At the risk of sounding philosophical, cultivate a healthy sense of detachment from your portfolio and markets. Photo: Bloomberg
An inescapable facet of being a relative return fund manager is that your performance is always measured against a benchmark index. A layperson may not take it kindly if they are asked, “How’s your performance?” But we fund managers are quite used to the question and the words underperformance and outperformance, though not very common in everyday usage, are quite common in the money management lexicon.
Equally inescapable is the fact that every fund manager, however good, will go through phases of underperformance, i.e. their fund’s returns will be lesser than the benchmark index. The only known exception to this was possibly Bernie Madoff but we all know how that ended. Not even Warren Buffett has escaped this truth. In fact, he puts a simple table with Berkshire Hathaway’s per share book value growth and S&P index returns on the first page of every annual letter that he writes to shareholders. The 2017 letter shows that in six out of the past 10 years, Berkshire’s book value growth underperformed the S&P 500 and yet nobody would debate the fact that the cumulative return, both absolute and relative, over many decades has been astounding. However an average investment committee whose patience generally wears thin after a couple of consecutive years of underperformance would have sacked Buffett as a fund manager thrice in his career. Not having an investment committee breathing down his neck is perhaps Buffett’s biggest competitive advantage.
Lesser mortals though have to play this relative performance game and the unfortunate part is that index returns can be computed for all time periods from minutes to decades. I vividly recall a conversation with a fellow fund manager who was lamenting that he was already down 25 basis points against the index and it was only 10.30 in the morning.
Availability bias means that what’s measurable will be measured, irrespective of whether it is signal or noise. There are a few tell-tale symptoms of a fund manager who is underperforming even if it’s for a short period of time, like a few months. The first symptom is obsession with daily relative performance. Waking up bleary eyed to check this first thing in the morning is the most common sign. An extension of this is an unhealthy obsession with the performance of one’s peer group funds. Once done checking your own fund’s net asset value (NAV), you go through the NAV of your peer group funds to see if they are doing better or worse. This also morphs into obsession with peer group portfolios and who is buying or selling what.
Another symptom is to dissect index returns and focus too much on stocks that are in the index and have done well over the last few months. While being sure of why you don’t own a certain stock is important, spending too much time analysing stocks and sectors just because they have done well in the recent past will lead to biases. Shying away from investor communication is another sign. This is true not only for underperforming fund managers but also for companies which are going through a soft patch in their business cycle. All of us know of companies that are on multiple business news channels and investor roadshows when the going is good, but go into a shell when things turn for the worse. Loss of productivity due to fleeting attention span, given the pre-occupation with price movements and a constant state of irritability, that in an advanced stage leads to viewing everything negative through lens of a conspiracy theory are some of the other pitfalls.
The symptoms might seem formidable and yet you are not the first fund manager to exhibit them. Through self-observation and learning from seasoned investors who have seen these cycles multiple times, there are a few hacks to better contend with the symptoms. The one that helps most is knowing your investment style. Every fund manager should be able to clearly articulate in what kind of a market environment their style would work and when it wouldn’t. This should be mandatory material in every marketing pitch and should be emphasized, especially in the good times.
In times when the portfolio is underperforming the index, having this clarity can give tremendous confidence. Buffett alluded to this quite early in his investing journey. In his second annual letter to limited partners written in 1957, he said: “Our performance, relatively, is likely to be better in a bear market than in a bull market… In a year when the general market had a substantial advance, I would be well satisfied to match the advance of the averages.”
Rather than staring at the screen, a better use of time is to revisit the rationales you had written while buying the stocks in your portfolio and see if they are still valid. Engage with management teams again to ensure that your conviction still holds and weed out names where the original thesis is not playing out. Also, this should be a time when you pro-actively communicate with your investors and re-emphasize your style. It is important to know that your investors derive comfort from your confidence and getting into a shell in such times is detrimental.
Lastly, at the risk of sounding philosophical, cultivate a healthy sense of detachment from your portfolio and markets. This does not mean you abdicate responsibility but it means that you should be able to prevent the symptoms from taking over all your waking moments. All this is obviously easier said than done and this is much more a note to self rather than a sermon for anybody else. But if this helps a fellow investor cope with the symptoms even slightly better, it would have more than served its purpose.
Swanand Kelkar is managing director at Morgan Stanley Investment Management. These are his personal views. The article appeared on livemint.com and is available here.
So, you’ve missed the great bull market. But that isn’t as irritating as that of seeing the neighbour – whose IQ is close to room temperature – drive up in his third new Jaguar in as many years. You consider yourself a ‘value’ investor at a time when such concept seems to be totally discredited. Year after year, you expected – convincingly – that the great bull would crumble. But it hasn’t. You purchased gold and lost. You sold Amazon.Com short. You lost. You’ve missed out on Microsoft, Dell, Qualcomm, Intel, Cisco, Yahoo and the assorted Internet wannabes. You expected an end to the mania but it has not come. O.K., you’ve simply earned the right to be frustrated. But now what?
