Sunday, January 24, 2010

The Super Bowl and Fund Selection II

One of the more popular of my blogs in 2009 was my comparison of fund selection and picking the winner of the Super Bowl. This year, the Lords of Football have been very successful in building excitement in anticipation of the annual event. The two conference play-off games match storied teams with a great deal of interest on the part of the press and the fans. As I will be traveling during the broadcast of the games, I will not know the results, but I am guessing that the winners will be compared to each other during the next two weeks in great detail. Almost as much detail as one should use in selecting mutual funds and other investment managers. Thus, at popular request I am repeating last year’s blog on the Super bowl and fund selection.

While I believe that you can use the thinking demonstrated in the 2009 Super Bowl blog, you should not expect to do so for the 2011 games. Both professional football and the investment community are on the cusp of significant change having to do with the attractiveness of the investment of time and emotion in the games of selection and the profitability of the exercise.

On the football side, this Super Bowl will be the last played under the collective bargaining agreement that is scheduled to expire on March 31st. What we do not know is what changes will occur and how these changes will impact the compensation for existing and future players. These unknown changes could well affect the make up of the teams. I believe the spat between Fox and Time-Warner Cable is also emblematic of the changing economics of all electronic distribution in the future. How much revenue will be produced, and how it will be divided, will evolve over the next several years, which in turn will have an impact on the money that will be available to the teams and their players. There is at least one other uncertainty. In response to health and other concerns, the Competition Committee will make changes, subtle or great for all NFL games. Starting next year, but becoming more pronounced in future years, each of these changes are likely to be game changers. These changes may well downgrade the value of past performance in selecting the winner of future Super Bowls and the point spreads.

On the investment side we had already identified a number of changes before the White House thundered forth on special taxes on bank liabilities, prohibition of proprietary trading and other attempts to prevent the prospect of a very large institution failing financially and putting others at risk. I have already commented on my concerns regarding the way the central marketplaces have been replaced by a system of fractured electronic communication systems, where price, volume, and identity of counterparties become opaque. Combine these structural changes with various accounting changes which make comparative operating earnings more difficult to determine and it is much more challenging to use valuation techniques based on earnings. Lastly, as hinted in last week’s blog, I am increasingly concerned that rumors about China can stampede other markets around the world, including our own.

Bottom line: you should enjoy this year’s Super Bowl and perhaps this year’s market, but do not expect them to be too much help in the future. As they used to say in ancient Rome, “Let the games begin.”

The Super Bowl and Fund Selection

For many of us, this is the season of selecting which team will win the forthcoming Super Bowl. This year is a bit different for me because of this blog.

One reader recently asked me about fund selection, and the analyst in me forced me to list selection criteria topics that could apply to each selection task. I stopped when I had listed 25 items. To reduce mental strain on your reading, and writing efforts on me, I will only briefly discuss 14 of the items. For other analysts and exacting types who would like to read the entire list, please send me an email,, and I will send you the list.

Before I begin, I should disclose that for the last 15 years I have worked with the NFL and its Players Association on their various retirement plans. I have been watching and thinking about the Super Bowl for many years before my professional responsibilities began.

SELECTION BRIEFS - For each selection point below, my Super Bowl observations are first, in bold. The related fund selection comments are second in italics, and my comments last, in plain type.

1. Compare the simple Won and Lost record compared with all other teams.

Compare Fund Performance Rank against all other funds.

Both sound bites are useful if the competition is in the past.

2. Analyze the success or failure in “Red Zones,” within 20 yards of the goal line.

Analyze the general price level of securities high vs. low.

Most of the time the game is played in mid-field or within normal price levels, but the big dollars are earned in extreme places both for the offense and the defense.

3. Examine the heroes, usually the quarterback and one or two backs or line backs.

Examine the Portfolio Managers or lead managers.

Unfortunately, little or no recognition is given to the offense or defensive lines (or analysts and traders). In many cases they make the guy up front look good while they do the hard work.

4. Understand that the Offensive Line protects the backs, creates the holes in the opposing lines and confuses the opposition.

Analysts, both within and outside a fund organization, see what others don’t or see it faster.

