Horizon Kinetics' March 2015 Commentary – Time and Chance

Author's Avatar
Mar 06, 2015

For long-term value investors, risk is not defined by the level of volatility but by the likelihood of shareholder capital being permanently impaired. Though often vilified, share price volatility is actually opportunity masquerading as Warren Buffett (Trades, Portfolio)’s heavy-drinking manic depressive –Â "the crazier he is, the more money you're going to make." In other words, volatility often proves a significant advantage to the long-term investor since the result can be an increase in the frequency of mispriced securities (i.e., opportunities). Less sanguine types simply accept it as an inevitable and unpleasant part of the investment experience. That said, in the behavioral psychology context, the frustration that some investors feel when their portfolios exhibit volatility that exceeds expectations is certainly understandable, especially if such volatility is not associated with positive excess rates of return in the near term.

The challenge for investors –Â professional or otherwise –Â is to remain steadfast during periods of elevated volatility and the oft-associated underperformance. This is not to say that investors should stubbornly refuse to revisit their investment theses if the fundamentals have changed. Rather, it refers to the ability to tolerate short-term stock price fluctuations when the fundamentals have not changed and still appear favorable. This uncommon ability not only epitomizes the successful investor but the successful decision maker in any field where there is an element of chance.

The temptation for many market participants is to draw inferences based on changes in share prices rather than based on underlying business fundamentals. As a result, many individuals tend to take assets out of the market when volatility is high and returns disappointing (and, of course, vice versa). Though many expect to come back into the markets in time to participate in the recovery, historical data show that identifying the peak or trough of a market cycle is extremely difficult, even for the most experienced professionals. And when the markets turn, they often do so quickly. To re-enter the markets once an upturn begins is, in most cases, to miss a significant portion of the return. In fact, studies such as DALBAR, Inc.’s annual Quantitative Analysis of Investor Behavior provide evidence that staying invested during periods of elevated volatility is associated with strikingly better long-term investment results.

Continue reading here.