Tips from Nicholas Sleep: Why good investing is a minority sport, and over-diversification is a bad idea
Sleep’s name may not find place among the investing legends that the market keep talking about all the time. But he has a superb investment track record and is regarded as one of most successful man in investing.
Sleep managed the Nomad Investment Partnership for over a decade, along with his partner Qais Zakaria, delivering 921% returns against 117% for the MSCI World Index between September 2001 and December 2013.
Yet, he always kept a low profile. He started gaining recognition recently following the publication of the Nomad Investment Partnership letters, which have earned a lot of appreciation in the investment circle.
Like many of the world’s greatest investors, Nick Sleep had an unorthodox start to his investing career. He didn’t take up business or finance, but studied geography to which he credits his love for asking questions.
In 2001, after a decade in the industry, Sleep and his partner Qais Zakaria launched the Nomad Investment Partnership. After beating the index for 13 years [20.8% per annum vs 6.5% index return per annum], Nomad was closed in 2014 as Sleep sought more ‘caring pursuits’.
His insights and knowledge on how to achieve success in investing is second to none. His pearls of wisdom have helped investors intimately understand the thoughts and mental models of many great investors.
Many investing veterans agree Sleep’s letters to the partners held rare insights, and they can go a long way in helping people achieve long-term investment success.
Here are a few selected gems:-
- Weigh your information properly
Sleep says before investing in a company, investors tend to focus only on what can be measured, which is mostly aided by analysts and to some extent by their own laziness.
But one can actually get a wealth of information about a company by focusing on its advertising, marketing and research & development, product integrity, product life cycle, market share and the character of the management.
“Information, like food, has a sell-by date. After all, next quarter’s earnings are worthless after next quarter. And it is for this reason that the information that Zak and I weigh most heavily in thinking about a firm is the ones which have the longest shelf life,” he says in one of the Nomad Investment Partnership letters.
- Be patient and think long-term
Sleep says the trick to being a good investor in the long run is to maintain a long term-oriented discipline. He says patience plays a key role in maintaining that discipline as sometimes emotions can get the better of people.
Sleep says in order to earn returns better than other investors, it is essential for one to do things differently from the crowd. “We can all do momentum investing, but it is emotional investing and I just don’t think it is that intelligent or profitable. Good investing is a minority sport, which means in order to earn returns better than everyone else, one needs to be doing things differently from the crowd. And one of the things that the crowd is not is patient,” he says.
- Creating right investment environment
Sleep says in order to make the right decision, it is important for investors to think rationally for which the right kind of environment is essential.
“We have the right environment to think things through, think rationally, and come to meaningful long-term insights. Whether our insights are economic or not will be our fault; it will not be due to the environment in which we work,” he says.
Sleep feels it is sometimes important to just hold on and do nothing when the environment is not conducive for investing. Also, he feels investors can compare an attractive investment opportunity with their already existing portfolio to decide whether they should invest or just stay put.
“Many great businesses are available at what seem sensible prices, but in our view, they do not compare favourably with what we already own, and so we move on constantly comparing what we have with the alternatives, but often, as far as the portfolio is concerned, doing nothing,” he said.
Sleep says investors should focus on the value of the underlying business, which they can derive from their thorough research rather than basing their decisions on the company’s last share price quote.
“We own shares for multi-year periods. So our continued investment success has far more to do with the economics of the underlying businesses than with their last share price quote. The trick, it seems to us, is, to be a successful long-term investor, one needs to recognise the sources of enduring business success, get in early and own enough to make a difference,” he says.
Sleep says in order to spot these great businesses, one can look for firms that have a process of doing many things a little better than their rivals. As these firms’ future success is more predictable, they are simply harder to beat.
“The simple deep reality for many of our firms is the virtuous spiral established when companies keep their costs down, margins low and, in doing so, share their growing scale with their customers. In the long run, this will be more important in determining the destination for our firms than the distractions of the day,” says he.
Sleep says most analysts and experts suggest investors to diversify their portfolios with many stocks, as it can give them an insurance against the market volatility.
But it is better to have a well-researched portfolio of only a few stocks and have good knowledge about them rather than having a diversified portfolio of many stocks bought after conducting limited research.
“The church of diversification, in whose pews the professional fund management industry sits, proposes many holdings. They do this not because managers have so many insights, but so few! Diversity, in this context, is seen as insurance against any one idea being wrong. Like Darwin, we find ourselves disagreeing with the theocracy. We would propose that if knowledge is a source of value added, and few things can be known for sure, then it logically follows that owning more stocks does not lower risk, but raises it,” he says.
- Have an ‘edge’ over others
Sleep says there are three sources of competitive advantages in investing, which can help one achieve success and get ahead of her peers.
“There are three competitive advantages in investing: informational (I know a meaningful fact nobody else does); analytical (I have cut up the public information to arrive at a superior conclusion); and psychological (that is to say, behavioural)… but the enduring advantages are mainly psychological,” he says.
Sleep says if investors follow a good investment process, then they are sure to get success in the long run, although its effect may not be visible immediately.
“Good investment process is not apparent in one quarter’s worth of transient stock price quotations, or one year for that matter!” says he.
- Keep learning from mistakes
Sleep says investors should consider the mistakes they make as learning opportunities. He says investors often make the mistake of keeping a static view of a firm formed at the time of purchasing a stock, which fails to evolve as the facts change.
This error gets reinforced by misjudgments such as denial (the facts changed) and ego (we can’t be wrong). There is also an over-dependence on price-to-value ratio type analysis, which can encourage a tighter range of outcomes than what occurs in reality.
“There is a philosophical argument that a mistake is only a mistake if you call it so. Otherwise, it is a learning opportunity. That seems like the right spirit to us. In investment terms, once lessons have been learnt, mistakes can be put on the price-earnings ratio of one and the resultant good behaviour on a ratio of more than one. In other words, mistakes become net present value positive,” he says.
Sleep urges investors to try and ignore the noise and market chatter going on around them and trust their own research before picking stocks.
“The investment industry, as well as many economic commentators, spend so much time shouting. So much commentary espouses certainty on a multitude of issues, and so little of what is said is, at least in our opinion, knowable. The absolute certainty in the voice of the proponent so often seeks to mask the weakness of the argument. If I spot this, I metaphorically tune out. In our opinion, just a few big things in life are knowable,” he said.
- Path to ‘Worldy Wisdom’
Sleep believes the real thrills of the investment process is discovery and learning, which can lead investors to achieve ‘Worldy Wisdom’.
“Worldly wisdom is a good phrase for the intellectual capital with which investment decisions are made and, at the end of the day, it is the source of any superior investment results that we may enjoy,” he said.
Sleep never relied on complex models, non-public information or business relationships to deliver his returns. Instead, he used his learnings from other disciplines, which he applied to his thinking.
He always liked to ask questions, think patiently, turning ideas upside down and challenge conventional wisdom which helped him gain insights that other investors couldn’t see. He stuck to his core competency, liked to keep things simple, and recognised the basic nature of the businesses he owned, which gave him the patience to remain invested in multibaggers.
(Disclaimer: This article is based on Nicholas Sleep’s Nomad Investment Partnership letters.)
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