the following simple “rule of thumb” for choosing quality titles for my portfolios:

Choose a CEF with a positive NAV trend, the highest discount and lowest leverage, and whose Total Return is more than its yield on NAV.

Of course, I don’t expect this rule to be comprehensive, but it helps me to steer clear of riskier CEFs, such as those that have a steadily declining NAV trend even when their price may quote at a premium on NAV. By way of example, I sometimes read articles that praise the distribution percentage for a particular CEF, but when I examine the performance of its NAV, I discover that it has lost 70 or 80% since launch. Maybe there’s something I’m missing…

(I must confess that not all my CEFs adhere perfectly to my “rule of thumb,” but in some cases they are titles that have been in my portfolio for years and from which I have not yet made the decision to separate.)

Regardless of the investing strategy you choose to follow, you should develop and refine your own method for selecting titles. You may be inspired by the choices of great investors who are also extremely generous with advice. Or, as I suggested to my neighbor Irene, you may choose to buy index-linked ETFs which let you bind to the market without the expectation of beating it while at the same time avoiding the risk of doing worse.

For many people approaching finance, this first step appears to be the most complex. In my opinion, however, the technical aspects of an investment are the easiest to understand with relatively little study. With this understanding you can assess your comfort and confidence in building your portfolio, while avoiding excessive diversification.

As Howard Marks says, in fact,

“most investors think diversification consists of holding many different things; very few understand that diversification is effective only if portfolio holdings can be counted on to respond differently to a given development in the environment.”

For Irene, an already diversified ETF on the MSCI World Index could be sufficient for her first step into managing her own investments.

Buy These Titles at the Lowest Possible Price

For a value investor, price has to be the starting point. It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad that they can’t be a good investment when bought cheap enough.” (Howard Marks, The Most Important Thing Illuminated, p. 29).

The importance of price when selecting a security is emphasized by Howard Marks in the previous quote and by Warren Buffett in his “Margin of Safety” investing principle. Buffet’s margin of safety revolves around only buying a security when its market price is substantially less than its intrinsic value. In the world of CEFs, the margin of safety is typically represented by the discount price on NAV. However, the trend of the NAV should not be overlooked, because it provides insight into the quality of the fund and its management.

As I’ve described in previous articles, when making a new purchase I try to take advantage of any sell-off and avoid mediating my load price upwards. Instead, I try to use any additional purchases to average the load price downward. Over the past few months, I’ve only made a purchase when the price of a CEF in which I’m interested has dropped.

Only a strong sense of value will give you […] the guts to hold and average down in a crisis even as prices go lower every day.” (Howard Marks)

Obviously, waiting for a favorable moment to enter the market can lengthen the time required to create a new position or expand an old one. Waiting takes a lot of patience, much more than you can imagine, if you want to avoid indulging in an irrational euphoria that results in buying titles when the markets go up and everyone is buying, or when others seem to make big gains and we don’t. Patience is one of the hardest parts of the game, because the fear of missing out or the disappointment of seeing the market rise while standing still often pushes us to act impulsively, exposing us to the risk of substantial losses when the market corrects or even reverses.

But if we are patient, our wait will be rewarded. The numbers tell us.

Going back to 1928, there have been more than 90 occasions in which the S&P 500 has declined by 10%, or more, from its recent high. That’s basically once every year. Even bigger declines aren’t all that rare, either, when you stretch your time horizon out further than recent memory…

“While the reason for each decline may differ, market pullbacks are part of the game. Based on history, here’s how often you could expect drawdowns of increasing severity…

• Down 10% every 11-12 months;
• Down 20% roughly every four years; and

• Down 30% approximately every 10 years.

“Obviously, even bigger declines can take a buzzsaw to our portfolios, as well, seeing as how two 40%+ drawdowns have taken place since the turn of the millennium.” (Taylor Muckerman, “Seeking Alpha Premium”)

Is it worth the wait in order to buy at “on sale” prices? Definitely yes, but how many of us manage to do it? When the markets rise there is an urgent need to participate, and resisting the temptation is not at all easy. If Irene, my neighbor, wants to start building her portfolio, periods of uncertainty like the current one will help her.

