This article addresses a practical framework for evaluating investments across equities, fixed income, and alternative assets. This article explains how trust, understanding investment terms, and system-level analysis influence investment decisions.
Today I’d like to talk about how I’ve learned to evaluate investments. I’ll keep the talk as generally broad as possible so that the principles discussed can be applied to as many asset classes as possible.
In short, the foundation of any investment is trust. And trust that managers will widen the organization’s economic moat year-over-year is paramount as an equity investor. For non-equity asset classes, this trust takes a slightly different approach though. For example, fixed income instruments incorporate duration, coupon rates, and default risk into their offering, while venture capital often offers the promise of future exits payouts. Either way, the key principle is that the investor has infallible trust that the person, company, or government body will grow their investment and return the full amount plus the gain back to the investor. This is what we believe is the core to investing, and we believe that this approach greatly simplifies the investment review process. When evaluating any investment, we ask ourselves: “Do we fully trust that this opportunity will return our money plus a gain, and will this gain increase the longer we hold the investments?”
“The highest form which civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another.” – Charlie Munger
This may seem as a simplified approach, but the nuance comes in understanding the terms of the investment offering. If within the terms of the investment offering it states that you won’t be getting your investment back, you, as the investor, trust that you won’t be getting your money back. This often isn’t so cut and dry, however. In fact, the sell-side of the offering may have an incentive to obfuscate the clarity of the offering terms so that investors who are less well-versed in investment language can be persuaded more easily. Lines may start to get blurry when the burden of knowledge is on the investor, which it often is. If a credit card offers rates that are SOFR + 9%, the investor must know the current SOFR (Secured Overnight Financing Rate) and what spread is currently competitive within the market – and what is competitive within the market is also a function of various aspects the investor must be knowledgeable on as well (e.g. economic policy initiatives). This theory applies to all asset classes and not just to the credit card example, and it is the responsibility of the investor to understand the terms. For example, if a company has a history of litigation and legal proceedings, the investor must educate themselves on that subject, and determine the impact of these trials. Systems Capital offers easy-to-use data for investors so that they can quickly access information that helps them educate themselves on prospective investments.
Of course, we hope that all investments are great investments, but we acknowledge that there are some investment opportunities that won’t return any of your investment, there are some opportunities that will give you what they told they will give you but leave you left worse off in the end, and then there are some investment opportunities that just aren’t for you.
Some investment opportunities may present a beneficial investment opportunity, but they may not be suited for your situation. Situations can differ based on risk tolerance, knowledge of asset classes, or personal preference – among other things. Some investors are searching for companies that are dividend producers, but not all companies issue dividends. There’s tons of variation and different investments serve different purposes.
We believe that the best way to find these great investments and to form the trust necessary is to understand all that there is to know about the investment we’re researching – to understand the entire system in which the company operates.
This, for us, is often approximately a year-long process and is highly critical in nature.
The goal of our data service is to help facilitate the acquisition of data so that we - and other investment managers - can spend more time analyzing the data, and less time collecting the data necessary for investment review.
We prefer investments that don’t require a high level of active management, and ones that we feel certain that the longer we hold the investment, the higher our investment gain. It’s the responsibility of the investor to understand the potential investment and if it is suitable for them. And once the investor understands the systems in which the investment operates – including the function it serves and the competitive nature of the offering – then evaluating whether or not the opportunity is worthy of investing is easy. All you have to ask is if you trust the other party will fulfill their end.
I know this is a simplified approach and it doesn’t go into details on discounted cash flows or other evaluation tactics, but resources such as how to conduct those calculations will be entered on a different page.
Below are some recommended readings that helped shape Systems Capital.
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