What a year! Despite being stuck at home for most of 2020, it has been a very eventful year.

The portfolio delivered a net return of 15.6%[1] in 2020 while FTSE Global All Cap index’s return is 16.8% during the same period. Our portfolio’s cumulative return since 2016 is 100% while the above-mentioned index’s cumulative return is 81.9%. Cash is 32% of the portfolio.

I prefer to show the investment return net of imaginary fees because any aspiring investment manager should be able to generate excess return net of fees.

[1] Assuming a fee structure of 1) no management fee, and 2) a 20% performance fee above 5% threshold i.e. 18.3% – (18.3%-5%)*(20%) = 15.6%

Live Portfolio’s 2020 Investment Return

Live Portfolio Investment Positions as of 31 Dec 2020

The 5-year milestone

During Warren Buffett’s early years operating his investment partnerships, he encouraged his partners to evaluate his investment performance on a 5-year basis and “preferably with tests of relative results in both strong and weak markets”. And so at this 5-year mark, it is time to take stock and reflect.

I am very pleased to generate an annualised return 15.6% over the last five years which has a respectable 2.2% advantage relative to our performance yardstick, FTSE Global All Cap Index, with an annualised return of 12.7%.

Our high cash level, fluctuating around 20-40%, has been a significant drag on investment performance for the last 5 years. Due to a combination of high market valuation and the relatively limited scope of my circle of competence, I have not being able to find enough attractively priced new ideas. While there is nothing I can do about the high market valuation, I am steadily expanding my circle of competence which should ultimately translate into more investment ideas and lower cash level.

This investment return is generated against the backdrop of a generally rising stock market over the last five years. The portfolio did experience a violent but short bear market in March 2020 where we fared better against the general market’s 30% decline with 15+% decline. By and large, I do not believe that I have experienced a full market cycle of bull and bear market to pass Warren Buffett’s test of “relative results in both strong and weak markets”.

Our investment journey has, so far, been very pleasant as we have not suffered a loss in any year so far. But I would like to make a prediction – this investment operation is almost guaranteed to suffer a loss in at least one of out the next 10 years but I just don’t know when the losses would occur. As Charlies Munger said:

“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get.”

While I would rather avoid any losses, especially the 50% decline ones, it is better to be mentally prepared for it. Unfortunately, I am confident that my prediction would come true. Better to accept it as a fact of life.

While we are on the topic of making predictions, I believe you are entitled to know my expectations for future investment return even if it is largely based on my simple estimates. You should note that my expectations are in fact more like aspirational goals and risk of disappointment is quite high.

Over the last 100 years, the annual return for US equities averages around ~7.5% while the Chinese equity market generated ~9% average annualised return for the last 20 years. So in the long run, we should expect equity returns to be in the range of 6-9%. For our chosen benchmark of FTSE Global All Cap, it generated 7.5% annualised return since its inception in 2002 which falls exactly in the range of 6-9%. Since the goal of this investment operation is to generate above average return, it is reasonable to expect 6-9% return as the lower end of our future return expectation.

While beating 6-9% might not seem like a very ambitious goal, vast majority (90+%) of fund managers are not able to beat the market consistently after accounting for management fees. This is true globally including US and China. Said in another way, only truly exceptional investors can generate better than average return in the long run. If you do not find an exceptional investor, you are better off with index investing.

But there are a few exceptional investors who has been able to outperform the market very consistently for a very long period of time. So it would be illuminating to evaluate their investment track record and use their track record to form the upper limit of our future investment returns.

Below are my best estimates of some of the world’s greatest investors returns based on publicly available information and I tried to use after-fees net return as much as possible.

World-class investors’ track record

These world-class investors generate long-term annualised return in the range of 15-30% and averaging around 20%. These are truly impressive performance as every one percentage point of outperformance when compounded over long period of time can lead to massive difference in cumulative return. For example, the difference in cumulative return between 10% and 9% annualised return over 10 years is 22.6%. Only world-class investors can sustain the advantage of 10-20 points above the long run equity returns of 6-9% for a long period of time.

In general, I believe it is fair to conclude that any investor who can compound at a rate of 20% net of fee for more than 10 years should be considered a highly competent one. Said in another way, any investor’s achievement of 80% return in any single year is clearly not representative of that investor’s long term performance. While 20% return may not sound like a lot, the power of compounding guarantees a very wonderful result over the long term. Just look at Warren Buffett, 99% of his wealth came only after his 50th birthday!

While I have every ambition to become the best investor that I can be, it is hubris to compare myself against the greatest of investors of all time. So I would consider myself doing a great job if I can achieve 15% annualised return net of all fees for the next 10 years. This is going to be no mean feat considering the current valuation is at alarmingly high levels.