When teaching an online class about the fundamentals of investing, the question of luck and specifically beginner’s luck came up. We have all seen the role luck plays, both good and bad, in our lives and our investment outcomes.
“Luck is what happens when preparation meets opportunity”
This is a quote often attributed to the Roman philosopher Seneca and captures some of the ingredients needed for success. Hard work is important and so is experience, either through our own mistakes or by learning vicariously from others. Persistence, grit, a mind open to experimentation and the ability to get comfortable with taking risks are all contributing factors.
For this article, I would like to focus on the role of risk in both life and investing. Beginner’s luck often comes from taking risks that the beginner is blissfully unaware of, and those risks paying off much to the delight of the beginner. More often than not, that luck runs out and the beginner moves on from either the casino, speculating in individual stocks or loading up on real estate in an environment where NINJA (no income, no job and no assets) loans were possible. There are times when that luck does not run out and the beginner has the time to learn and benefit from the initial momentum. Most of us see and hear about success in business, careers and investing because of survivorship bias. The ones that fail, often do so in relative obscurity.
The other kind of risk taking comes from an a priori understanding of the probabilities of the situation or investment, using experience to determine the size of the bet and having the humility to realize that the best laid plans often don’t come to fruition. The focus should remain on the process more than outcomes, as long as there is intellectual honesty in evaluating the outcomes and learning from them.
This month I decided to take a big leap by quitting an executive position at a growing private equity funded company in San Francisco to focus all my time and effort on InsideArbitrage.com. After writing about merger arbitrage and insider transactions every weekend for well over a decade, the site had picked up enough traction for me to take the leap. We launched a premium service on Inside Arbitrage in January 2018 and it was encouraging to see the growth of the premium service as well as the low attrition rate among subscribers. We added new strategies to the site (SPACs, spinoffs, etc.), built depth within our existing strategies by adding new tools and kept the price of the premium service the same during the last four years. I ate my own cooking and own the majority of the stocks featured in our monthly special situations newsletters and our model portfolio.
I am very excited to have the time to do more research, write more often and build out a product roadmap I have had in my mind for quite some time now. You will start seeing this in the form of new features and eventually new strategies on the website in the coming months.
Coming back to the role of risk in investing, there has to be a willingness to take prudent risks as long as you have done the work to understand the opportunity and the downside. During times of turmoil, especially like the ones we saw in 2008-2009 and March 2020, there is a tendency to slip into analysis paralysis and not act on generational opportunities. While current market conditions might not be favorable to equities, potentially for years to come, there are always pockets of opportunities. We featured three merger arbitrage positions last month in a mid-month update and have been nibbling on stocks from a watchlist of over 40 “broken growth” stocks.
For those willing to go out further on the risk spectrum, I am often reminded of a conversation I had with an ex-fund manager over coffee in Palo Alto several years ago. He discussed a strategy of potentially investing in every merger with large spreads. Both academic studies and research from the Inside Arbitrage database of deals has shown that nearly 95% of all announced mergers and acquisitions close. This high risk/high reward strategy taps into that probability and assumes that the potential gains will more than offset losses from the deals that end up failing. Starting positions after the spread has already widened and understanding the premium paid for the acquisitions could help limit the downside. The strategy is too far out the risk spectrum for me personally, especially since deals with increasing spreads are more likely to fail. However, I will have more time now to dive deeper into the nuances of this strategy to see if it is possible to offset some of the risk, while picking up a majority of the reward the strategy offers.
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