OCTOBER CLIENT LETTER: LEARNING TO LOVE LUMPY, THEY HATE US
Nov08

OCTOBER CLIENT LETTER: LEARNING TO LOVE LUMPY, THEY HATE US

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Learning To Love Lumpy Generally speaking, markets are sadistic tools for separating capital from those who are both emotionally and intellectually unprepared for the challenge at hand. As emotional individuals we are inherently unprepared for the primary challenge of inverting greed and fear instead of falling victim to the burdensome exertion of their influence during the most inopportune moments. Secondarily, as individuals in an ever fast paced society, we are unprepared to remain patient in the face of constantly shifting value equations reflected in green and red ticks on a minute to minute basis five days per week. Equity investors would be much better off, if like the real estate market, values were only available through expert appraisal which would only take place on occasion of a sale or borrowing on the asset. This type of structure would eliminate the need to obsess over price, which for the most part is inconsequential except for a few times per year. The liquidity afforded by the equity markets, while being one of its most attractive attributes is also its greatest force for manipulation and the ultimate failure of the investor who dreams of Buffett like riches. Buffett is famous for saying, "the stock market is a device for transferring money from the impatient to the patient." Patience takes on a different meaning based on which sector you are invested in. For example, in large cap, widely traded equity names, patience means that you are subject to price manipulation on a much more frequent basis than the thinly traded, deserted names that I happen to favor. When the markets swoon as they recently did, large cap investors take on correlation risk as securities are largely lumped in same basket with the classic dumping of the baby with the bathwater taking place. This correlation risk is a much less prominent feature of the micro/small-cap marketplace. The more off the run the security, the less an investor has to worry about correlation to the broad market indices. There is a trade off, however. The lack of influence created by the broad market creates long periods of relative inactivity in small company names. And when the gains do come, they show up in lumps that total a few weeks of movement per year. The rest of their time is spent effectively grazing on a pasture waiting for a regrettable trip to abattoir or preferably, a blue ribbon at the state fair. This tendency towards lumpy gains is as much a form of manipulation running counter-intuitive to prevailing...

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