Keep Them for the Long Term

And here we come to the point. For much of his career, Warren Buffett only held a handful of stocks, with a “forever” horizon. There is not a single great investor who promotes portfolio rotation, which is one of the mantras of modern finance. Portfolio rotation is both a cross and a delight for managed savings and pension funds. It allows them to increase the fees charged to their subscribers, without demonstrable benefits.

In times like the present, not reading stock market news and not listening to opinions on the markets is probably the best strategy.

I have no use whatsoever for projections and forecasts. They create an illusion of apparent precision. The more meticulous they are, the more concerned you should be.” (Warren Buffet)

Unfortunately, doubt creeps in and the desire to do something grows, even when “do nothing” would be the wisest choice. Holding on and waiting for the storm to pass is the best thing, but also the hardest. Rivers of money have been lost by self-styled “long-term” investors panicking over the short-term volatility of their portfolios. Volatility is part of the investing game. Volatility and risk are synonymous only for those who are short-sighted; those who take a true long view understand the difference between volatility and risk.

In moments of general panic, it actually makes sense to increase one’s positions by taking advantage of any sell-off, without indulging into “creative” purchases at bargain prices. Doing so makes it possible to build or increase positions in previously selected quality titles.

It’s our job as contrarians to catch falling knives, hopefully with care and skill. That’s why the concept of intrinsic value is so important. If we hold a view of value that enables us to buy when everyone is selling –and if our view turns out to be right­– that’s the route to the greatest rewards earned with the least risk.” (Howard Marks)

Irene has not yet asked herself how she wants to handle her investments long-term. When I told her that choosing quality titles and keeping them for the long-term is the best strategy, it seemed to her an obvious choice. It may seem obvious, but which of us can manage to do it when faced with market forecasts, fears of rate hikes, statements from central banks, newspaper articles, tips from financial planners, and advice from friends?

Investing Is Nothing Without Control

To paraphrase a famous advertisement from the 1990s, which featured Carl Lewis, investing is nothing without control. Finance experts and financial advisors are seen as sorcerers because they have the technical knowledge to deal with the markets. This creates an asymmetrical relationship with people like Irene, who get lost in the face of the mountain of acronyms with which stocks, bonds, and funds are identified.

But having the technical knowledge does not mean knowing how to invest, an activity that requires above all discipline and control of one’s emotions. This is especially true in times like these, when the markets are drifting and even certain financial newspapers are fanning the fires of worry with apocalyptic headlines, prophecies of collapses and alarms like “save whatever you can.” Over the course of a few days the scenario can change. Now there are rumors of recession and stagflation, two gloomy prospects that frighten savers. So, they find comfort and reassurance in the arms of the “experts,” to whom they cling in search of safe havens for their portfolios.

As I see it, the technical knowledge of financial instruments accounts for 10%; the remaining 90% is psychology and management of one’s emotions. But in this you almost always have to do it yourself.

A Short Update on My Portfolios

As a contributor on Seeking Alpha, I see many readers constantly looking for new titles and new ideas. They fail to realize that more often than not the best titles, when properly managed, are probably those already in their portfolios. Investing is sometimes a boring activity, where doing what you already do well counts for more than exploring new horizons. Personally, in recent years I have devoted myself more and more to behavioral finance. Lately, I have been studying the mental models that Charlie Munger has talked about so many times in his long career. Understanding how to help my brain work better interests me more than finding out about the latest ETF on gold or the latest CEF on the NASDAQ.

• Cupolone and Giotto, my two income portfolios, have remained unchanged for a few months. My last changes were done between March and April, 2022 when I built positions in BST, CCD, CGO, EOS and SPE. I have not made any further changes after the recent market rebound. Their prices are currently still below my load price, but not to the point that they are worth buying to average down. I prefer to keep my remaining liquidity as an option on the future in case the market resumes its downward path. Then, and only then, will it be worth increasing my positions.
• Because I decided to stop exploring new horizons, I only selected three of the BDCs I was following (ARCC, CCAP and SSSS) to integrate into my Masaccio “tactical” portfolio, which today consists of seven titles.

