Stephen Bland on the subject of tinkering.
My article on HYP capital, specifically the lack of it mattering, last week attracted a good deal of controversy on the HYP board, as indeed I intended it do because, although I don't follow the board much these days, whenever I do look at it I find that it has been hegemonised by those seeking capital gains, tailoring the approach to their own ends and giving the mistaken impression to newcomers that tinkering is part of the original idea.
People can do what they want with their own money, of course, but as far as my strategy is concerned they can't, because if they do then they aren't following it. And if they aren't following it, it's something else and not an HYP. I'm not saying such variations have no merit -- great if they work for you, but once you have endorsed a major variation like making gains part of your aim and taking steps to achieve it by trading, then it has ceased to be an HYP as I define it.
Some may ask what entitles me to define it and lay down the rules? Simple, I invented HYPs so I define what they are. You don't like it, that's okay, but then give your version another title so as not to confuse people. And by the way, I don't claim to have invented the basic concept of HY share investing -- it is a very old strategy, much older than even I am, and that's saying something. What I claim to have devised is the structured version I call HYP aimed at the hands-off investor with its particular rules, of which the most fundamental and unwavering is diversification.
I said last week that probably the oldest HYP argument on the Fool is whether capital matters -- well, that and tinkering. Having made myself clear on the former, in this article I'm going to make myself clear on the latter and then I'll shut up about HYPs for some time.
Whether capital matters and today's subject of tinkering are closely related, because an investor who targets capital gains as an essential element of the HY approach has only one way to try and influence this. That is by tinkering, which means voluntary trading in HYP speak.
So why should I be against tinkering for most HYPers? It may be easier to understand this if I put aside temporarily my position that capital doesn't matter in order to play devil's advocate for this purpose. Then, even if I feign the view that capital does matter, I have found that capital will do better for most investors long term by doing nothing than by attempting to increase it by tinkering.
I have termed this idea "market trading". What I mean by this is that the market will, on balance and over time, trade at much better terms for you via corporate action like bids, spin-offs, reorganisations and so on, than you can do for yourself.
The great majority of small investors famously make poor trading decisions. I have confirmed this by seeing the efforts of a lot of small investors over the years, plus brokers and others in the business have confirmed it. The most common fault of those who consider themselves long-term investors, but who are nevertheless willing to trade on occasion, is over trading and selling too soon.
And this applies to HYPers in particular as well as to other long-term investors in general. There is no reason to suppose that the typical HYPer is any more savvy about trading than other small investors.
The trouble is that HYPing, and small investing generally, is flooded with people who think they have the skill to trade, against the weight of evidence that they almost certainly don't. It's largely a macho thing, confined very largely to the male ego because successful trading is one modern substitute for more ancient ways of trying to prove you are a real man. Most women don't feel they have to prove anything and make far better long-term investors, being willing to leave well alone.
What makes investors sell too soon? A modest capital gain and in the other direction, panicking over a capital loss possibly induced by some business problem which appears major at that point but turns out to be ephemeral with hindsight.
By taking that modest gain, you are more likely than not to be giving up a far larger gain that may occur over time. And by taking that loss, you are missing out on the recovery that may occur over time. Not in every case, I know that we can all give examples where selling turned out to be the correct move. But this a question of the optimum overall strategy, of where the most advantage lies, in cognisance of the fact that too many small investors don't know when a sale is the right move or not, they just think they do. I'm saying that the optimum position is that doing nothing will be a lot more profitable on balance in time than doing something.
It's worth looking at the reasons for this, at why I believe market trading beats tinkering. It's because the market, though not wholly efficient, is not wholly inefficient, either. Especially when it comes to the big caps that are used for HYP construction, because those shares are closely watched and have a lot of vested interests.
Thus for example, over the years, it is fairly likely that a number of shares in an HYP may be taken over. HYP1 had several bids in its early days. This will in nearly every case realise a much larger gain than the investor could have done by trading it earlier, even taking the holding time into account. But note that you never know which ones may be taken out and it can be those where you least expect it.
My point is that generally, inefficient big-cap companies will be dealt with one way or another in the long run to the HYPer's benefit. Not every one but that is the trend. Other methods include spinning off new shares or reorganisations involving replacing the management and so on. And it's not only inefficient companies that are taken out by bids. Many others are too just because the bidder wants the business. A lot of such bids involve the bidder overpaying and don't work out, but who cares? If you score a fat gain on an HYP share this way then market trading has worked for you.
And in the light of all this I have often referred to HYPs as being for eternity as a minimum. Do nothing, forever. Except to deal with mandatory changes when they occur. Nothing that has occurred over the years, not even the major slump in share prices and dividends that occurred in the last few years when the credit crunch hit has changed my mind. If anything, it has reinforced my view that tinkering does not pay and that too many HYPers will get it wrong if they attempt it.
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