May
7
“Adding MOS to the investment process adds a constraint and every constraint creates a cost. What, you may wonder, is the cost of investing only in stocks that have a margin on safety of 40% or higher? Borrowing from statistics, there are two types of errors in investing: type 1 errors, where you invest in over valued stocks thinking that they are cheap and type 2 errors, where you don’t invest in under valued stocks because of concerns that they might be over valued. Adding MOS to the screening process and increasing the MOS reduces your chance of type 1 errors but increases the possibility of type 2 errors. For individual investors or small portfolio managers, the cost of type 2 errors may be small because there are so many listed stocks and they have relatively little money to invest. However, as fund size increases, the costs of type 2 errors will also go up. I know quite of few larger mutual fund managers, who claim to be value investors , who cannot find enough stocks that meet their MOS criteria and hold larger and larger amounts of the fund in cash.”
Musings on Markets: Margin of Safety: An alternative risk assessment tool?
Is cash so terrible? He just got done praising Klarman, to whom holding cash is next to godliness.
