Principles

Power laws define our life. Yet most people are struggling to understand how non-linear relationships amplify results.
 
We founded Blackwall Capital with a view toward investing for the very long term – at least over a full market cycle.
 
The table below illustrates the point that seemingly modest differences in an investment’s annual rate of return can generate profound differences in the ultimate gain over long periods of time.

Focused
Independence
Patience
Culture “HAILGIP”
Do good
Embracing the miracle of compounding
Risk versus return
Few bets, infrequent bets, big bets
Use a latticework of mental models
Markets are wrong
Pay attention to incentives
Getting the investment process right
Know when to sell
Be conscious of leverage
Be the last man standing

Focused

It is easy to get distracted. Staying focused is essential to improve over time.

 

Our focus is on equity investments. We adhere to the principles of value investing while strongly emphasizing risk aversion. It is paramount to understand the companies we invest in and to stay within our circle of competence. However, at times of accelerating disruptive technologies and business models, we like to learn continuously and expand our boundaries step by step.  

Independence

Being truly independent is paramount and runs deep in our DNA.

 

As a company, Blackwall is controlled by its operating partners. We value our external partners but none of them has any influence on our investment decisions.

 

We are continually searching for new investment opportunities that meet our criteria. In this process we focus on our own research and our own processes. We listen very selectively to other investors and analysts for whom we have good reasons to respect. Our geographic set-up was chosen to allow for easy access to companies where needed and to avoid the herding mentality found in big financial centers.

We pay particular attention to psychological biases that may impact us. While we are not immune to them, we strive to constantly improve and implement processes that guide us away from heuristic shortcuts.

Patience

While short term market swings impact individual share prices, it is the real fundamentals that control the long-term valuation of a company. Therefore, on a single company level our preferred investment horizon is 3-5 years (ideally even much longer) to harness the profound effects of compounding.

 

As Warren Buffet says,

“The trick is, when there’s nothing to do, do nothing.”

 

Infinite patience to act, doesn’t mean to not prepare ourselves. It provides the time to learn, to search for new ideas, and to prepare for the right moment to act – when we see something that makes sense – fast and with conviction.

Culture “HAILGIP”

Our corporate culture can be summarized under the acronym “HAILGIP”. It stands for:  

 

Honesty  

Authenticity  

Integrity  

Love  

Giving  

Intelligence  

Passion

 

These are the guiding principles we use to interact with our investors, partners and colleagues.

 

As Michael Eisner points out in his book Working Together: Why Great Partnerships Succeed,  the best way to find a great partner is to be a great partner. That has been true for us in all areas of our life and it is true of the people we most admire. 

Do good

At Blackwall Capital, one of our primary aims is for the investments to ultimately benefit the planet and our society. ESG considerations are an integral part of our investment approach given our ‘value investing’ philosophy has always encompassed criteria such as business sustainability and good corporate governance. More recently, we reinforced our research approach in this area to now include a wide range of environmental and social aspects.

The Friedman doctrine of shareholder value resonates strongly with us. However, we believe that it does not need to be in contradiction of other targets but be a solid anchor within a broader set of purposes.

Within our overall ESG research efforts, we concentrate on finding companies that have successfully applied ESG criteria to their way of doing business. Our desire is to support the financing of companies that can succeed in business while at the same time doing good for society as a whole. In our opinion, sustainability is essential in securing the long-term viability of businesses and hence also in successful and responsible investing.

Embracing the miracle of compounding

Power laws define our life. Yet most people are struggling to understand how non-linear relationships amplify results.

 

We founded Blackwall Capital with a view toward investing for the very long term – at least over a full market cycle.

 

The table below illustrates the point that seemingly modest differences in an investment’s annual rate of return can generate

profound differences in the ultimate gain over long periods of time.

 

Big losses are the real killer of returns.

 

The key to compounding our investors’ wealth at the highest possible rate is to minimize the probability of a permanent loss of capital. As the table here illustrates, the more you lose the harder it is to just get back to where you started.

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Risk versus return

The general view is: the higher the return, the higher the risk. Investors who expect more return must accept higher risks.

 

We disagree. Howard Marks introduced an interesting variation on this simplified view by adding the notion of a probability distribution of returns. Riskier investments have a higher prospective return, but by no means is it guaranteed. By the same token, getting the analysis

correct means it is possible to buy assets generating the same return at lower levels of risk. The ideal investment is highly skewed towards the upside with a modest downside risk.

 

In our view, the path to successful investing is not to maximize returns but to minimize risk, while capturing above trend line returns. At times, market volatility can be a friendly partner to achieve this goal.

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Few bets, infrequent bets, big bets

The equity market is a pari-mutuel system. This means that great companies are usually  priced higher than weak ones. The real skill is to find the mispriced ones. This is much harder, and the opportunities to place such bets much rarer, than most people think.

 

Fortunately, there are some trends working in our favour:

 

Passive investing and ETFs are becoming the dominant group of investors, moving many stocks in sync. Although the momentum often lasts for a long time, they provide a pool of opportunities.

