Know the Why.

When it comes to investing, “the only constant is change”.

When I was studying for my CFA exams (2007, 2008, & 2009), I used some videos from Kaplan’s Schweser. Some of their instructors would recommend using memorization in some of the subjects covered (specifically in Quant, Swaps, & some FSA). I found this to be a huge waste of time. When memorizing something, you’ll “know” that one thing – the end result, and while it might help you pass an exam, that’s about as useful as it gets.

Alternatively, if you analyze & understand what drives any given conclusion, why things are the way they are, and how they make sense etc. then even if one (or more) of the variables in the equation change, you’re not thrown off because you actually understand the concept.

When I was studying in Yeshiva, I mostly studied the Talmud (or Gemara). The Talmud is not like the Jewish Code of Law, where you learn about the actual laws and customs for each day etc. The Talmud is the epitome of analysis.

From Wikipedia:
“Much of the Gemara consists of legal analysis. The starting point for the analysis is usually a legal statement found in a Mishnah. The statement is then analyzed and compared with other statements used in different approaches to Biblical exegesis in rabbinic Judaism (or – simpler – interpretation of text in Torah study) exchanges between two (frequently anonymous and sometimes metaphorical) disputants, termed the makshan (questioner) and tartzan (answerer). Another important function of Gemara is to identify the correct Biblical basis for a given law presented in the Mishnah and the logical process connecting one with the other: this activity was known as talmud long before the existence of the “Talmud” as a text.”

Either way, this helped formulate my passion for analysis and my drive to always understand “the Why”. Memorizing or just listening to what supposed to be done isn’t enough. Something will change – it always does, and if you only know what to do in that exact scenario, you are left without the ability to adapt to any changes.

When I create an IPS (Investment Policy Statement) for a client, it is based on current conditions. One of the most crucial parts of any IPS, is updating it as the client’s risks and/or objectives change, whether it is because of volatility in the markets or because of changes in their own individual circumstances.

The same is true when I build a portfolio allocation for a client, it is essential to know why we are holding what we’re holding, so that when the circumstances change, we can easily adjust the portfolio to reflect those new factors.

This is equally important when it comes to selecting and investing in individual equities. Numbers change. Fundamental change.

A perfect example is $YHOO. Most $YHOO longs over the last couple of years are/were long for the Alibaba Group exposure. Check out the correlation between $YHOO and $SFTBY over the last three years:

$YHOO $SFTBY 3yr chart

Since September of 2012 when $YHOO sold half of their Alibaba stake at a ~$40B valuation, the reported / speculated Alibaba valuation has skyrocketed, so have these two “tracking stocks”.

The key is, once Alibaba does go public, in which $YHOO will be forced to sell 40% of their remaining stake, who is going to purchase $YHOO? People that want Alibaba exposure can buy it directly. (See $GSVC after both $FB and $TWTR IPOs)

Know why things are happening, know why you own what you own, so that when things change, you can adapt accordingly.

- Aron

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2 Responses to Know the Why.

  1. Pingback: Thursday links: embedded bias | Abnormal Returns

  2. Pingback: What We're Reading ~ Analytical Links 3/26/14 — Trading Your Own Way

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