Broyhill Letter Highlights V: Aggressive vs Defensive Investing

This is the fifth piece in our Broyhill Letter Highlight series, highlighting our thoughts on aggressive vs defensive investing 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.

V: Aggressive vs Defensive Investing

Bull markets are often confused with genius. A dart-throwing chimp will occasionally hit a bullseye, but as much as he might like to think so, that doesn’t make him the next Warren Buffet of dart-throwing (whoever that is).

In a bull market, aggressive risk-taking can easily be confused with intelligence. The challenge for investors will be holding onto those gains when the tide goes out.

Big gains are certainly far more exciting than avoiding losses, but we’ve never been particularly fond of excitement. Occasionally spectacular, yet volatile, returns can bring fame and fortune for heavy-hitting investment managers, but their clients rarely come along for the ride.

We are trying to make as much money as possible without sticking our necks out too far. It's too easy to be lulled into complacency when asset prices are marching higher. We must resist this temptation in order to survive the next cycle with our composure, capital, and confidence unharmed.

Good investing isn't necessarily about earning the highest returns. It's about earning pretty good returns that you can stick with for a long period of time. That's when compounding runs wild. This simple statement is perhaps the most overlooked and underappreciated fact in all of finance.

“Pretty good returns” are just not exciting. And investors crave excitement, even if they won’t admit it. They place more weight on unlikely outcomes than they should. Just as gamblers are willing to throw away money on lottery tickets for a small chance to win, investors are seduced by the excitement offered by speculative, high-risk stocks. Most investment managers are happy to oblige and provide their clients exactly with what they want. Simply put, a more volatile portfolio increases the expected value of a manager’s compensation.

All this excitement comes at a cost. Even the most spectacular gains can be wiped out by a single, large loss, destroying years of investment success and eliminating the benefits gained by compounding.

Evolution has hardwired investors to buy sexy and sell humdrum. Possibility generates enthusiasm, eagerness, and anticipation, which investors pay up for. As a result, many of our peers find it hard to resist the temptations of hugging the benchmark, following the herd, or going for a little excitement, even if it’s “just for a second, just to see how it feels.”

Near-certain outcomes are regularly undervalued by investors. Certainty engenders boredom and requires endurance and persistence.

People often confuse maximizing returns with minimizing boredom. Investing doesn’t work that way. Opportunity hides where others don’t look. People stay away from boredom, for fear of being bored. But at the right price, boredom is as exciting as it gets.

Big losses can shake investor confidence even more than their bank accounts. Decision-making under such stress is far from optimal. As a result, aggressive investors that may have enjoyed the fruits of a bull market, often see those fruits spoil. A more disciplined approach, which allows gains to accrue more slowly, often ends up with a much larger basket of fruit to enjoy.