LTBH portfolio experiment.

For me personally I’m interested in long term conpounders, recently discussed by various “superinvesters” in the new William Green book Richer, Wiser, Happier.

For them it seems to be an ongoing pivot away from pure value investing, influenced by Munger.

I think it boils down to a having a moat, be it a product / service, network or management… some are a combination and competitive advantage, a long runway for growth, very conservatively financed (often flush with cash) and a capital light business model that can scale and will make money no matter what (think Pandemic) and of course a reasonable valuation in relation to future growth prospects.

Old school companies think Coke, McDonald’s, Walmart.

Modern Day…

Facebook, Alibaba, Google.

When I consider such companies for investment they are already highly profitable, no unicorns or future prospects here , certainty of strong cashflows and income are of paramount importance.

Buy them at reasonable prices and hold long term.

“Can I beat the market?”

I know that this is not the point of the exercise, but for a 30 year hold, it would seem to me that one could safely increase the return using leverage. Warren does it.

Say that one borrowed 25% of equity at an interest rate 2 percentage points below the non-leveraged return, maybe 6% interest and 8% non-leveraged return respectively. The interest payments would be 0.25*6% = 1.5% of the total assets, probably less than the dividends from the portfolio. Under these conditions the leveraged return of the portfolio would increase to 8.66%, versus 8.0% for the non-leveraged portfolio.

Like I say, it’s not the point of the exercise, but it’s fair to note that long holding periods do have some advantages, such as more predictable returns.

2 Likes

Not for this portfolio, it’s unleveraged but for my personal portfolio I started 12 years ago at zero after putting all savings into a house deposit and have used interest only mortgages putting any excess into the market over time.

This is now 7 figures (£ sterling). The house price has doubled too. It’s a strategy I’ll continue into the future. 30 years to go.

It’s also a strategy that could be used to pound / dollar cost average purchases into trackers, that’s what I’d recommend for most, or 50% S&P index 50% BRK. Sit back and relax.

one could safely increase the return using leverage. Warren does it.

Say that one borrowed 25% of equity at an interest rate 2 percentage points below the non-leveraged
return, maybe 6% interest and 8% non-leveraged return respectively. The interest payments would be
0.25*6% = 1.5% of the total assets, probably less than the dividends from the portfolio.
Under these conditions the leveraged return of the portfolio would increase to 8.66%, versus 8.0% for the non-leveraged portfolio.

This certainly works, but the key word here is “safely”.
It depends what type of loan is used.
If it’s a long term fixed rate mortgage you can very comfortably service, go for it.
If it’s a broker margin loan that can be called on an hour’s notice for no reason, run away from the idea.

Plus, remember to stop doing it if the real interest rate becomes meaningfully closer to the expected rate of return.

Jim

5 Likes

If it’s a broker margin loan that can be called on an hour’s notice for no reason, run away from the idea.

Jim, I’d love to understand better the reasons for your wariness of broker margin loans, because I’ve been sorely tempted to take one out to achieve a modest level of leverage (1.25x)

I know that a broker can raise their margin requirements fairly quickly. I read that Interactive Brokers did that around election time (and maybe other times before) - up to 67.5% I believe. But if I did the math right, even if they ratcheted margin requirements to that level again, it would require a pretty substantial drop (-40%) occurring at the same time to get a margin call on such a relatively small amount of leverage.

And if leverage was initiated at a point where a substantial drop had already occurred, the likelihood of both of those factors (an -additional- substantial drop at the same time as a significant increase in margin requirements) happening at the same time -seems- very remote chance, at least on the surface. But then leverage via deep ITM call options also carries some risks (albeit remote, perhaps even more remote), especially if a person is unable to raise funds from other sources, which is the case for me as someone who is taking on some leverage in some of my retirement accounts. Am I missing something else key/critical that makes the situation risky?

2 Likes

Topic reminds me of WEB’s commentary and humor:

“My partner Charlie says there is only three ways a smart person can go broke: liquor, ladies and leverage. Now the truth is — the first two he just added because they started with L — it’s leverage.”

6 Likes

I’d love to understand better the reasons for your wariness of broker margin loans, because I’ve
been sorely tempted to take one out to achieve a modest level of leverage (1.25x)
I know that a broker can raise their margin requirements fairly quickly. I read that Interactive
Brokers did that around election time (and maybe other times before) - up to 67.5% I believe. But if
I did the math right, even if they ratcheted margin requirements to that level again, it would
require a pretty substantial drop (-40%) occurring at the same time to get a margin call on such a
relatively small amount of leverage.

Am I missing something else key/critical that makes the situation risky?

