Wolves fail more often on their hunts than they succeed. As Nick Jans states in his book A Wolf Called Romeo,
Survival hinges on a brutal imperative: more energy must be gained than lost, across endless hard miles. To fail is to die.
When there is a lot of snow on the ground hunting packs travel in single file with different animals taking the taxing lead position. A well-worn path through the snow is a very attractive option for the pack. Less energy is spent forging their own path, leaving more energy to survive until the next meal.
The well-worn path through the snow can get wolves into trouble. Nick Jans goes on to tell how some of his Inupiaq trapper friends will drive a snowmobile, packing down the snow, and setting traps just off the newly made pathway.
If you’ve done any backpacking or hiking you know the appeal of the well-worn trail. When you’re out in the middle of nowhere the well-worn trail is mentally soothing. You don’t have to constantly check your map. You don’t have to constantly wonder if you’re going the right way. You don’t have to constantly keep a distant object fixed to your bearing. You just have to walk. You know many people have walked this trail before. You know that they made it safely. And you know you will too. Your mind is free to think about other things. You are in a state of cognitive ease.
Following a well-worn path also puts the wolves into a state of cognitive ease. Trappers take advantage of this. And like wolves, when we’re in a state of cognitive ease we can get into trouble. Especially with investing.
The Well-Worn Path of 13Fs
It’s 13F season. That time of year when all the large asset managers file with the SEC on what they own in their portfolio during the previous quarter. I have my list of people and funds that I follow. I use their filings as an idea generator and a study tool. When a manager I follow adds a new position and it fits into my dividend growth universe, I try to reverse engineer why it is an attractive investment. If I can reverse engineer the investment thesis, and I’m confident in my work, and the company is still cheap I may buy it.
This process takes a lot of work and produces cognitive strain.
It is far too easy to substitute the research work with the rationale that manager X bought it and manager X is a billionaire with a great track record. Therefore, I should buy this company too.
This line of thinking, the search for cognitive ease, can get investors into trouble. The most recent example is Valeant (VRX). The image below is from Whale Wisdom and it shows which asset managers held Valeant (VRX) as a large position in their fund during the quarter ending December 31, 2015. It includes some very impressive names.
All the names on that list did their homework. I hope.
The problem is the average investor or the average portfolio manager seeing all these famous names holding Valeant and then investing in Valeant too. Because how could all these famous money managers be wrong? They can when Valeant’s management is playing fast and loose with their accounting. Resulting in a restatement of earnings.
This is not to say that the average investor or average portfolio manager would’ve caught the accounting irregularities. But did they do the necessary research to build the necessary confidence in Valeant’s business strategy to invest? Probably not. And when you don’t do your own work, what do you do when you when you get caught in a trap?
When investing in a company you saw in a 13F, are you buying it because you did the research and the company is a compelling bargain? Or did you substitute it with the much easier question, “does manager X have a great track record?”
If you want to learn more about 13Fs and how to use them, Market Folly is having a sale on its newsletter dedicated to 13Fs Hedge Fund Wisdom.