5 Investment Books for 2021 / Brazil & LatAm Equity Strategy

 It is becoming a “tradition”: For the last 7 years, I have been hosting an investment book club with some buy-side
clients (let us know if you want the list & highlights). The discussions are enriching: we not only discuss the books,
but we also invite top management and board members to talk about: strategy, capital allocation, shareholder
alignment, technology impact, among other topics. In a recent edition, we invited a Head of Research from a
Quant Fund to discuss Factor Investing, Which I view as the “DNA” to look in a stock.
 Here are the 5 investment books for 2021; I chose them as they cover widespread and crucial themes in
investment: Successful Portfolio Manager Investing Profile, Investment Cycles & Technology Impact, Valuation
Methods (Factor/Quant and Qualitative), Private Equity Approach, among others.

Which investment book would you recommend us to read in 2021?

Your Complete Guide to Factor-Based Investing: The Way Smart Money Invests by Andrew Berkin / Link
 Net/Net: interesting book from the Head of Research at Bridgeway Capital Management that discusses the
basics of factor investing. A factor is a numerical characteristic or set of characteristics common across a broad
set of securities.
 Five Characteristics of the factor criteria. In his Book, Mr. Berkin mentioned that factors should have a
combination of five characteristics: 1) persistent: odds of outperformance hold across long periods: for
example, it reached 78% for Value, 91% for Momentum and 80% for Quality in U.S. equities for a 5-year period
from 1927-2015; 2) pervasive: premium has been found across geographic regions (beyond the U.S., it worked
for Europe and EM as well); 3) robust: it works for a different set of metrics (for example, P/E and P/B on the
value); 4) investable: it needs to work after considering implementation (the case of momentum); and 5)
intuitive: present a logic, risk-based or behavioral based.
 Discussing the Three Most-Demanded Factors: Value, Momentum and Quality: There are more than 600
exhibits in the factor zoo. As per Mr. Berkin, he considers five as the most representative: 1) Market (i.e.,
excess return of stocks less risk free rate), 2) Size, 3) Value, 4) Momentum, 5) Quality/Profitability. In his
book/presentation, he focused on the three most demanded: a) Value: it is close to historical lows and he
believes it will continue work in the future; in this factor, he prefers to use a combination of metrics rather
than a single indicator, yet he notes that trailing earnings work better than forward and prefers to use GAAP
accounting instead of adjusted earnings (his firm has a PhD in accounting to work with financial data);
Sales/Price is not a good predictor in his view; b) Momentum: more focused on cross-sectional stock returns
(12-month performance disregarding the last month) rather than earnings momentum; it can be used to avoid
value traps (multi-factor strategy); c) Quality: gross profitability works better than ROE in his studies. When
combined with other factors (e.g. Value), Quality yields higher returns.
 Does it Work in Brazil? In our Brazil Strategy series of Quant reports, we found encouraging results for Value
and Earnings Momentum. On the Value side, trailing P/E and forward FV/EBITDA worked, with the former
producing a 549% return since the start of 2006 to 2017 (alpha of 236%), while the latter accumulated a 486%
of return (alpha of 179%). Let Us know if you want the reports.

The Long Good Buy: Analysing Cycles in Markets by Peter Oppenheimer / Link
 Outstanding book that discusses cycles in quantitative and practical way. The author divides the equity cycles
into four phases that reflect the different drivers as the economic cycle matures: (1) the despair phase, when
market moves from its peak to its trough (a bear market); (2) the hope phase, usually a short period (on
average 10 months in the US), when the market rebounds from its trough through multiple expansions. It is
usually when the highest returns in the cycle are obtained, despite that macro data and profit results of the
corporate sector remain depressed; (3) the growth phase, when earnings growth is delivered and drives
returns (usually the longest period: on average 39 months in the US and 29 months in Europe); and finally (4)
the optimism phase, the final part of the cycle, when investors become increasingly confident (or complacent)
and valuations tend to rise again and surpass the earnings growth (usually, this phase has lasted 25 months in
the US). There is a Marginal gain aspect for the markets: as for the S&P 500 index in the US (based on averages
 since the 1950s), the best period for equities tends to be when the ISM is in negative territory (with a reading
of below 50) – usually consistent with recession or weak economic activity – but when it reaches a positive
inflection point.
 The Power of Dividends & The starting point of valuation matters. Reinvesting dividends is one of the most
powerful ways to grow wealth over the long term. Since the 1970s, ~75% of the total return of the S&P 500
can be attributed to reinvested dividends and the power of compounding. Great valuation peaks (1929, 1968,
1999) tend to be followed by very poor returns on a risk-adjusted basis, and very low returns, at market
troughs (1931, 1974, 2008) tend to be followed by strong returns. The author mentions that the R-squared
between the Shiller (CAPE) P/E (real price/10-year average real earnings) and 10-year future equity returns
from US market is very high (roughly 0.70). Meanwhile, the R2 is 0.20 for the 2-year returns, 0.40 for 5 years
and 0.60 for 20 years (see exhibit 2.12). The message from valuation is clearer when it is at a relative extreme
(either very low or very high).
 Investment Styles over the Cycle. On the page 93, the author mention a clear picture (on average): the
underperformance of value in the optimism phase. In this final part of the cycle valuations tend to increase in
equity markets even as profit growth slows (growth stocks typically have their strongest relative returns). On
the other hand, stronger economic growth is usually associated with better performance of value (cheap)
stocks because these are often more cyclical in terms of sensitivity.
 The long good buy. Over 10-year holding periods, the occurrences of negative returns in equities fall
dramatically to 3%. For those who can afford to take a long-term investment horizon (at least 5 years), equities
tend to make a good long-term return even with the ups and downs of a typical cycle. As the author point out,
such conditions can be described as providing the best opportunity for investors to achieve a ‘long good buy’.
The average annualized total return for US equities since 1860 has been about 10%, over anything from a 1-
year to a 20-year time horizon. For 10-year government bonds, the average return has been between 5% and
6% over the same holding periods. Although returns adjusted for volatility (risk) are much lower for equities
than for bonds in the short term, over the longer term investors are generally rewarded for taking risk.
 Tech Concentration. Since 2008, technology has increased its share in the global stock market from 7% to
12%; at the same time, it has nearly doubled its share of the US market, from 13% to 21% in the S&P. In the
late 1990s, technology's share of global market capitalization rose from just 10% of the S&P in 1996 to a peak
of 33% in 2000.