 

Regulatory changes like Mifid II should result in a consolidation of sell-side research, potentially reducing coverage in the small- and midcap segment.

Disruptive technologies are accelerating, destroying business models and creating new ones at an ever-faster rate.

 

Identifying mispriced assets requires a deep analytical understanding and a sensible approach toward valuation. The latter is more art than science, as there is nothing precise about the future. Incorporating reasonable assumptions, leaving a wide margin of safety and a highly favourable return-to-risk profile, is a good starting point.

 

Companies whose share price can increase 5x to 100x – at low risk – are very rare. When we find them, we want to invest significant amounts.

Use a latticework of mental models

The idea for building a “latticework” of mental models comes from Charlie Munger.  Munger’s system is akin to “cross-training for the mind.” Instead of isolating ourselves in the small, limited areas we may have studied in school, we study a broadly useful set of knowledge about the world, which will serve us in all parts of life.

 

The models must come from multiple disciplines because the world’s wisdom is not found in one narrow academic discipline. Rather, it is the big, basic ideas of all the truly fundamental academic disciplines. The mental-models approach inverts the process to the way it should be: learning the important subjects deeply and then using that powerful database every single day.

Markets are wrong

We do not believe in the Efficient Market Hypothesis.

 

While markets are quite efficient most of the time, they are certainly not all the time. Ben Graham’s analogy of the manic-depressive “Mr. Market” who will be wildly overexcited one day and deeply depressed the next, serves as a great mental model. We need to make the market our servant, not our master – using it to our advantage to buy bargains when pessimism reaches extreme levels and to reduce risk when the crowd is overly exuberant.

Market prices on individual companies are even more biased toward inefficiencies, be it along the investment horizon (eg large caps) or the basic understanding of business models (eg small and mid-caps). Our focus is on doing our own proprietary research which we believe is the key to identifying such inefficiencies and to use them to our advantage.

Pay attention to incentives

Many investment funds are run by managers who don’t have a substantial personal investment in their own funds and who work primarily with other people’s money. This creates an incentive to maximize short-term performance, and can ultimately lead them to taking increased – sometimes even excessive – risk.

 

An important component of the set-up at Blackwall Capital is to ensure that our incentives are properly aligned with the interests of our investors. Every partner in Blackwall is invested in our funds and our incentive structure is designed for growing our holdings over time. 

In addition, we are highly sensitive to company management incentive schemes, as well as the business models of the companies we invest in.  

Getting the investment process right

We are passionate about the process of investing, but we maintain critical distance from our investments. It is very important to be able to walk away from any individual investment and not to fall in love with it. Mark Twain makes the point:

 

“What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so.”

 

The process of investing includes searching for stocks, measuring their value, buying at the right price, monitoring and eventually selling. Critically, it also means reviewing mistakes. Buying and selling, the steps most people focus on, take but a moment. Searching and monitoring are the most time intensive – and are never-ending processes.

Know when to sell

There are only three times to sell a stock.

 

The first is when we realize we made a mistake and a company did not meet the criteria, i.e. our assessment of fundamentals has changed.

 

The second is when a company ceased to meet the criteria – for example, when the share price achieved our fair value, or a less able management assumed control.

 

And third, when we come across a fantastic opportunity and the only way we could buy it is to sell something else first.

Be conscious of leverage

The fastest and most effective way to lose money is to take risks with capital that we do not already own.

 

Buffett’s comment about the implosion of Long Term Capital Management brings it to the point:

 

“Whenever a really bright person who has a lot of money goes broke, it’s because of leverage... It’s almost impossible to go broke without borrowed money being in the equation.”

Our base funds don’t use any leverage. In addition, we are sensitive to the leverage applied in our company investments. Even companies with the most desirable business models can suffer tremendously when leverage increases to unsustainable levels and earnings leave little margin of error. The collapse in Dignity, the listed funeral company in Europe, is a great reminder for that.

Be the last man standing

Jack Ma once said:

 

“Today is brutal, tomorrow is more brutal, but the day after tomorrow is beautiful. However, the majority of people will die tomorrow night.”

 

Whether it is building a company or investing money, these are highly competitive businesses. Some are going for the short-term glory at excessive risks.

 

We rather prefer a conservative long-term approach, aiming for consistency and using a high margin of safety. This should not only allow us to do well when others are struggling, but also gain strength throughout such periods. 

Big losses are the real killer of returns.
 
The key to compounding our investors’ wealth at the highest possible rate is to minimize the probability of a permanent loss of capital. As the table here illustrates, the more you lose the harder it is to just get back to where you started.

The general view is: the higher the return, the higher the risk. Investors who expect more return must accept higher risks.
 
We disagree. Howard Marks introduced an interesting variation on this simplified view by adding the notion of a probability distribution of returns. Riskier investments have a higher prospective return, but by no means is it guaranteed. By the same token, getting the analysis
correct means it is possible to buy assets generating the same return at lower levels of risk. The ideal investment is highly skewed towards the upside with a modest downside risk.

In our view, the path to successful investing is not to maximize returns but to minimize risk, while capturing above trend line returns. At times, market volatility can be a friendly partner to achieve this goal.