The overconfidence effect is a well-established bias in which a person’s subjective confidence in his or her judgments is reliably greater than the objective accuracy of those judgments, especially when confidence is relatively high. Overconfidence is one example of a miscalibration of subjective probabilities. Throughout the research literature, overconfidence has been defined in three distinct ways: (1) overestimation of one’s actual performance; (2) overplacement of one’s performance relative to others; and (3) overprecision in expressing unwarranted certainty in the accuracy of one’s beliefs. The most common way in which overconfidence has been studied is by asking people how confident they are of specific beliefs they hold or answers they provide. The data show that confidence systematically exceeds accuracy, implying people are more sure that they are correct than they deserve to be. – Wikipedia

September saw markets give up some of the gains we’ve seen in the very strong run since March 2020. The realities of COVID/lockdown related supply-chain issues, quickening inflation and political uncertainty around the globe seem to be finding some acknowledgement in financial markets. There is a heightened sense of apprehension. Most investors we speak to have two questions: 1) What’s next? 2) How should we position ourselves?

“What’s Next?”

COVID and the resultant lockdowns have had a knock-on effect on global supply chains. This has led to shortages in a number of key areas. Shortages lead to price increases. The US inflation rate is currently north of 5%, a level breached only once previously in the last 30 years (mid-2008). The Fed tells us this uptick in inflation is transitory, but inflation is notoriously difficult to predict. Inflation has implications for interest rates, and interest rates for asset prices. There’s also the question of what impact trillions of dollars of stimulus will have on inflation and asset prices, not to mention a host of other issues which further compound the uncertainty of the future.

And that’s really the answer to the question of “What’s next?”: Uncertainty. The future is and always has been uncertain. We don’t know what inflation will do next, nor do we know exactly how financial markets will react. And that’s just concerning inflation. There are many other important factors that we also know very little about.

Contrast this basic truth with what you see daily in the financial media. There is no shortage of pundits brimming with confidence ready to tell you precisely what the future holds. Ironically, you’ll find someone to confidently express whatever you want to hear. Their accuracy is nowhere near their confidence. Of course, the media houses will parade the ‘winners’ who got their calls right in the last round for as long as their credibility lasts. There are always people predicting everything, so it’s easy find someone who got it right after-the-fact. Consistently doing the same ex-ante is a different story.

The reality is that no-one seems to be able to consistently predict the future. And even when we do make correct predictions, markets often don’t react the way we’d have anticipated. This makes prediction-based investing problematic, and prone to error.

“How should we position ourselves?”

When we’re asked the questions “What’s next?” and “How should we position ourselves?” the implicit assumption is that the answer to the second question depends on the answer to the first. But unless you’re able to answer the first question with a high degree of accuracy (vs. confidence), it should have very little influence on the answer to the second question.

Because we don’t know what the future holds, nor how markets will respond to specific events, we need to aim for a robust portfolio that is likely to deliver good results under a wide range of future scenarios, and stick to it. Discipline is by far the most underrated trait of successful investors. In an industry where everyone is ‘clever’, and as a consequence overconfident, discipline is the key to avoiding costly mistakes and achieving consistent results.

The problem is that there tends to be a very large gap between our perceived accuracy (i.e. confidence) and our actual accuracy. This is overconfidence. We need to think soberly about our ability to predict the future.

One of the biggest mistakes that investors make is to reposition their investment portfolios in a major way in anticipation of some future event of which they are confident they know the outcome. Time and time again investors will sell out their portfolios or go all-in on a specific asset/industry/geography, abandoning a sound investment plan and setting in motion a series of behavioural biases that make it very difficult to get back to where they should be. It takes just one big mistake like this to derail a successful investment journey. Now we can always get back on the right track, but it can be difficult, and these mistakes can be costly.

An example…

Let’s say you sold everything in 2016 as RBS suggested, predicting an impending global deflationary crisis. By the end of the year, global stock markets had risen 18%. What now? Do I buy everything back again? If so, on what basis? By this time there’s a good chance you’ve set an anchor around the level you sold. “If the market just gets back to where I sold, then I’ll buy everything back.” So we give it some more time… In 2017 markets climbed another 24%.