The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution by Gregory Zuckerman / Link
 Entertaining book that tells the detailed history of Jim Simons, the founder of Renaissance Capital. Simons
was a pioneer in the data-driven/algorithmic, which translated in more than US$100 billion in profits and
remarkable average annual returns of 66 percent (39% after fees) from the Renaissance's signature Medallion
fund since 1988. The quant revolution is happening as we speak: as of early 2019, Quant investors represented
close to a third of all stock-market trades, a share that had more than doubled since 2013.
 Human Behavior and Comprehensive Process. Renaissance's success is a reminder of the predictability of
human behavior: they study the past because it is reasonably confident investors will make similar decisions
in the future. At the same time, staffers embrace the scientific method to combat cognitive and emotional
biases, suggesting there's value to this philosophical approach when tackling challenging problems of all kinds.
They propose hypotheses and then test, measure, and adjust their theories, trying to let data, not intuition
and instinct, guide them. Another lesson of the Renaissance experience is that there are more factors and
variables influencing financial markets and individual investments than most realize or can deduce. Investors
tend to focus on the most basic forces, but there are dozens of factors, perhaps whole dimensions of them,
that are missed. By analyzing and estimating hundreds of financial metrics, social media feeds, barometers of
online traffic, and pretty much anything that can be quantified and tested, they uncovered new factors, some
borderline impossible for most to appreciate.
 A book club? Simons proposed a new idea: senior executives would be assigned three papers to read, digest,
and present—a book club for quants with a passion, to take advantage of tens of thousands of peer-reviewed
research papers are published in disciplines including economics, finance, and psychology.
  Managing Risk. The LTCM collapse reinforced an existing mantra at Renaissance: Never place too much trust
in trading models. Yes, the firm's system seemed to work, but all formulas are fallible. This conclusion
reinforced the fund's approach to managing risk. If a strategy wasn't working, or when market volatility
surged, Renaissance's system tended to automatically reduce positions and risk. For example, Medallion cut
its futures trading by 25 percent in the fall of 1998. By contrast, when LTCM's strategies floundered, the firm
often grew their size, rather than pull back.

(Outliers) Fora da curva 2 by Florian Bartunek - Link

 The second book increase the scope beyond investment fund managers and tells the history of 13 financial
market investors and entrepreneur (career and investments), namely: André Street, Arminio Fraga, Arthur
Mizne, Guilherme Benchimol, Henrique Bredda, Leonardo Linhares, Márcio Appel, Martin Escobari, Mauricio
Bittencourt, Patrice Etlin, Paulo Passoni, Roberto Vinhaes and Veronica Allende Serra. At the end of each
chapter, there is a summary of the main advices from interviewees.
 What´s common? The willingness to take risks and stand out from the consensus are some of them. Also, how
they deal with mistakes overtime
 Seven things that caught our attention:
o Andre Street: Advices: 1) Figure out what you would like to do, then it becomes a pleasure; 2) Be
paranoic: evaluate risks even the smaller one; 3) Be humble: it helps continuous learning; 4) Build a
reputation: honesty - your word is your biggest asset; 5) Fell in Love with the Client’s problem to find
a solution; 6) Ask for help: mentors.
o Martin Escobari: Habit of creating checklists: what is a good business and what is not. This is the first
funnel. Then you need intuition. The GA funnel reaches 520 to 1.
o Mauricio Bittencourt: In search of the soul of the companies: a company with a culture of not taking
risk, rarely will grow fast. Advices: 1) look for Winning Culture: Ambev, Equatorial, Renner and Localiza
are some examples.
o Patrice Etlin. Private Equity: business is patience, resilience and deep analysis. Focus on bottom-up
approach. Five Favored sectors: consumption, retail, Education, healthcare and financials.
o Arminio Fraga: "When there is people acting without economic goals in the market, this usually
creates gain opportunities". Example of Mexican Bonds. Thailand artificial currency.
o Arthur Mizne: A PM needs to have a clear strategy definition: explain in one sentence what you do.
Ideally managing one fund and is obsessed about it. Ask the Peers if the manager is recognized as a
differentiated one. Interest alignment: how much of the PM net worth is invested in the stock fund.
o Paulo Passoni: Create a Pre-mortem before invest.
 This book is in Portuguese.

