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The Investment Ideology

Some time ago, I was talking about the principles that drive the creation of the successful investment company. I designated three key elements: investment idea, investment strategy and investment tactics. Now I will go into details of each of these elements in order to provide the complete picture of the investment ideology.

The core element I was talking about is the investment idea. As I designated, the investment idea must be firm, must never be changed and instead the investment strategy must be changed to accommodate to the current environment. This may cause confusion, because you might be taught that the investment strategy must be firm and you must change your investment tactics and adapt operating models. And there were no words about the investment idea itself.

This is the pure misconception of the investment ideology. The term “ideology” itself means that you have to have the idea in the center. If you have only investment strategy and apply the relevant tactics and operating models, then your investment company is coreless and shaky. You will understand why it is so by following my discussion further.

So what is the investment idea itself? In my discussion of the successful investment company I was talking that the idea spins around the questions “how” and “what”. It is not the exact answer to these questions – the investment strategy, tactics and operating models will provide with the exact answers.

The investment idea can be defined as a set of guiding principles which represent your perception of the investment business. The best way to explain it is by the example. For example, the idea of value investments can be expressed using such guiding principles:

1. Preserve the margin of safety by investing in undervalued businesses or buying at a discount;
2. Invest only in businesses which has firm true value and strong intrinsic value (earning power);
3. Invest only in businesses with business models which you comprehend;
4. Do not invest in red-hot and young companies which ignore the general company development path (by the way, this rule was roughly ignored during the Internet-bubble);
5. Do not build up too much debt and do not invest in highly leveraged companies;
6. Do not invest in financial institutions, unless you need it to serve your portfolio businesses or manage your capital and cash flows.

No wonder if these principles look familiar to you. They are as simple as they must be. And these are the principles that must guide the value investment company through and through. They must be never changed, neglected or ignored. Instead the investment strategy, the second element of the investment ideology, must be adapted if necessary.

Once you have defined your investment idea, you are ready to elaborate the investment strategy which will allow you to implement your investment idea. The investment strategy is a sort of the roadmap which defines where to go, where not to go, how far and deep to go and what to do in order to get to the place where you want to be and preserve your positions there.

Basically, any business must have three strategies in the armory: assault strategy, defense strategy and retreat strategy. Do not worry about the military terminology – I use it in order to put things straight and simple. The purpose of each strategy is obvious. The assault strategy must define how you will penetrate to the market, gain the market share and attack your opponents (competitors) in order to defeat them and gain more market share.

The defense strategy must define how you will protect your market share, your name (brand) and products from assaults of your opponents. The retreat strategy must define how you will exit the market and dismiss part of your business, should it be necessary to protect the company from falling apart and from the complete capitulation (bankruptcy). All three strategies must be coherent and adapted to the existing business and political environment.

The three strategies are applicable to the investment company. The assault strategy must define the investment portfolio structure, the investment vehicle and general investment rules which shape up the investment idea with numbers. The latter is the key performance and risk indicators which must form the coherent control system shaped up as the risk-rewards profile. The assault strategy also must define the standard deal flow.

The defense strategy of the investment company must define how the company will protect the value of its portfolio and portfolio’s positions. In the financial world it is known as the risk management. Thus the efficient risk management strategy must be elaborated. The retreat strategy of the investment company must define how the company will spin off in the case of high market turbulence and fall-out, like the current one.

Thus the defense strategy must establish practices in order to protect the company from the market turbulence and fall-out. In the financial world it is known as the liquidity and capital management. So the realms of the defense and retreat strategies are the risk management and the liquidity and capital management. The efficient analytical environment must be created in the investment company not only to identify systemic shock events in order to leverage them, but to prepare for them as well.

Finally, investment tactics and operating models define how daily operations are executed, what tactical approach it is better to use in order to leverage a foreseeable opportunity, how it is better to handle an issue or a force-majeure situation to prevent losses and reputation damage, etc. The investment tactics support the daily decision making process. They are driven by a situation or an issue. But the investment tactics and operating models are always bounded by the three investment strategies.

When the investment strategy must be revised? Mainly, the strategy must be revised when the environment changes, e.g. under the pressure of regulators or by the appearance of new strategic opponent. Also the strategy must be revised if it is proved to be inconsistent with the current market conditions, strategic maneuvers and assaults of the opponents, or if it is proved to be erroneous because of strategic miscalculations occurred as the result of unchecked or falsified data. How to determine that the strategy is erroneous? You will either incur losses or stall in development.

Any investment company must have the investment ideology, must develop its investment philosophy, its investment idea. I stress again that the idea of making money for the sake of money does not support the economy and society development – it demoralizes and corrupts the economy and society. It also does not allow building the coherent and valuable investment portfolio. It only drives bubbles and makes the system to go to pieces, when it gets red-hot. But there have always been corrections – system failures that bust the bubbles and force someone to pay for others’ blindness, ignorance, greediness and lack of the common sense.