Broyhill Letter Highlights III: Time Arbitrage

This is the third piece in our Broyhill Letter Highlight series, highlighting our thoughts on time arbitrage over the years.  You can access other posts in the series here.

For those who would like to revisit our letters in full, we will also be gradually sharing them to our Research Studio throughout the series.

III: Time Arbitrage

Increased competition for returns has resulted in shorter time horizons. It’s human nature. Returns are greatest for those willing to take the risk before the light at the end of the tunnel. Things often get worse before they get better, and the best returns typically come when things appear darkest, just before the light begins to shine.

Patience is a virtue. It’s also the greatest advantage we have in a world where price is set by investors focused on the next tick. This world is highly competitive. This world forces our peers to overlook long-term opportunities for fear of short-term underperformance. We can’t win in this world. Winning here requires dozens or perhaps hundreds of correct decisions in a given year. Very few can do this consistently. It’s a hard game to win. So we don’t play it.

To win in the long term, we must do something different. We see little to gain in staring at our screens all day. Rather, our odds are greatly improved by making fewer decisions over a longer time horizon where competition has dwindled. For those willing to stomach some short-term volatility, the long-term rewards are as great as they’ve ever been. By playing in a different arena than the crowd, we can expect to beat them.

In difficult times, investors abandon the “outside view” for an “inside view.” Said differently, panic shortens time horizons and shines a spotlight on immediate risks rather than longer-term probabilities. It is during these temporary bouts of doubt and drama that we look to get involved.

It is impossible to know with certainty when to sit on your hands and when to harvest ideas. Decisions must be made with less than perfect information. Ideas must be given adequate time to develop and mature. Rush the process and put capital to work too quickly, and you forgo the option to buy later at lower prices. The other extreme is to wait for prices so low that bargains are available everywhere. But wait too long, and you risk missing out on some decent crops along the way. You also risk not having any investors left at the end of the season. Since predicting stock market cycles is as reliable as predicting the weather, prudent investors will harvest what they can when the weather is good, leaving enough dry powder in the portfolio to survive another season.

While cycles of underperformance are difficult to endure, they are a necessary evil. If value outperformed all the time, everyone would buy value stocks until they were no longer a value. It is precisely these periodic bouts of underperformance which create the value in value stocks and the foundation for long term outperformance.