2011 Annual Investment Performance Review

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On the one hand I am pleased that I did not lose much money during the last year, while many hedge funds had a disastrous track record.  On the other I am very disappointed to break my streak of outperforming the S&P 500.  It could also have easily been a very different story.  Later I will delve into a reflection on learnings from the year.  But first let’s see the results……

Leprechaun Investor saw a slight loss of 3.2% for the year, compared to the total return for the S&P index (including dividends) of 2.1% in positive territory.  The long term results are updated in our tracking table.  Of course the Buffett figures will be added later in February.

Leprechaun
Investor
S&P 500 Difference Buffett Difference
1996 255.2% 23.0% 232.2% 31.8% 223.4%
1997 57.9% 33.4% 24.5% 34.1% 23.8%
1998 21.3% 28.6% (7.3%) 48.3% (27.0%)
1999 89.6% 21.0% 68.6% 0.5% 89.1%
2000 (0.3%) (9.1%) 8.8% 6.5% (6.8%)
2001 (47.7%) (11.9%) (35.8%) (6.2%) (41.5%)
2002 (55.8%) (22.1%) (33.7%) 10.0% (65.8%)
2003 114.0% 28.7% 85.3% 21.0% 93.0%
2004 (13.9%) 10.9% (24.8%) 10.5% (24.4%)
2005 42.8% 4.9% 37.9% 6.4% 36.4%
2006 9.8% 15.8% (6.0%) 18.4% (8.6%)
2007 10.3% 5.5% 4.8% 11.0% (0.7%)
2008 (10.5%) (37.0%) 26.5% (9.6%) (0.9%)
2009 30.1% 26.5% 3.6% 19.8% 10.3%
2010 40.8% 15.1% 25.7% 13.0% 27.8%
2011 (3.2%) 2.1% (5.2%)

The long term record continues to look very bright with the 5 year performance in the charts below, comfortably exceeding the benchmark.  Of course I am always happy to accept some short term volatility or underperformance in exchange for better long term results.

Leprechaun Investor outperforms S&P benchmark easily over 5 years

Portfolio performance over 5 years (2006 to 2011)

Mis-timing some key macro trends

Looking at the macro level, this was a year where getting timing right meant everything.  My general positioning for the year was bullish for gold/silver, energy and pharma, with an especially strong weighting to gold mining stocks, and neutral on general stocks.  In the relative performance chart on the right you see strong volatility compared to the benchmark, until beginning in the 4th quarter performance began to track the market.  Note that this period of this chart is actually end January 2011 – end January 2012.

Leprechaun Investor portfolio was very volatile relative to benchmarks

Relative Performance of Leprechaun Investor compared to Benchmarks

The peaks in April and September were due to strong gold/silver performance.  This could have been even better if I had more gold relative to silver, but I avoided silver (the real big winner) because it really is a risk-on play (and I wanted to be conservative – rightly so considering the poor stock markets and Euro crisis).  Secondly the metals performed far better than the miners.  Now, in early 2012, it finally appears that miners have touched the bottom of their valuation range compared to the metals, so hopefully this will pay off in future.

Secondly I did not lock in gains at some of the key turning points.  It would be nice to predict the tops perfectly, but it is always better to stay with the momentum.  Rather than pick perfect tops, I prefer to get the timing right for buying when fear is at it greatest.  Nevertheless one key missed opportunity was in September, when I was sure that after gold/silver had started its initial plunge, that they would bounce back together with the broad market in a relief rally before another plunge.  When the relief rally failed to materialize I should have just sold.

Diversification in individual trades helped

Looking at major gains in individual stocks there is no single sector play that was overwhelmingly successful.  The main theme that paid off was in written puts to profit from the high volatility of stocks during the fall sell-off.  RIMM also stood out for exceptional gains on the short side.