This chain of events leads either to a kind of financial depression where you never get back to your target portfolio, or capitulation where you take your medicine and move on. The longer you wait, the more difficult it becomes to swallow the medicine. Granted, you might get lucky, but those stories are the exception rather than the rule. It’s better not to put yourself into this kind of position.

So what does a robust portfolio look like?

A robust portfolio first has the correct asset allocation. This means having enough cash to meet short-term liabilities, and enough risk assets to meet your long-term liabilities. Next, a robust portfolio is focused on high quality assets with reasonable valuations. The portfolio must also be diversified in terms of industries and countries, but not to the extent that quality or valuations are compromised. Finally, a robust portfolio avoids excessive leverage, which triggers liquidation during a crisis.

Any major changes in your overall investment portfolio should aim to draw you closer to your ideal portfolio, not away from it. Once this portfolio is established, do not allow “What’s next?” questions to draw you significantly away from it. If you are going to entertain these questions, keep the changes small. Better yet, if you spend less time thinking about these questions, you’re less likely to make these kinds of mistakes.

Finally, it’s worth remembering that against a backdrop of perpetual uncertainty which included the Great Depression, WWII, numerous recessions, wars, market crashes, inflation in the ‘70s, the tech bubble, the housing bubble, etc., the last century has seen the S&P 500 index grow from 4.4 to 4400, not counting dividends.


Country Risk

When managing a global portfolio it’s important to have a handle on the risks inherent in the places we’re investing our funds. The approach most investors take is similar to the approach with which they assess individual stocks: Do I recognize the name and how does it make me feel? This really isn’t adequate, especially when it comes to emerging markets. As with smaller individual stocks, which many investors overlook, there are good businesses operating in smaller countries that actually score well on country risk metrics. These countries are often simply overlooked because of their size.

On the other hand, just as there are some major companies with questionable quality, there are also some major countries where the risk is greater than investors realize. It’s good to have a handle on the relevant metrics and also to see how they change over time.

It’s also interesting to see how our own country stacks up against other international markets. We tend to have a bias towards that with which we are familiar. We often consider other countries with far less risk than our own to be uninvestable, while having the vast majority of our assets invested here where the risks are often greater. (Also read SA Foie Gras.) If the specifics of the analysis aren’t of interest, scroll down to the last two paragraphs and see how South Africa fares – some food for thought.

How do we quantify country risk?

The first issue we need to address is how to make an accurate assessment of country risk. Most investors approach this as they do with every other aspect of investment: Stories and predictions. What does the economic growth outlook look like, what industries are growing and which countries feature prominently, etc. Our approach is somewhat different. We focus on the preconditions that make for a favourable economic and investment environment, rather than unknowable predictions of the future.

For us, the most important factors when considering country investment risk are respect for property rights, and investment freedom. The Heritage Foundation generates such scores for countries, which are described as follows:

1. Property Rights

“The property rights component is an assessment of the ability of individuals to accumulate private property, secured by clear laws that are fully enforced by the state. It measures the degree to which a country’s laws protect private property rights and the degree to which its government enforces those laws. It also assesses the likelihood that private property will be expropriated and analyzes the independence of the judiciary, the existence of corruption within the judiciary, and the ability of individuals and businesses to enforce contracts.”

2. Investment Freedom

“In an economically free country, there would be no constraints on the flow of investment capital. Individuals and firms would be allowed to move their resources into and out of specific activities both internally and across the country’s borders without restriction.”

Using the Heritage Foundation’s scores for these two variables, we generate our own composite and rank countries accordingly.

Secondary Factors

While our primary assessment of country risk is based on respect for property rights and investment freedom, there are a number of secondary factors that we also take into consideration. We consider scores for business freedom (how easy is it to start and run a business?) as well as labour freedom (how onerous is labour regulation?). We also look at the size of a country’s economy (larger economies are inherently less vulnerable), their inflation rate (avoid hyperinflationary environments) and their debt picture.

Finally, we consider measures of income inequality (e.g. GINI coefficient) and poverty. Countries with income disparity and poverty are more prone to civil unrest.

How do we manage country risk?