What It Takes: Lessons in the Pursuit of Excellence by Stephen Schwarzman - Link

 Interesting book that tells the story of the founder of Blackstone, a world´s top private equity firm. The book
is filled both with business success stories and personal experiences, to apply both in our work and personal
lives in order to reach a culture of excellence. “If you’re going to commit yourself to something, it’s as easy to
do something big as it is to do something small. Both will consume your time and energy, so make sure your
fantasy is worthy of your pursuit, with rewards commensurate to your effort”.
 Investment process: avoid loss, focus on key variables and create ownership. Anyone with a proposal would
have to write a thorough memorandum and circulate it at least two days before any meeting so it could be
carefully and logically evaluated. These discussions had two fundamental rules. The first was that everyone
had to speak, so that every investment decision was made collectively. The second was that our focus should
be on the potential investment's weaknesses. Everyone had to find problems that hadn't been addressed. This
process of constructive confrontation could be challenging for the presenter, but was designed it never to be
personal. The "only criticism" rule liberated them to critique each other's proposals without worrying that we
might be hurting someone's feelings. They train their professionals to distill every individual investment
opportunity down to the two or three major variables that will define the success of our investment case and
create value.
 o There were many other great aspects to their culture. Every Monday morning, for example, all of
investment teams gathered to talk about their deals and their context, starting at 8:30 a.m. and
running until early afternoon. They discussed the global economy, politics, conversations with
investors, media and any issues that might affect the business. Then they went through a list of live
deals, sharing the insights and ideas from different activities around the world. Everyone could attend.
Those who had something relevant to say were encouraged to say it, whatever their age or rank within
the firm. All that mattered was the quality of their thinking. To this day, according to Schwarzman,
Monday mornings remain the clearest demonstration of commitment to transparency, equality, and
intellectual integrity.
 The benefits of the IPO. According to Schwarzman, a successful IPO raise permanent capital to invest in the
firm and expand the reach. If the markets turned, they would not have to worry about keeping the lights on.
And it would allow the partners to sell their ownership stakes over time if that's what they wanted to do. It
transformed them into a global brand and bring deals, new limited partners, and new opportunities. Also, it
reinforced “one-firm” culture even as it enabled them to develop new lines of business. Entering the big crisis,
Blackstone had $4 billion in cash from the IPO and a $1.5 billion revolving credit line to draw on if they needed
it.
o Being big. “The better our performance, the more money our investors gave us to manage. And the
more we had to manage, the more we could innovate. We could do bigger deals, add new lines of
business, and attract the right talent to manage them”. In the equity markets, being big can hurt your
performance. If you want to buy $1 million of an S&P 500 stock, you can do so without moving the
price. If you want to buy $1 billion worth, the market will push up the price before you can complete
your purchase. In their world, they found the opposite happening: as the funds grew and rivals
struggled, the size became a major source of advantage. They found buyers and sellers eager to work
with them. They moved away from participating in many competitive auctions with other private
equity firms into situations where they could focus more specifically on the value to both sides and
less on rival bidders.
 The importance of education. “I have long believed that education is the passport to a better life. A good
education has the power to affect whomever it touches for the better. We all have a duty to not only preserve
the knowledge that is handed to us but also develop it in a way that improves its relevance and impact for
future generations”.

Finally, if you fancy sitting down on the beach or workout in the gym, I will suggest a podcast (a Book may be too
formal!) that continues to catch my attention: Value Investing With Legends. This podcast, hosted by Columbia
Business School Professor Tano Santos, interview some of the world's greatest investors on how they developed their
investment process. Among this year invited speakers were: Howard Marks, Michael Mauboussin and Tom Russo.

I wish you a Merry Christmas and Happy New & Profitable Year!
See you in 2021

Regards,

Daniel Gewehr
Managing Director - Head of Latam & Brazil Equity Strategy
Head of Brazil Research
+55 (11) 3012-5787
[email protected]