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Excerpt Q1 2019 letter

“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.” (Jeff Bezos)

Global markets took a dive in the last quarter of 2018, just to recover almost fully in the first weeks of January. Such sudden swings are fascinating and proof that markets are not efficient. Overall, there was no event that should have caused two major swings in market sentiment within a few weeks. If anything, the new year started where the old one had left off, with a government shutdown in the USA, geopolitical tensions, worries about a no-deal BREXIT, trade tensions, etc.

In periods of higher volatility, it’s easy to be swayed by the market’s sentiment and react in a pro-cyclical manner. In a benign environment, we feel safe, generous and willing to take on risks. In a volatile environment, we become fearful and cautious. Therefore, it’s also in human nature to crave investment products designed to reduce volatility. Unfortunately, most of these products are likely to underperform the market over time, as they either cost valuable upside or are pro-cyclical in nature.

In his career, Warren Buffett suffered four major dips where the market price of his investment vehicle, Berkshire Hathaway, dropped by more than 35%. Yet, Berkshire’s market price has increased a staggering 2,472,627% since he took control in 1965. In other words: 1 dollar turned into 25,000 dollars! Obviously, it would have been great for investors to time the dips. However, buy-and-hold was more than good enough.

Investing is a humbling activity, especially when one pursues a contrarian approach. There are times where the general market is down, times of underperformance or mistakes, and periods where one may look stupid and exposed. To beat the market, an investor needs to behave differently from the mainstream.

What helps overcome our natural tendency to strive for popularity and to overemphasize volatility, what helps us stomach periods of weak performance?

  1. Focus on value, not price. I view the marketable common stocks that iolite owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits. If the markets were to drop 20-30%, our positions would go down as well. Just because something is cheap does not mean it is not going to go down. However, most of our positions should recover quickly as I consider the underlying companies in a position to use their undervaluation, their strong balance sheets, or their positioning to proactively exploit any period of market distress. If I correctly assume a position is undervalued, any market correction will only have a temporary impact on the portfolio. If I make mistakes or I am too slow to respond to changing facts, the portfolio may suffer permanent capital loss.

  2. Thinking probabilistically. I deal with uncertainty by pricing it in. Humans naturally crave for leadership and firm answers. However, the future is uncertain and it is my task not to get carried away by a good story. Instead, I think about what could go wrong: the known knowns, the known unknowns, and the unknown unknowns. The lower the price I pay, the higher the margin of safety and the less vulnerable the portfolio is to undesired events. It is difficult at the time of purchase to know any specific reason why iolite’s investments should appreciate in price. However, because of this lack of glamour or lack of dependence on catalyst-driven market movement, I was able to invest at cheap prices. Sometimes, our positions will appreciate fast, many times it will take years. Sometimes, the payoffs to us will be modest; occasionally, the cash register will ring loudly. And sometimes, I will make expensive mistakes. Overall – and over time – we should get decent results.

  3. Focus on process, not output. We judge decisions based on the facts known at the time, not based on outcome and with hindsight. Some of the most successful investors I have encountered in my life come from families with a long tradition of intelligent risk-taking (or better: risk-pricing). There are a few benefits in a family setup: intimate trust, a multi-generational bond, permanent capital, and a common culture of thinking. Whereas most corporations are driven by short-term goals and politics, the most successful trading families are driven by a strong emphasis on process over outcome. They don’t discuss results, they discuss investment theses, they are open to challenge each other, they are dedicated to lifelong learning, and there is an openness to change opinions when necessary. Experienced merchants know that luck is required to become successful, but that the frequency and magnitude of lucky events depends on the work one puts in. As the old saying goes: “every man forges his own destiny”.

I am proud to consider iolite a family of likeminded investors that are in it for the long-term, that endure volatility, and that are striving for intellectual honesty. Any investor’s strength is ultimately determined by the capital available to him. Thankfully, iolite has an outstanding capital base.

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