Perhaps so : )

Well, first, the math is nasty.
Let’s say it’s a Regulation T account and they allow borrowing up to 50% of the value of the stock, which means 2:1 leverage.
That sounds like a lot if you’re only using 1.25:1 leverage, but it isn’t.
As you note, it would take a 40% drop. Or as I would put it, “only a 40% drop”.
But note also that it only takes a 40% drop for a single trade for their computers to wake up and sell you out if it feels like it.
They can be very aggressive, and they warn you that they may be the counterparty on the liquidation.
They’re very businesslike, but they are in the vampire squid category: they are not your friends.
And once you breach the rules, they don’t limit themselves to the a mount of liquidation that would bring you back into compliance…they liquidate as much as they like.
(As a specific example, I ran into that myself–they liquidated $79400 worth of positions because of a margin loan of $684 in an account I wasn’t watching, with zero notice or even notification at the time.
That entailed a $48k realized loss, and the value of those liquidated positions was up 84% by the time I learned of it)

Plus, on top of all that, they can simply change the leverage limit at any time, with a few minutes of notice, and they have done so in the past.
They could call all margin loans, completely, any time they want.
So trying to following the rules is no help–they can change without warning.
Plus, when the rules do change, it’s generally during a market panic and those aren’t the prices at which you would want to be a forced seller.

So, in short–

  • Prices can do anything, short term.
  • Rules can do anything, any time.

Either one of those would be sufficient to rule out using broker margin loans.
The Blanche Dubois approach to investing is not one to be recommended.

And if all that weren’t enough, try reading all the rules on Reg T margin and portfolio margin, intraday and end-of-day.
If you understand them all, and they haven’t changed by the time you finish reading, you’re smarter than I am.

These agreements can be pretty tricky—at one point I was considering using contracts for difference (CFD).
I think maybe those are prohibited for US persons, not sure.
Basically it’s like single stock futures contracts that never expire: you pay interest on the “borrowed” amount from day 1 even if you have a cash balance.
In any case, I wanted to know what the actual rules were, so I asked for a copy of the actual contract implicitly referred to as the C in CFD.
Back and forth I went, over a period of weeks, and all they could say was that in effect the contract was whatever was currently the sum of their web pages that day.
I never used 'em. Even a bookie or loan shark will tell you up front what the vig is.

Jim

32 Likes

one could safely increase the return using leverage. Warren does it.

Speaking of leverage, here is a nice anecdote about Buffett visiting a credit analyst at Moody’s. Weston Hicks later became CEO of Alleghany:

"I did these meetings for years and felt like I’d seen it all. Then, one day, I met the antithesis of “very important” and “imperial” CEOs and executives who had a problem answering questions about their business. Warren Buffett and Charlie Munger from Berkshire Hathaway came in for a visit. They arrived in a taxi, not a limo, with no hangers-on, not one person with them at all. When I addressed him as “Mr. Buffett” he said, “Please call me Warren.” They had come in to talk about a debt issuance, and Buffett made a self-deprecating joke: “My mother always told me to avoid liquor, ladies, and leverage. I’ve avoided the first two, but sometimes I like a little leverage.” Our analyst, Weston Hicks, was an excellent insurance industry analyst and asked detailed and probing questions. Buffett and Munger spent an hour, an hour-and-a-half, giving very specific answers. When the meeting ended and we were walking to the elevators, Munger said to me, out of earshot of Weston, “Make sure you keep that analyst. He’s really good.”

https://www.stories.finance/stories/noe?ss_source=sscampaign…

16 Likes

The ‘kindness of strangers’. Brilliant grab…

I believe. But if I did the math right, even if they ratcheted margin requirements to that level again, it would require a pretty substantial drop (-40%) occurring at the same time to get a margin call on such a relatively small amount of leverage.

What work under normal circumstances, doesn’t work always. I had a margin call and liquidation in IBKR once, simply because of pre-market quote. The worst part of it is, they chose to liquidate my preferred shares which are by very illiquid, and guess who was the counter party???

My preferred which had a previous day closing quote of $23, they sold my position at $14, and it closed the day at $23.15. That was 2000 shares, $14K loss, and technically I was not even on a margin call because market opened much better than the pre-market quote. They increased the margin based on the pre-market quote and sold of all my positions one that is absolutely illiquid. They could have sold my SPY, Apple or various other positions, but just took those preferred shares out of my hand. Do I believe it was randomly selected by machine? Absolutely not, someone looked at my book and decided how to make the maximum profit for IBKR and executed the trade.

They take what they want.

IBKR gives you great margin, but just be careful, their margin requirements change on dime, positions get liquidated at their choice and never forget they take what they want.

11 Likes