If, on the other hand, you are the bold and lucky fellow who loaded up on Cisco five years ago, your knees must be a little shaky as you stand at the Temple of Unrealized Gains. ‘This bull will go on’ you reason, but then you doubt yourself. You don’t know. You aren’t sure. You hear little voices, conflicting opinions; you see the volatility, the excess, the mania, and the mother of all bubbles staring you in the face – not to speak of a hefty capital gains tax lurking out there. So, what will it be?
What are we, investors, to do?
Let’s talk about it. But first, let us examine the great investment paradox. The making of a fortune, whether small or large, in one’s chosen profession is certainly a significant achievement. To put it aside for a rainy day, the next generation, or as a source of future income and financial security is also prudent and wise. But to preserve and manage this wealth is an endeavor far more difficult than that of making it in the first place. And this is the paradox.
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With so many articles dedicated to the debate on value stocks vs growth stocks I think it’s a good time to revisit what Seth Klarman calls ‘Value Pretenders’ in his best-selling book, Margin of Safety.
Here’s an excerpt from that book:
“Value investing” is one of the most overused and inconsistently applied terms in the investment business. A broad range of strategies makes use of value investing as a pseudonym.
Many have little or nothing to do with the philosophy of investing originally espoused by Graham. The misuse of the value label accelerated in the mid-1980s in the wake of increasing publicity given to the long-term successes of true value investors such as Buffett at Berkshire Hathaway, Inc., Michael Price and the late Max L. Heine at Mutual Series Fund, Inc., and William Ruane and Richard Cunniff at the Sequoia Fund, Inc., among others. Their results attracted a great many “value pretenders,” investment chameleons who frequently change strategies in order to attract funds to manage.
These value pretenders are not true value investors, disciplined craftspeople who understand and accept the wisdom of the value approach. Rather they are charlatans who violate the conservative dictates of value investing, using inflated business valuations, overpaying for securities, and failing to achieve a margin of safety for their clients. These investors, despite (or perhaps as a direct result of) their imprudence, are able to achieve good investment results in times of rising markets.
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Warren Buffett provides a great lesson for all investors in the book – The Warren Buffet Way, by Robert Hagstrom. The lesson is that investors can spend weeks and years reading and analyzing information on prospective companies, but according to Buffett, “It’s not what you look at that matters; it’s what you see.” The lesson learned by Buffett happened during his investigation of IBM back in 2011.
Here’s an excerpt from the book:
Buffett confessed that he came late to the IBM party. Like Coca-Cola in 1988 and Burlington Northern Santa-Fe in 2006, he had been reading the annual reports for 50 years before his epiphany. It arrived, he said, one Saturday in March 2011. Quoting Thoreau, Buffett says, “It’s not what you look at that matters; it ’s what you see.” Buffett admitted to CNBC that he had been “hit between the eyes” by the competitive advantages IBM possesses in finding and keeping clients.
The information technology (IT) services industry is a dynamic and global industry within the technology sector, and no one is bigger in this industry than IBM. Information technology is an $800 billion-plus market that covers a broad spectrum of services broken down into four different buckets: consulting, systems integration, IT outsourcing, and business process outsourcing.
The first two, combined, contribute 52 percent of IBM ’s revenues; 32 percent comes from IT outsourcing; and 16 percent from business process outsourcing. In the consulting and systems integration space, IBM is the number-one global provider—38 percent bigger than the next competitor, Accenture. In the IT outsourcing space, IBM is also the number-one global provider—78 percent larger than the next competitor, Hewlett-Packard. In business process outsourcing, IBM is the seventh-largest provider, behind Teleperformance, Atento, Convergys, Sitel, Aegis, and Genpact.
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“In the chronicles of American financial history,” writes David Clark in The Tao of Charlie Munger: A Compilation of Quotes from Berkshire Hathaway’s Vice Chairman on Life, Business, and the Pursuit of Wealth, “Charlie Munger will be seen as the proverbial enigma wrapped in a paradox—he is both a mystery and a contradiction at the same time.”
On one hand, Munger received an elite education and it shows: He went to Cal Tech to train as a meteorologist for the Second World War and then attended Harvard Law School and eventually opened his own law firm. That part of his success makes sense.
Yet here’s a man who never took a single course in economics, business, marketing, finance, psychology, or accounting, and managed to become one of the greatest, most admired, and most honorable businessmen of our age. He was noted by essentially all observers for the originality of his thoughts, especially about business and human behavior. You don’t learn that in law school, at Harvard or anywhere else.