Based on our assessment of both primary and secondary risk factors, we establish upper limits to individual country exposure. Essentially we classify countries as Tier 1 – 4. Tier 1 is most investable, and Tier 4 is uninvestable. We set higher limits for more investable countries, whilst also giving consideration for the size of the markets. While United States and New Zealand may both be classified as tier 1, our exposure to New Zealand is necessarily limited by the size of the opportunity set. We also set overall tier limits so that we don’t overexpose ourselves to low tier countries in aggregate.

Note that we don’t set exposure targets like most investment managers do. This is because we aren’t benchmark cognizant. We set upper limits and then maximize exposure to our best investment ideas (specific stocks) within these constraints. If we don’t have good ideas in a certain country, we don’t invest there. Most investment managers set geographic exposure targets. This means that they must maintain significant exposures to the United States, Japan, UK, etc., irrespective of where their best investment ideas are. This is suboptimal in our view.

Results by Primary Score (0-100)

Countries with GDP greater than USD 150bn:


Results by GDP

Top 30 Countries by GDP:

So how does South Africa stack up?

Since most of our investors are South African, we should consider where South Africa ranks both in terms of primary factors and secondary. This has obvious implications for the domestic/offshore exposure debate. We’ve long argued that the traditional local/foreign exposure paradigm borrowed from the US/Europe makes no sense for local investors. Our economy is less than 1% of the world and we face far greater risks than 1st world countries.

Categorizing the world between South Africa and Offshore and placing these two options as equals is ludicrous.

South Africa ranks 43rd of 55 countries with GDP greater than USD 150bn, on property rights and investment freedom. This isn’t surprising given our government’s policies regarding land expropriation, capital controls and the endemic corruption we face.

Further, on secondary measures, we’re a small economy which scores relatively poorly in terms of business and labour freedom. We have the highest income inequality score of any country in the world. 55% of our population lives below the poverty line. Do we see civil unrest in our country? Our debt is also growing rapidly. The only bright spot is that our inflation is under control, for now.

Invest by merit, not familiarity

I don’t want to paint a picture only of doom and gloom. Brazil, Russia, India and China score roughly the same as us (though they are larger economies with less inequality and poverty). Many consider these countries  to be viable investment destinations. But we need to be realistic when we compare South Africa to other investment destinations and when deciding how much to invest “offshore”. For a global investor, the reality is that South Africa is a borderline investment destination.

If I suggested that you invest half your money in Brazil or Thailand or Mexico or Turkey or Poland or Hungary or Chile – you’d call me crazy. Yet these are mostly bigger economies than South Africa. They all score better on the primary and most of the secondary country risk metrics. Then there are more developed economies like Taiwan, Norway, Israel, Australia, Canada, Sweden, Hong Kong and Singapore. Not to mention the giants of United States, Europe and Japan. These are all unquestionably superior investment environments.

As global investors, we should consider the scope of investment opportunities and the inherent risks when making offshore allocation decisions. It’s high time we abandon the traditional local/offshore allocation models. Our local investments should compete against the global opportunity set on merit, not familiarity, for a place in our portfolios.


What does it take to achieve extraordinary returns?

Three years ago we wrote an article called The One Percent  in which we discussed the advantage of being able to cover a very wide opportunity set. It’s all very well getting the basics right in terms of stock analysis, but if your ability to apply that process is limited to 100 stocks, it really doesn’t help much. You’ll either be forced to invest everything in your best couple of ideas, forgoing diversification. Otherwise you’ll water down your process in order to diversify. Most investors, particularly professionals, will favor the latter.

Few investors, even professionals, are able to scale a good investment process consistently beyond a few hundred stocks. This is because a) their process doesn’t lend itself to scaling across different industries, countries, etc., b) they lack the resources to look beyond the major index constituents, c) their clients have limited their mandate to a specific subset of the global market, d) they are comfortable to limit themselves to names they’re familiar with, or e) they are unaware of the problem.

Further, most institutions that do have very wide coverage (investment banks for example) employ 100s of analysts across the globe with very little consistency. This means that they have no mechanism for consistently identifying their best ideas. They piece together various industry and country portfolios to arrive at one over-diversified global portfolio. They may as well run an index fund.

Minimum Requirements

In order to achieve extraordinary results, we need to do something extraordinary, which requires – at a minimum – the following:

  1. A scalable process that can identify good businesses trading at good prices;
  2. The ability to apply this process consistently to a very broad opportunity set. The wider the opportunity set, the better the potential portfolio;
  3. The desire and the intestinal fortitude to select only a portfolio of best ideas, even if it looks nothing like the benchmark index.