5. A Defensive Line breaks up the offense’s plays and protects their goal lines.

The contrarians look for weaknesses in momentum and uncover the big users of Cash.

In items 4 & 5, we see the importance of the supporting roles contributing to the success of the team and the fund.

6. In terms of compensation, both groups use financial incentives to motivate their teams. In professional football, the players have well-defined contracts.

In the investment world, most serve as “at will” employees, but often the bulk of their compensation is paid as a bonus.

Too often the bonus emphasizes current year performance and very little, if any, based on team-building and leadership.

7. A vital factor is the football team’s Front Office, who provides the financial and real estate resources to build the franchise.

In fund organizations, the business management often has similar responsibilities, including reporting to shareholders (both inside and outside), as well Holding Companies, particularly those of banks, insurance companies, and brokers.

Fund stakeholders usually have different (longer) satisfaction time thresholds.

8. Penalty-prone teams may try too hard, generating loss of yardage on the field, and fines off the field.

Similarly, a fund could wander or purposefully enter the “information gray zone.”

This straying action could negatively impact a fund’s performance.

9. Fan Support can be very encouraging at both open practices and game time, and may give some teams a big home field advantage.

Retail investors who buy with a broker’s assistance and 401(k) investors tend to be more patient than some institutional investors or pure no load investors who only focus on near-term performance or momentum.

The NFL team front office and a fund’s business management both understand the long term cost of losing their base.

10. The “Hail Mary Pass” is an extremely long pass thrown at the end of a game to attempt to reverse a losing score.

Similarly, a fund may have an out-sized position, often in a relatively, thinly traded stock during the last quarter of the year.

Both approaches have produced winners, but not as often as tried. Desperation does not produce comfort for investors nor fans.

11. A running game focuses on backs going through or around the defensive line, mostly resulting in short yardage that occasionally leads to big yardage and a score.

A fund, trading for small advantage in short periods often produces more highly taxed gains.

The tax orientation of the manager is often a good clue to who should own the fund.

12. The fact that any team in the league can win on any given day is particularly true in the last three games, especially after the teams that do not make the playoffs are eliminated.

A fund’s “season” is its performance, annual period. It is unlikely that a bottom performing fund can become a top performer late in the period, but it can happen. The winners are likely among the current performance leaders, or among those showing momentum. This is particularly true in a tightly defined peer group.

Do not despair for this year’s laggards. Often a particular period is being used to develop a winner over a longer time period, particularly when, or if, market conditions change.

13. What about a “Winners Curse?” To the best of my memory there has never been a winner of four consecutive Super Bowls.

The same can be said for funds. Except in the case of a long market, rarely do winners repeat three years in a row and even twice is difficult.

The winners become celebrities and at least become more expensive, if not more difficult to manage. The winners attract fair weather friends and fans who are more demanding than those who were steady company in the dark days.

14. Dynasties are extremely difficult to sustain. Start with the Winners Curse and the absolute fact that each year humans get older and more prone to the trials of the flesh. Among these mortal groups are team scouts, who may miss insights or talent opportunities.

In the investment world there is no business-wide compensation cap, and only 100% of equity that conceivably could be redistributed and most of the time much, much less.

So after all this analysis what are my choices for 2009? You will understand that I can not make a public prediction as to the winner of the Super Bowl as all the participants are clients. However, going through the thought drill of the above items, I do not see that any single team has an overwhelming advantage. My guess is that the two finalists will be a surprise to most of us, and particularly one of them. The key question is whether the game will be close, which is a function of luck and the Zebras (the officials). So I root, as I do each game, for the Zebras. May they call a good game!

In terms of fund selection, I will go just a little further out on a limb for the non-paying crowd. First, I do not expect a repeat of this year’s winners. I expect the winners to be more diverse than this year’s Dedicated Short Biased funds. The winners will be based on their individual security selection skills, which can be found in equities, fixed income and international securities. A top down approach will not be effective enough.

A number of winning portfolio managers will come back from long-forgotten victories, while other winners may be inexperienced investors who did not see the same risks that their colleagues feared.

Let the Games begin...

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