Thursday, 24 December 2015

My Investment Mistakes of 2015

One of the reasons I love investing is that it is not just a battle against other intelligent, knowledgeable and committed people but a battle against yourself. Each of us have biases that prevent us from acting optimally and it is by knowing ourselves better and designing strategies to overcome these biases that we become better investors. It is in this spirit I offer, not a celebration of the 2015 successes or tips for 2016, but some of the mistakes I made this year:

Not being bold enough when the downside was negligible

On 12th August a company called Pure Wafer announced that they would return 140-145p to shareholders from an insurance payout related to a fire in the UK part of their business. The shares opened that day at 145p to buy, presumably due to generally poor market sentiment in August 2015. Given that the company still retained a profitable US trading business then it was highly unlikely the shares would be worth less than 145p. I used all of the spare cash in my dealing account to purchase shares and then turned to my spread betting account. However at this point I was not bold enough. Given that the downside was negligible I should have used all available margin to open a position however I was too cautious and only added a small amount. The shares rapidly rose to 165p that day as others realised the opportunity and following the sale of the trading business should return 188p in total to investors. The market rarely offers a free lunch but when it does you need to absolutely stuff yourself.

Thinking that buying the best companies in an industry with bad economics would protect the downside

One of the biggest investment themes of 2015 has been the rout of commodity prices and the impact on commodity producers. Although I’ve never liked commodity exposure as investment theme in itself there are certain attractions to owing oil companies. Their assets are easily analysed and assets that will be drilled or developed far in the future are often neglected in valuations giving opportunity to those with longer term investment horizons. As a contrarian investor I wanted exposure to the sector but to limit the downside should there be no medium term oil price recovery. Therefore I added shares like Ophir & Bowleven that had strategic assets and large cash holdings. Despite paying historically low prices and below cash in the case of Bowleven that didn’t stop prices falling as the oil price fell further. When a sector is seriously out of favour then everything gets sold. This maybe illogical and may be a good contrarian buy going forwards but the strategy of buying the cash rich oil companies didn’t in reality protect the downside in 2015.

Being too worried about the spread

The commodities rout has had a knock on impact into the oil services sector leaving a number of companies looking very cheap, at least on historic metrics. I’m always interested in extremely sold off shares and unlike oil exploration and production companies the service companies often have other subsidiaries unaffected by the oil price collapse. Two such companies that are on my watch list are Northbridge Industrial and Pressure Technologies. In both cases I was very close to buying, Northbridge quoted at 66p and Pressure Technologies quoted at 147p. In both cases I rejected the quote because I didn’t want to pay the full ask. Prices now are 89p for Northbridge and 192p for Pressure following trading statements or results that were not great but simply not as bad as the market feared. Sometimes it pays to pay up, especially when prices are already significantly depressed.

Failing to exit an investment going wrong quickly

On 17th March defence training specialist Pennant International reported their FY results. Although on the surface they seemed to be fairly positive a detailed reading of the figures suggested that they were struggling in a number of areas and were overly reliant on a few contracts. Since I was slow to do the full analysis the price had dropped from 98p to c.80p by the time that I had realised that things were not as rosy as they initially appeared and due (presumably to loss aversion) I didn’t sell. Today Pennant trades at 40p.

Exiting promotional shorts too soon

Nothing goes up 4-5x in a couple of months without significant amounts of ‘hot money’ being involved. Therefore when you see these sort of rises in story stocks they can make very good shorts. Particularly where there is some kind of share overhang on its way (e.g. a lockup period for a major holder ending) which will apply pressure to reverse the flow of hot money. The area that I have found most lucrative is companies that have entered into an equity swap financing deal like Amur Minerals or AFC Energy. These deals see the company raising funds by issuing shares to a company like Lanstead Capital but using that cash to enter into a swap agreement with Lanstead whereby the cash payment they receive each month depends on the share price. This leads to a strange mix of incentives. The management want the share price as high as possible but once it has risen the swap provider wants to sell as many shares as possible to fund their payments to the company and reduce the amount that they pay. Hence the spike up and the slow decline:

Amur Minerals

 AFC Energy

So what’s the mistake? In both cases having got good entry points (40p for Amur Minerals & 54p for AFC Energy) I closed the shorts far too soon (27p for Amur & 33p for AFC.) What went wrong was I started to fear the promote would push the shares higher and failed to believe my own analysis that said that the share overhang of the equity swap provider exiting would push the shares much lower and reverse the flow of hot money. Amur currently trades at 8p and AFC at 24p. It’s annoying to get the analysis right but not fully capture the resulting move.

Underestimating how foolish takeover buyers can be

In March 2015 the Australian law firm Slater & Gordon paid £640m for the legal services part of Quindell a company of which I was short. My analysis had shown that there were significant issues with the quality of Quindell's business and that without Slater & Gordon's intervention the group was likely to run out of cash. It seemed completely illogical that S&G would pay a significant premium of £640m for a business that was close to bankruptcy particularly since it would require significant debt and equity raise by S&G to fund it. As it turns out that my analysis was probably correct and Slater & Gordon have subsequent lost almost 90% of their value since the deal. What I got wrong was probably not the analysis but dismissing quite well sourced rumours that a deal had been done and then closing the short when the deal was announced. The rest of the Quindell business was of such poor quality that if I'd simply rode out the intitial deal spike I still would have made money on the short.

I’m sure I’ll make many more mistakes next year and despite these this year I made enough good decisions to generate an ok return. My aim however is not to repeat these particular ones.

Wishing you all a Happy Christmas! And may you only make new mistakes in 2016 too.


  1. Interesting write up. I think you may be a little hard with some of your mistakes.... If youd closed your shorts and the share price subsequently rose, youd look like a genius.
    I think typically once several months have passed after the peak then the hot money and nervous holders have gone or are diminishing. Near term cash or funding requirement is also a nice to have imo. There seem to be many companies around like this so im planning a few shorts over the break. Dia, brady, pci, wan. PCI is imteresting as it could be another Afren....i did well on that but the whipsawing at the end was unsettling :-)

  2. "However at this point I was not bold enough. Given that the downside was negligible I should have used all available margin to open a position however I was too cautious and only added a small amount."

    Completely reckless thinking - highly possible that the very next day any CEO could be arrested for fraud or some other event. Over time I think you need to anticipate this. I structure my portfolio so no one stock can ever take me out of the game no matter how extreme the risk / reward ratio. Possible use of guaranteed stops could stop this.

    I enjoy the blog could you put mine in the blog roll -

  3. Hi Rob,

    Thanks for the thoughts. If you look back at some of the articles I started with on portfolio construction though you'll see I am actually a big fan of diversification as a way to protect against unforseen circumstances. Therefore let me take the opportunity to explain why I believe not adding more to the Pure Wafer position was both a mistake and would not have constituted reckless behaviour:

    1. Margin in my spreadbetting account constitutes less than 10% of my total portfolio.

    2. Fully utilising my available margin would have given me a c.15% gross portfolio weight instead of c.10% that I ended up with.

    3. A wipe out at a 15% weight would be painful but would easiliy be met through utilising available cash outside my investment portfolio, which i could then have built up again by closing other positions if desired. There was zero risk of serious portfolio damage (which I would define as 30%+ loss.)

    4. This levergaged position would not have been a long term investment. This was a short term market inneffeciency where market makers had failed to properly price the security in relation to that day's news announcement due presumably to general market weakness. The pricing anomoly corrected itself within hours. The chance of a unexpected adverse announcement in a company exhibiting no red flags within an hour or so of a market update while not zero is very, very small.

    Looking at your blog (which I've added to my blog roll) I see that compared to your portfolio even at full margined-weight this position would be smaller than some of yours'. In general I am also more diversified than you and on average probably in more finacially secure stocks. So in reality I think our strategies are probably very well aligned with regards to unforseen risk mitigation.