Note that 2 of the 3 won’t cut it. A great process applied to a wide opportunity set, but then over-diversified or constrained by benchmarks won’t result in extraordinary returns. Going with your best ideas won’t help much if they aren’t any good. And you won’t find too many great ideas if you can’t sufficiently cover the global opportunity set.

How do we stack up?

At Bellwood we aim to tick all 3 boxes. We are relentlessly focused on process and we have very wide coverage of the global stock market. We’re continuously developing our capabilities on both fronts. Finally, our active share is ~95%, demonstrating our commitment to building best ideas portfolios.

Some examples of the fruits that have been borne by this process since 2018 include: Kakaku.com, Evolution Gaming, NetEnt, IGG, XD, Thule, Systena, Challenger, Banco Santander Chile, Mexican airports, and Silicon Motion. These have contributed substantially to our returns, especially over the last year. You won’t find these stocks featuring in many other portfolios.

Going forward we’ll keep searching for investment ideas like these, and we’ll keep building portfolios that reflect our conviction in this process, which is anything but ordinary.

Investing in the Misinformation Age

If the last half-century was the Information Age – a time of rapid progress in terms of access to information – I think it’s fair to say that we’ve gone beyond that and crossed firmly into the Misinformation Age. COVID and the US Elections have demonstrated how easy it is to deliberately spread extremely polarizing disinformation on both ends of the opinion spectrum. This kind of disinformation can influence behavior significantly, sometimes impacting masses of people. This has always been true for financial markets (though probably with less malice) where mass euphoria and mass hysteria have driven market cycles to opposing extremes for centuries. What has been the cause of this? Too much information. More specifically, too much of the wrong information.

Financial media – or business entertainment if you prefer – has always pushed the excitement factor of investing. Big success stories, dramatic meltdowns, outliers and extreme performers, bold predictions made with absolute confidence, exciting growth stories and edgy investing trends. Balance sheets and valuations are far too boring for TV.

The key to successful investing is being able to sift through the ocean of misinformation and find that information which has some value. Ignore everything else.

Focus on things that are knowable and important

At the 1998 Berkshire Hathaway annual shareholders’ meeting, Warren Buffett was asked about his views for the global economy over the ensuing decade. His answer was that he focuses on things that are important and things that are knowable. The future global economic environment? Unknowable.

More than 20 years later, with more ‘information’ at our fingertips than ever before, this advice is probably more relevant than ever. A useful framework for assessing information is to categorize everything according to the following matrix:


Quadrant 1

Quadrant 1 represents information that is both knowable and important. This is where Buffett would recommend we focus our attention. This includes things like current valuation, financial strength of the business, cash flow, rough financial estimates, some ballpark scenarios of how the business is likely to develop over the long-term, competitive position of the business, profitability, etc. Although this information is readily available, it isn’t very exciting. We don’t see much attention drawn to this quadrant in our business entertainment. This provides an edge to those who are willing to forgo the entertainment factor and keep discipline with a process focused on these things. That’s what we do at Bellwood.

For individual investors, information about the fees you’re paying to advisors (and fund managers and product providers), as well as the transparency of your investment structures is critically important yet often ignored. Most investors would do well to spend the time looking into this.

Quadrant 2

Quadrant 2 represents information that is knowable, but not important. This probably represents the bulk of what is produced by financial media. It includes things like the discussion of daily market fluctuations, arbitrary economic data points, precise quarterly earnings numbers, endless expert opinions, etc. It could be summed up as over-analysis. Investors can easily make bad decisions when they become distracted by irrelevant information or suffer from analysis paralysis.

In practice, professional analysts spend their days learning about every detail of an industry or company. The vast majority of this information isn’t useful for the purpose of making investment decisions. Worse, too much useless information can lure you into the trap of focusing on the wrong information. It becomes a distraction. Knowing a lot about something isn’t the same as knowing what’s important.

