I recently spent a rather fruitless day searching for a CD storage rack. You remember those, right? People used to stack their extensive CD collections into tall storage racks, which served the dual purpose of impressing their friends with the size of the CD collection and ensuring ease of access to any particular CD. I say “fruitless day” because, as a shop assistant was kind enough to tell me, “you are searching for gold, sir.”
Perhaps I ought to point out that I am not the intended end customer (my dad is) and that this particular end customer set very specific requirements for his new CD rack (it must be large, but not too large and it absolutely must be black). Consequently, after a day of trudging through various stores, pawnbrokers and trawling the Internet, I have come to the conclusion that this particular customer will have to remain unsatisfied. However, I am sure that he will be overjoyed to hear that the experience reminded me of some useful investment principles and therefore forget all about the fact that he still does not have his CD rack (there is always hope).
Of course, I could have told him before setting off on this expedition that the chances of success were not great. Most of us are well aware that the sales of physical recorded music have been in decline for years and that, prior to the onset of the global coronavirus pandemic, live music events were seen as the lucrative growth area in the music business. Ironically enough, while the pandemic put paid to any activities involving a crowd, the use of music streaming services accelerated. While the trend had started earlier, 2020 turned out to be the year that streaming went mainstream (excuse the pun). Rapid growth in music streaming has resulted in revenues from recorded music hitting twenty-year highs, more than compensating for losses in revenue from live events. At the same time, sales of physical recordings continue to decline and, close to home, Musica stores will soon be a thing of the past. Logically, when people no longer own physical recordings, they have no need to store them (neatly or otherwise). Hence, no CD racks for sale.
This put me in mind of a recent comment made by a chief executive in a presentation: “There are no sacred cows in this business”. Broadly speaking, this means that one should not get too attached to a specific asset in a business. Trends change or better opportunities come along.
Get rid of the unproductive cows
Just as changing trends affect businesses, they also affect your investment portfolio. In the busy-ness of managing our investments, we sometimes forget to take the time to consider the bigger picture. Regularly (once or twice a year, perhaps), take a step back and review the composition of your portfolio. Recall the reasons that investments are in your portfolio and decide if they are still valid.
Frequently, I find small, meaningless positions creeping into my investment portfolio. Sometimes because I wanted a toehold with plans to invest more, but never got round to it, or sometimes because the performance of a position lagged the rest of the portfolio (I am not going to admit to losing money in writing, so “lagged” it is). Nevertheless, I find that such positions are rarely worthwhile. Because of their size, I am not paying them the attention that I should, so that even if they turn out to be gold nuggets, I would never know. More likely, if I am not paying them that much attention they might not be worth holding in the first place. I find it a useful exercise to remove any investment from my portfolio that I am not willing to increase to a meaningful weight. It concentrates my attention on investing only in what I consider the best opportunities. It also helps to identify potential trends – if a position is small because its performance is lagging the rest of the portfolio, it is time to consider if the trend is accelerating or due for a reversal.
However, there is a second important element to this comment to consider: “There are no sacred cows in this business.” For certain businesses, there are assets that are far too important to ever consider selling. The secret Coca-Cola formula or the algorithm behind the Google search engine springs to mind. These assets represent the core, the workhorses, of the business. Without them, the business does not exist.
Know your workhorses
It is important that you identify your investment workhorses. These are the investments that create the value in your portfolio over the long-term. Over time, various terms have been used to describe these; “Blue chips”, “Quality” and “Compounders” come to mind. These are the investments that form the core of your portfolio and provide reliable income and growth which support the achievement of your long-term investment goals.
Here it is important to remember that all investments underperform from time to time. Workhorses are those investments that you keep through various cycles, allocate a significant portion of capital to, spend the most of your research time on and never sell to take a chance on a new fad that is bound to be the “next big thing.” Knowing which investments are your workhorses is essential to avoid panic selling and preserving wealth for the long-term.
Talking about horses, you will be familiar with the well-worn story about how the invention of the automobile destroyed the buggy whip manufacturers. However, perhaps it is time we start mentioning the wheel and shock manufacturers that merrily continued along. Even as the mode of transport changed, the central need of human beings to get from one place to another did not. Some businesses remained relevant throughout this transformation. Today, the global pandemic has raised a great deal of uncertainty about what the future “normal” will be. It is in times like these we want to find the businesses that serve the central human need, rather than a specific manifestation of it.
Identify a few chameleons
Let me start off by making it clear that investment chameleons are not the same as “consumer staples”. Investments in food production companies, for example, are far more likely to be workhorses than chameleons. Finding chameleons can be difficult as the key is to find a growing human need that will be served by this company even if the way in which the need is satisfied changes. Fortunately, the current global pandemic has provided an opportunity to identify just how adaptable your investment animal is.
It is now quite clear, for example, that investments in logistics properties are good chameleon investments, as they support the supply chains of both physical and online retail. Not only that, disruption to global supply chains increased demand for space by smaller, local manufacturers. Consequently, companies that specialise in logistic properties have sustained dividends and operated fairly normally throughout 2020.
Businesses that adapted well to the turmoil of 2020 provided not only stability to an investment portfolio, but also unexpected pockets of growth. Chameleons are the businesses that add innovation to your investment portfolio and their adaptability during a crisis are the underpinnings of a truly successful investment portfolio.
Here it is important to realise that music is also a central human need. We will always want to listen to music, although the medium might change over time. Some canny investors have realised this and set up investment funds which own the underlying writers’ rights. As these funds can earn revenue, irrespective of how or where we listen to music, the increase in streaming activity meant that their revenue, cash flow and dividends actually increased during the pandemic.
Although the time of CDs and CD rack manufacturers may be over, these music investment funds may well be the chameleon investments of the future. After all, if the lack of a CD rack changes my dad’s listening habits (maybe he decides it is time to go digital or, more likely, go back to vinyl), he will still be listening to music that earns royalties for these investment funds…