What makes a good investment?

People who know what I do for a living occasionally ask ‘what makes a good investment?’ 

They are not looking for sound, basic advice like ‘shares are risky but if you buy a well-diversified portfolio and hold it for the long-term you should do reasonably well.’  They can get that from the weekend newspapers and talking heads on TV. 

What they want are tips about how to do better than others and be really successful, even when others are failing. How can ‘lay’ people build a strong portfolio themselves? Surely intelligent, well informed folk can learn enough to be successful without paying exorbitant fees to professional managers who, let’s face it, seem to make a lot of mistakes anyway?

I usually respond by posing this anecdote:

Will Rogers was an American humourist, newspaper columnist and social commentator who was recognised as witty and a very wise commentator on life generally.  He wrote in answer to the same question:

‘Buy land. They ain’t making any more of the stuff.’

I then ask what people think of that as a simple investment maxim. The answers are generally as follows:

‘It sounds great, it reflects the basic law of supply and demand, and so should be a good investment thesis.’  General murmurs of agreement follow.

But then someone says: ‘hang on – there must be more to it.  They do in fact create more land all the time’.  This is true and examples are:

• re-zoning to allow apartments to be built where only houses or factories were allowed
• reclaiming land around waterfronts and swampy areas to open up residential and commercial developments; gentrifying inner city suburbs is another example of this
• better transport infrastructure which means outlying suburbs are ‘closer’ to the city and other amenities.

So we have to modify our thesis to ‘buy land but only when you know that it is going to be improved in some way’.

So have we got a sound investment thesis at this point? My answer is no. You see where this still falls down, and what separates professional from lay investing, is an innate understanding of a vitally important maxim, which Will Rogers missed. What he should have said was ‘buy land/shares/real estate/ whatever, but only if you know something about it that no one else knows!’

This is the hard part and why investing can be difficult. You see when you know something, everyone else does too. When information becomes public, it immediately becomes embedded in prices and you can’t make above average returns from it anymore. If governments plan to rezone, or build a new wide access road, the land around that immediately changes price and it is impossible to capture a premium. That’s why insiders get prosecuted for leaking this type of information. The same goes for shares – company management must be scrupulous in publically announcing any information that will affect share prices. They can’t just tell a select few.

So how do you get to know information before everyone else? That is the big question. If you are interested in how we build this type of hypothesis into our investment philosophy and practice let me know and we can follow up on this post.

The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and you should get professional advice before relying on this information.

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