Quadrant 3

Quadrant 3 represents information that is important, but not knowable. In other words, if you could know it, it would be very useful, but you can’t. The investment industry spends a lot of time and money trying to get at this info and convincing themselves that they do indeed know it. The timing of the next market crash, 12-month target prices, 2021’s outlook for the dollar, the next recession, upcoming election results, etc. CNBC has no shortage of gurus ready to tell us all when the next big meltdown is coming. This despite their terrible track record of getting these calls right in the past.

In day-to-day practice, most fund managers take a top-down approach based on macroeconomic forecasting which informs their asset allocation, geographic allocation, industry allocation, etc. Bottom-up stock selection is an afterthought, often also built on predictions or narratives, despite the evidence that this approach doesn’t add value.

Quadrant 4 represents information that is neither knowable nor important – things we don’t know, that have little impact on investment outcomes.


I’ve highlighted quadrants 2 and 3 in red because these are the areas where most investors get side tracked to their detriment. These areas are also where the business entertainment tends to focus. If you want to become a better investor, think about the information you consume and start to categorize it according to this matrix. Then spend less time in quadrants 2 and 3 and more time in quadrant 1. Professionals would also do well to direct their resources away from analysis and development of models focused on quadrants 2 and 3 towards quadrant 1.


A Practical Example: ZAR Blinkers

We’ve written about this before in Don’t let the Rand dictate your portfolio but this example is so prevalent that we need to highlight it again. Most South African investors recognize the need to invest globally. But when it comes to pulling the trigger there is one factor that drowns out all other considerations: The ZAR exchange rate. If I were to categorize this in terms of our information matrix, I’d put it somewhere between quadrants 3 and 4. Definitely unknowable with debatable importance.

Although the exchange rate is important when viewed in isolation, it is only one of a number of other important factors that impact your investment returns. Once due consideration has been given to all of them, the exchange rate becomes far less important. When investing in a global portfolio there are many currencies, not just USD. These exchange rates are also important, and some of them are also cheap. What about valuations of the actual assets you’re buying? These are of far greater importance than the exchange rates.

Right on ZAR, but wrong overall…

What can we know about the ZAR exchange rate? We can know that over time it is likely to follow a weakening trend against most developed market currencies. We can also identify extremes in the exchange rate, though we can’t identify inflection points with any accuracy. Short-term moves are unknowable. The same is true for stock market valuations. But we often find extreme ZAR weakness is accompanied by depressed stock market valuations. What you lose on the one, you tend to gain on the other. This makes short-term moves less important.

Let’s go back to 3 April 2020. The USD.ZAR exchange rate was 19.04. At 31 December 2020, the exchange rate was 14.69. Many investors sitting on cash earmarked for offshore investment would have balked at the idea of taking money offshore at 19.04 to the USD. So they sat on their cash and waited. Come December, 14.69 looks a whole lot better – 23% stronger – well done. Only… the MSCI World Index rose 54% in USD (18% in ZAR) over that time. So we got the exchange rate right, but we’re worse off by 18% overall because we weren’t paying attention to the other important factors.

Risk management is important

Another important consideration is how much of your wealth is focused in South Africa. Most South African investors have the vast majority of their wealth focused in South Africa (which represents less than 1% of the world). They send money offshore because they need to manage their risk (and they want to take advantage of the wider opportunity set). But some like to speculate on the currency by bringing it back when the Rand seems weak, hoping to take it out again at a better rate. This is a dangerous game to play when you consider that the Rand is highly unpredictable. It is also only one of many other factors that affects your total return. Finally, the principle of risk management through global diversification (which falls squarely into quadrant 1) should dwarf any potential return from playing the exchange rate over time.

As South African investors, we put far too much importance on the exchange rate when it comes to global investing.


Two other common examples that investors should beware of:


  1. Trying to time the next market crash. You’re better off focusing on asset allocation and investing consistently through market cycles;
  2. Making investment decisions on the basis of big macro themes or stories: The Dollar, the Fed, QE, China, aging population, green technology, etc. These are difficult to predict and even more difficult to quantify. You’re better off building a globally diversified portfolio focused on simple investment fundamentals at the micro level.


When making investment decisions, don’t fall into the trap of being distracted or blinkered by considerations that fall into quadrants 2 – 4. Focus solely on considerations that fall into quadrant 1. Rather blinker yourself from the ocean of other misinformation out there. You’ll achieve better results over time.