Caledonia Investments: The Legacy of John Darling

It was revealed this week that Caledonia Investments intends to short sell stocks for the first time in their history. A definite sign that buy and hold strategies are no longer generating sufficient returns (as I mentioned in my article on algorithmic trading).

Caledonia Investments was formed in 1992 as a vehicle to manage the inherited wealth of 20 or so members of the Darling family. These family members own 28% of Caledonia Investments (which manages approximately $A2 billion). In 1998, Caledonia was opened to outside investors.

The Darling family fortune was created by John Darling, a 19th century Scottish immigrant to Australia who founded a wheat and flour milling business. Apparently, by the 1880s, this business was Australia’s largest wheat exporter.

Current members of the Darling family that have taken prominent roles at Caledonia Investments include Michael Darling, his cousin Ian Darling and Ian’s father David. Like Rupert Murdoch, Michael Darling attended Geelong Grammer School and Oxford University. A privileged upbringing to say the least.

Ian Darling is also a documentary maker. Hhe produced the excellent Woodstock for Capitalists, a documentary made at the time of the Berkshire Hathaway AGM in 2000. If you haven’t seen it, go and get a copy.

Caledonia has tried to emulate Warren Buffett’s investing philosophies, which is why their announcement of their intention to short sell stocks is so interesting.

Caledonia does not disclose on their web site what the returns have been for each of their funds. Obviously, the move to short sell indicates to me that recent returns have not been sufficient. Media reports always refer to “excellent returns” achieved by Caledonia, but where do outsiders find the proof of this?

One rather indirect method of determining how successful Caledonia has been is to look at the wealth of the Darling family over time.

In 1990 the Darling family were worth approximately $A330m and are now worth in the vicinity of $A600m – that’s a compound return of about 3% per annum over that time period. This obviously compares unfavourably to many other rich Australians.

For example, over the same period of time, Kerry Stokes went from approximately $A150m to $A2.5 billion (14.3% compound), Lindsay Fox went from $A50m to $A2 billion (19.2% compound), Frank Lowy went from $A550m to $A5 billion (11.1% compound) and Stan Perron went from $A260m to $A1.9 billion (9.9% compound). I could quote many more.

If the Darling family had compounded their wealth at 10% per annum over the period 1990-2011, their fortune would now be approaching $A2.5 billion, the fact that it’s nowhere near that is revealing for a family that now manages money for outside investors.

The Darling family’s investment prowess also doesn’t compare favourably to two of the great investing families of Australia – the Hains family and the Millner family.

The Millner family also inherited great wealth but seem to have made many astute investments, one of the best being New Hope. You can actually invest alongside the Millners in one of their listed companies such as Milton Corporation (and the management expenses are miniscule compared to fund managers like Caledonia).

Senior figures at Caledonia Investments seem to have a wide variety of extra-curricular interests such as acting as trustees for various non-investment related bodies. I don’t like to see this, if you are managing my money, I want you absolutely focused on that without outside distractions.

Individuals will need at least $A250,000 to invest with Caledonia, with some funds requiring a minimum investment of $A500,000 and individually managed accounts requiring $A10 million(!).

The Secret World of Algorithmic Trading

In recent times I have been doing a fair amount of algorithmic trading based on a system that I designed a few years ago (which I rather unimaginatively named “Black Box”).

Black Box is just a piece of software that uses statistics to determine long and short entry points for a group of large highly liquid stocks. Each trade will typically result in a profit of between 1.5% to 4% (over an average holding period of 14 days - an annualized return of 39% to 104%). All trades are given up to 39 days to reach their targeted return before being time stopped.

I will normally have 1% to 2% of my portfolio invested in each trade. Black Box bases the trade size on the volatility of the underlying stock combined with the maximum allowable loss.

Black Box is seldom wrong in its signals, but of course it will be wrong on occasions. One of the main features of Black Box is its ability to largely filter out noise in price movements which is the bane of most traders. Of course I’m not going to tell you how Black Box does this, or indeed how Black Box works at all. The only systems you can see for free are the ones that don’t work.

While I still hold a long portfolio of great stocks like Berkshire Hathaway, Coca-Cola Amatil (CCL.AX) and Woolworths (WOW.AX), there are very few companies post GFC that can just be bought and held on to. However, there are far more than can be successfully traded using algorithms.

The primary criteria I use for algorithmic trading candidates are:

1. Large companies;
2. Highly liquid;
3. Fundamentally sound;
4. Relatively high price volatility.

Once I’ve selected the companies, it’s then a matter of feeding the required data into the computer which uses my algorithms to spit out entry signals on both the long and short sides. Ex dividend dates and important announcements also come into play here.

It’s always exciting to see what signals the computer is going to give. Of course, sometimes it won’t give any signals at all, which is fine.

Algorithmic trading is not for everyone, it requires a good knowledge of the relevant mathematics and statistics (that’s why all those huge algorithmic hedge funds employ mathematicians, in fact mathematicians like Ed Thorpe and Jim Simons were pioneers in this industry). But all this doesn’t mean that you have to be a mathematical genius. Algorithms vary in their complexity and complexity doesn’t automatically equate to larger profits.

It’s not much use buying books on the subject of algorithmic trading. As always, no one is going to give you the algorithms and strategies that will make your fortune in a book! Successful strategies and algorithms are normally being used by a few enough people to be effective. Once a strategy is widely known it will cease to work and that is the basic problem with any valid strategy that has been published in a book (or for that matter on the internet).

I may publish some of Black Box’s past trades here in coming months, so stay tuned.

Happy New Year to all.