The clear theme on the losses for the year, was the repeated disappointments in biotech.  I believe this is a critical sector for long-term gains so I persevere to find the right approach.  I learnt from previous years to have a more diversified basket of stocks.  Unfortunately most of the basket were losers!  I tried to apply more technical charting to the stock selection since it is impossible to get an edge on what drugs will be approved or not by the FDA.  However I entered stocks after the initial run up and did not avoid shock selloffs on sudden bad news.  Two patterns seem promising to improve returns from biotech stock investing: 1) to invest in companies well before an FDA event, and to sell just before the event occurs (however this is too much work for me to track), 2) if a stock starts underperforming, sell first and ask questions later, but if a shock selloff has already occurred continue to hold, because almost without fail these stocks eventually recover the price before the crash.

The new year 2012 has started very promising, and we aim to recover our outperformance track record once again.

Update 31 Jan, 2012: I just saw the 2011 results for the panel at Barron’s Roundtable as compiled by PunditTracker.  So I can’t really complain after beating all but three of these star investment advisers.

2011 Returns
Fred Hickey 9.2%
Felix Zulauf 6.4%
Mario Gabelli 5.6%
S&P 500 -1.1%
Abby Joseph Cohen -2.7%
Meryl Witmer -3.9%
Roundtable Average -5.0%
Oscar Schafer -6.1%
Marc Faber -12.3%
Scott Black -13.6%
Archie MacAllaster -27.8%
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2010 Annual Investment Performance Review

This could also be subtitled “Why should I care about what Leprechaun Investor blogs about”.  Of course you should only be interested in what I have to say, if my views and approach have been successful over time.

I have always been religious about tracking my investment performance.  It is all too easy to kid yourself about the returns that you are achieving in your portfolio.  This especially happens because over time you are generally adding to your investments.  In order to get a true performance picture you need to normalize for these investment inflows.  Today I share my simple approach to tracking returns, and in future I will cover more sophisticated approaches.

Beyond generating a positive return you also want to make sure that you are beating a competitive performance benchmark.  For this I simply take a leaf from Warren Buffett’s annual letter to shareholders.  He maintains a table of total annual returns (including dividends) for the S&P 500 index.  Each year he compares the annual increase in book value of his company.  The following table shows the returns of Leprechaun Investor compared to both the S&P 500 as well as Buffett:

Leprechaun
Investor
S&P 500 Difference Buffett Difference
1996 255.2% 23.0% 232.2% 31.8% 223.4%
1997 57.9% 33.4% 24.5% 34.1% 23.8%
1998 21.3% 28.6% (7.3%) 48.3% (27.0%)
1999 89.6% 21.0% 68.6% 0.5% 89.1%
2000 (0.3%) (9.1%) 8.8% 6.5% (6.8%)
2001 (47.7%) (11.9%) (35.8%) (6.2%) (41.5%)
2002 (55.8%) (22.1%) (33.7%) 10.0% (65.8%)
2003 114.0% 28.7% 85.3% 21.0% 93.0%
2004 (13.9%) 10.9% (24.8%) 10.5% (24.4%)
2005 42.8% 4.9% 37.9% 6.4% 36.4%
2006 9.8% 15.8% (6.0%) 18.4% (8.6%)
2007 10.3% 5.5% 4.8% 11.0% (0.7%)
2008 (10.5%) (37.0%) 26.5% (9.6%) (0.9%)
2009 30.1% 26.5% 3.6% 19.8% 10.3%
2010 40.8% 15.1% 25.7% 13.0% 27.8%

When you look at the indexed returns in the following chart, you notice the amazing consistency of Buffet and the huge volatility of the Leprechaun Investor portfolio.  The fall out from the dotcom bubble was a very painful, and important lesson for me.  Up until that point I was enjoying terrific returns and had grown too confident in my abilities.  This meant that when the bubble burst I was not ready to change direction.

Performance vs Benchmarks 1996 - 2010

Performance vs Benchmarks 1996 - 2010

I took the lesson to heart and became better at managing downside risk, even if that meant sacrificing stronger returns in the good times.  As you can see in the next chart, the compounded returns have paid off handsomely, even surviving one of the most brutal bear markets since the Great Depression.