Bill Gates said of him: “He is truly the broadest thinker I have ever encountered.” His business partner Warren Buffett put it another way: “He comes equipped for rationality… I would say that to try and typecast Charlie in terms of any other human that I can think of, no one would fit. He’s got his own mold.”
How does such an extreme result happen? How is such an original and unduly capable mind formed? In the case of Munger, it’s clearly a combination of unusual genetics and an unusual approach to learning and life.
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Warren Buffett is recognized as the greatest investor of all-time because of his discipline and conservative approach to investing.
Instead of focusing on the short term, Warren Buffett focuses on the long term.He also has a low appetite for risk, buying companies that active traders would find boring beyond all belief.
Buffett once described his investment style as, “I’m 85% Benjamin Graham.” (Benjamin Graham is known as the godfather of value investing. His book, The Intelligent Investor, is respected as a classic on Wall Street.)
Just look at Warren Buffett’s company Berkshire Hathaway’s (BRKA) stock price appreciation over the past 20 years. And yes, you are reading that correctly, the stock currently trades for over $260,000… per share.
Berkshire currently holds a market cap of approximately $430 billion, making Warren Buffett the third richest person on the planet.
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Even with a time machine, a lot of people wouldn’t want to own the best-performing stocks.
Monster Beverage (NASDAQ: MNST) was the best-performing stock from 1995 to 2015. It increased 105,000%, turning $10,000 into more than $10 million.
But this isn’t a retrospective about how you should wish you owned Monster stock. It’s almost the opposite.
The truth is that Monster has been a gut-wrenching nightmare to own over the last 20 years. It traded below its previous all-time high on 94% of days during that period. On average, its stock was 26% below its high of the previous two years. It suffered four separate drops of 50% or more. It lost more than two-thirds of its value twice, and more than three-quarters once.
That’s how the stock market works.
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The pressure to outperform all the time leads stock pickers to constantly seek mean reversion trades
Over a three-year time period, stock prices tend to mean revert. This has spawned numerous investment approaches that try to squeeze capital gains out of those reversions. Classic deep value investing, as popularised by Benjamin Graham at Columbia Business School, taught that you would succeed by buying 50-cent dollars and selling them when and if they reverted to the mean. The “Dogs of the Dow” strategy of buying the 10 highest-yielding Dow stocks was born out of mean reversion.
Over long time periods, common stock performance falls on a bell curve like the one listed below. Half the stocks outperform and half underperform. Among the poorest performers, some go to 0%, and 5% of common stocks do so poorly that they can ruin a concentrated stock portfolio. (1)
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Santa knocks on all our doors not once, but four times a year. During his off-season, he reliably shows up bearing profitable gifts on February 14th, May 15th, August 14th and November 14th. These are the deadlines for 13-F filings with the SEC.
The “13-F” is a quarterly disclosure required of all individuals and entities who have $100 million or more invested in US equity markets. The 13-F is due within 45 days of quarter-end and lists the updated stock positions of the managers. These filings are publicly available at no charge to anyone. Websites like Dataroma make it a breeze to track the picks of various value investors. There is such a thing as a free lunch.
Non-believers will complain that buying these picks after a multi-month delay simply can’t work because markets are too efficient. Well… not so fast. A 2008 study by Professors Gerald Martin and John Puthenpurackal entitled, Imitation is the Sincerest Form of Flattery, cloned Berkshire Hathaway’s equity portfolio between 1976 and 2006 by investing in the positions with a substantial delay. Their cloned portfolio always bought (or sold) on the last trading day of the month that it was publicly disclosed that Buffett had bought a new stock or lightened up on an existing one.
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There are literally tens of millions of stock market and private investors today. The personal investing revolution has enabled anyone with a few hundred dollars to trade stocks. But we don’t have millions of great investors. Only a select few will ever be bestowed this title. So, how can you try to be one of them? You can emulate the people who were – or still are – the greatest. Below is our list of 8 of the greatest investors of all time; let us know in the comments below if you think we’ve missed out on any important names.
This list was compiled based on inputs from our members of Value Investing Clubs in UK, France, Belgium and Austria, and from our users at our FinTech company CityFALCON. Our focus at the Value Investing Clubs and CityFALCON remains on long-term fundamental investors who are looking to go through research to buy, hold and sell financial assets to generate strong higher than inflation returns.
Warren Buffett
We will just start off with the obvious case: Warren Buffett. Who doesn’t consider him one of the greatest, if not the greatest investor? Born just in time for the Depression (1930), Warren Buffett was born in Omaha, Nebraska, whence he eventually took his nickname “The Oracle of Omaha”.
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