Together my three income portfolios contain 30 titles, as follows:

Cupolone

• BlackRock Science And Technology Trust (BST)
• Calamos Dynamic Convertible and Income (CCD)
• Calamos Global Total Return (CGO)
• Eaton Vance Enhanced Equity Income II (EOS)
• Eaton Vance Tax-Adv. Global Dividend Opps (ETO)
• Eaton Vance Tax-Adv. Dividend Income (EVT)
• Guggenheim Strategic Opp (GOF)
• John Hancock Tax-Adv. Dividend Income (HTD)
• Pimco Corporate & Income Strategy (PCN)
• Pimco Dynamic Income (PDI)
• John Hancock Premium Dividend (PDT)
• Pimco Corporate & Income Opportunities (PTY)
• Cohen & Steers Quality Income Realty (RQI)
• Special Opportunities Fund (SPE)
• Cohen & Steers Infrastructure (UTF)
• Reaves Utility Income Trust (UTG)

Giotto

• Credit Suisse X-Links Gold Covered Call ETN (GLDI)
• JPMorgan Equity Premium Income ETF (JEPI)
• Global X Nasdaq 100 Covered Call ETF (QYLD)
• Global X Russell 2000 Covered Call ETF (RYLD)
• Credit Suisse X Links Silver Shares Covered Call ETN (SLVO)
• Credit Suisse X Links Crude Oil Shares Covered Call ETN (USOI)
• Global X S&P 500 Covered Call ETF (XYLD)

Masaccio

• AllianceBernstein Holding LP (AB)
• Ares Capital Corp (ARCC)
• Crescent Capital (CCAP)
• Royce Value Trust (RVT)
• SuRo Capital Corp (SSSS)
• XAI Octagon FR & Alt Income Term Trust (XFLT)
• Global Dividend Growth Split Corp Ordinary Shares (GDV.TO)

Overall, Cupolone shows strong gains despite the fact that the most recently added CEFs are below breakeven point. Stocks purchased in spring 2020 continue to sail at full speed.

Giotto shows a slight loss (with GLDI and SLVO the most penalized titles) but the cash flow it generates is more than satisfactory, especially with respect to the ETN components, which I use to offset previous losses.

Masaccio is currently entirely biased toward financial services and consists of a MLP (AB), three BDCs (ARCC, CCAP and SSSS), a senior loan/CLO fund (XFLT), another focused on small cap (RVT), and a Canadian CEF that invests in a diversified portfolio of equity securities of large-capitalization global dividend growth companies (GDV.TO) AB is currently in good gain while all the other titles are around or just below par, except SSSS which, on the other hand, is dropped a lot and is still struggling to recover.

Summing Up

As I have stated on many previous occasions, I can’t keep my positions intact and give up substantial capital gains when the value of my shares rises to historic highs. For this reason, I’ve developed an investment strategy that I call “position trading.” The hallmark of this strategy is that if and when my titles hit new highs, I lighten my positions, thereby getting some extra returns. Otherwise, I simply enjoy distributions.

As we have seen, market dips of around 10% follow each other practically every year, and even 20% dips are not uncommon events. It is not a question of playing on market timing, but of becoming aware that the black swans swim in the pond near our house.

If you follow this strategy you have to arm yourself with patience, as I am doing right now. Personally, I don’t think the storm has passed, and indeed I fear that this temporary rebound is only ephemeral. For now, I stay still so I avoid averaging up the price of the securities I am interested in, but should there be new sell-offs I would return to the market and increase the positions that have fallen more, mediating them downwards at more favorable prices.

But this is something I will not talk about with Irene yet. She is young, and it’s a good idea for her to begin building her long-term portfolio… at least in this case forgetting the advice of the Latin poet Horace, “carpe diem, quam minime credula postero.”

P.S. I would like to take the opportunity of my 40th article to thank my priceless Colorado friends, Lynne and Michael, who with Chartusian perseverance proofread all my articles, month after month, trying to make sense of them.