Performance vs Benchmarks 2002 - 2010

Performance vs Benchmarks 2002 - 2010

As an aside: Warren Buffett was one of the greatest influences on my investment style.  Early in the 80’s I contacted Berkshire Hathaway, and they kindly sent me reprints of all his letters.  Nowadays it is much easier with the link to his letters online.  However for a broader and more easily digested alternative I cannot recommend Roger Lowenstein’s biography of Buffett strongly enough.

Update February 24th: Warren Buffett’s annual letter just came out.  I updated the table and the charts with the latest year for Buffett’s data.  He also did the calculation for the dividends of the S&P 500 which took the return up from 13% to 15.1%

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Key investment opportunities and risks for 2011 – 2012

Dollar Fall

Before we dive in to my views on where to place your bets for the next couple of years, it is important to understand the context for my views.  I see the world economies as extremely unbalanced and while we have seen stability in the stock markets for nearly two years, at any moment volatility can explode.  The big problem is that economic cycles of boom and bust are inevitable.  However in recent decades politicians and bureaucrats have been trying to eliminate the bust cycle.  Each time we enter a recession, before we have completed the full course of bitter medicine to cleanse our system of the excesses, governments rescue us with free money and other stimulus.  We enjoy a short term high, but push the problem of rehab to our future generations.

With this context here are my quick takes on what lies ahead for a mix of sectors, currencies, geographies, and industries:

image Dollar: this is the pivotal trend to track which will influence the direction of many of the other markets.  The US government is debasing the currency by running the dollar printing presses non-stop.  If this was any other currency that is not the world’s reserve currency it would already have crashed.  Watch for the rest of the world to lose patience, and to cause a currency crisis.
image Euro: not a good alternative to the dollar because of the risks from the debt crisis on the periphery.
image Bonds: there is a huge overhang of debt in the world (especially government debt) which will continually need to be rolled over.  Once inflation takes a hold it will wipe out any returns from bonds with their fixed payments, especially long duration bonds.  I am watching out for opportunities to short the long bonds.
image Emerging markets: this was the best place to play the recovery from the 2009 market bottom.  Long term it is still one of the most promising sectors, but short term it is priced for perfection.  Escalating food prices and general inflation are a big risk, and any slow down in demand from the developed world will be critical.
image Gold and Silver: will benefit from money printing in the rest of the world.  These are also assets that are not collateral against debt, and will not be pressured in a debt squeeze.  This is a very volatile sector, and there are sure to be some big downdrafts ahead.  Currently I am most overweight in these metals, especially silver mining stocks.  In the last several weeks I have added to my positions very substantially to be ready for a breakout.
image Commodity metals: will always have long run demand in their favor while emerging countries industrialize.  However they are too economically sensitive for my liking in the short term.
image Agriculture: would be my favorite investment choice, if it were not so difficult to find a vehicle to capture the upside.  There are several ETF’s (DBA, JJG) which have done well recently.  However I prefer to avoid commodity ETFs because of bad experiences in the past.  Fertilizer companies are also an option but they have already had a huge run-up.  Best would be to buy a farm, but I am not one for muddy boots.
image Real Estate: values are kept inflated by debt which is temporarily almost free of interest.  As soon as realistic rates are payable, the cost of debt will put a huge pressure on values.
image S&P 500: the US stock markets can continue to be levitated by QE2.  When the stimulus is removed the market will be very exposed to a fall.  I expect this to happen between now and September this year.  But until they fall stocks, could continue to rise to the level before the 2008 crisis.
image Retail: mass consumers will continue to be squeezed between unemployment, negative home equity, inflation and taxes.  There is simply no justification for stock prices to be higher than before the 2008 crisis.  I am gradually increasing shorts.
image High Tech: covering software, hardware, chips and Internet.  Often there are great opportunities for high returns if you pick the right technology wave.  However valuations during these waves are sky high.  I think the risk/reward is generally better for entrepreneurial activities than for public companies.
image Pharmaceuticals: everyone knows that most of their patents are expiring in the next few years.  However not everyone has priced in growth drivers from emerging markets and an aging population, nor scope for cutting costs in large Sales and R&D budgets.  With a high dividend, this is a good option for some stability in a portfolio.  I have a medium position which has substantially underperformed the market so far.
image Biotech: a very volatile sector, but nothing can deliver such high returns if you get it right.  I trade a limited amount actively with small positions based on technical charting.
image Energy: scarcity due to peak oil will drive ever higher prices.  The crazy irony is that people complain about high oil prices, but in fact they are not high enough to provide enough ROI for oil alternatives.  My take on the subsectors:

  • Oil: prices should rise faster than inflation.  Oil stocks provide great dividends and the downside should be limited.  However growth options are limited for the oil majors.  I am overweight oil stocks.
  • Natural Gas: currently in huge oversupply, however this is a relatively clean energy source and I have been buying now, but it will require patience to see returns.
  • Clean energy: still too dependent on subsidies. Once oil stays well above $100, then we may finally see this industry take off.
  • Uranium: in the medium term nuclear energy is the only realistic alternative to oil.  It delivers good ROI and can be scaled up in the required quantities.  The cost of uranium is a small part of the total costs of a nuclear plant, and there is huge scope for price increases as demand rises.  I am very bullish on uranium mining stocks, but in the short term they have probably gone up too quickly, so I will wait before adding to positions.

I’d love to hear your thoughts and any agreements or disagreements with this list.  In the following posts I will drill down into more detail on many of these topics individually.  Let me know your particular interests.

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Introduction to the Leprechaun Investor

To kick this blog off, I’ll provide a short intro to give a context on my background and why this blog may be useful to you  –  or not, if you don’t care about what goes on in the world and how wealth is created (or lost) 😉

Experience Built through Booms and Busts

gold cast bar

I have been an active investor since the mid 1980s.  My introduction was in stagging the public stock flotations in Great Britain (if only it was always so easy to make money!).  I went on investing in stocks and options. During my MBA at MIT Sloan School of Management, I took a break from the stock market – along with a short term hit to my wealth.  In the dotcom boom I made and lost a fortune like so many others.  I became a lot more cynical of where politicians and bankers were leading world economies.  This cynicism helped me mitigate the great 2008/09 crash, and even more importantly to be well positioned for the recovery.

My background is as a software engineer, and after my MBA I have specialized in marketing with high-tech and software companies. Since I have high exposure to software in my career, I tend to diversify and focus on other sectors for financial investment.  In practice this leads me to avoid most of the hyped momentum stocks.

Investment Style

My investment style is overwhelmingly to buy with a one year plus time-frame.  I complement my core long-term positions with more active trades, which include taking on leverage when the risks warrant.  I also take a contrarian view which often means that I take some short-term losses and the bulk of the gains take time to realize.  I spent many years looking at the fundamentals of stocks and investing based on that.  I have seen too many times though, when apparently sound fundamentals get crushed out of nowhere.  My style has now matured where I take a big picture, macro view of which the secular trends are, and then use some fundamental analysis, with a very heavy dose of technical analysis to help choose specific stocks and determine entry and exit timing.

What I will Share in this Blog

During all these years I have refined my skills, and proved to myself (it is all about wealth creation) that I could deliver returns over the up- as well as down-cycles.  The lessons I have learned along the way have been extremely expensive which made them so much more valuable – and I will share all my lessons learned.  In in this blog I will give detailed insights to my portfolio mix and trades.  Most important though, is the thinking process that I will share, as well as the tools and sources that I use.  My aim in writing this blog is absolutely not to provide any trading recommendations, rather it is to teach readers to fish.

In order to provide a quick into for future visitors, I’ll cross post this to the About page.

Welcome!

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