Sunday, August 15, 2010

Investment Selections Improve with Adjustments Before Eliminations

Too many mutual fund and separate account managers are selected by bracket rankings as used in basketball, World Cup football (“soccer” as we call it in America) and tennis, unlike golf and horse racing. In the first three sports, the winner and other high ranking finishers are derived from their last bracket victory without the recognition that some losing competitors are materially better than some of the winners of weaker brackets. In other sports analysis, sophisticated watchers adjust the results for many variables such as the conditions of the competitors and the conditions of the competition itself. Intense followers of sports are not the only ones to adjust their thinking and actions before their rooting begins.


This weekend Ruth and I had the pleasure of listening to the Boston Symphony Orchestra (BSO) and the Boston Pops, both in concert and in rehearsal. Each of the overlapping groups was made up of very talented professional musicians probably at the heights of their musical careers. Nevertheless their equally talented conductors clearly modified how each piece of classical music was played. In watching and listening to the maestros one could detect adjustments they wanted the performers to make in well known pieces that have been played, in some cases, for hundreds of years. I am not a music critic, but I recognized that some of the adjustments made during the performances were similar to the adjustments that I believe should be made when examining the performance records of various equally talented investment managers.

Looking at the parallel adjustments between the two very different art forms can be instructive. In each case the conductor knows that while past performances can be illustrative of the desired future performance, today’s conditions (known and unknown) are different.

Pieces of music and individual stocks, bonds, or commodities were originated to stand on their own. In the real world they are going to be used in conjunction with others, e.g. a Beethoven program, overtures to great operas, love themes through the ages, the development of the American musical, etc. An individual security may be only one component of a concentrated portfolio with a singular focus, or a broadly based portfolio to participate in a general market movement, or an asset allocation portfolio, etc.

A great concert is not just a collection of individual pieces of music, it should be one with a point of view. Similarly, a successful investment portfolio is not just a collection of currently highly performing positions. Thus, I look beyond the aggregate performance of a fund to see how many securities contributed meaningfully to the overall performance. To my mind, a fund with one or two spectacular winners, (particularly if they are initial public offerings or from one segment of the market) is very different than a diversified portfolio producing similar results.


While the great maestros can get better results from each of their players on any given day, there will be a range of skills delivered, just as a portfolio manager needs to recognize the different level of research that he/she is utilizing. Some fund managers rely on a deep culture of professional research analysts within their shops, such as the American Funds (Capital Group is their manager), T. Rowe Price, and Janus. They will give an investor a steady result different than a brilliant solo performer like Fairholme. Good orchestra leaders vary their programs and interpretations to a lesser degree. Portfolio managers are selected by the turnover of their audience (shareholders) which are often a demonstration of time horizons. CGM Focus has attracted short term investors by its volatile and sporadically good performance but has a very good long term record. Other funds with solid long term records who are able to buy bargains in down markets because they raised cash in high markets attract long term investors; good examples of these are the various Mutual Shares funds, the Dodge & Cox equity fund, Longleaf, plus some of the Ariel and Marsico funds.


Many (if not most) of the members of this blog community are serious professional investors. You manage money for yourselves and for your clients. What distinctions do you apply when looking at fund records? What eliminations do you make from the leader lists? What filters are you using and will you share any with us?


Before leaving the BSO and the Boston Pops there is another important contributor to their beautiful music that I should acknowledge. Over many years the BSO has built a very large community of contributors. As a contributor and investment advisor to numerous non-profits, I am envious of the size and composition of their program book’s advertisements and endorsements. As with portfolio management organizations, producing good results over time is rewarded with capital that promotes successes in future generations.
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