In last week’s post we discussed the questions that arise from
examining turnover rates. Most fund
selectors are concerned about too high of a turnover rate. They are worried
that these funds basically rent positions in the stock and are only in “the
name” for a relatively brief period not for the longer-term profit generation
from growth of the underlying issuer. Another consideration is that the costs
of transactions including spreads between actual transaction prices and the
pre-transaction bids eat into the profits of ownership, particularly when
appropriate after-tax costs are considered.
After a series of
visits over the last year with managers who have something of a value
discipline (even though a few claim to have a growth orientation), it was stated that there was a risk that some turnover rates are too low. Their portfolios go for
years with a number of investments that don’t work out. Often these securities
do not totally collapse in price and may eventually go up to a perceived value
price. What is not taken into consideration is the opportunity cost of not
having winners or at least market performance during the elongated holding
period.
Warren
Buffett’s bad lessons
For many investors,
analysts, and portfolio managers we focus on the writings of the two great
names in our pantheon of analytical thought, Ben Graham and Warren Buffett. We
are guided by their words, and not what they actually did or do. Many believe
what Warren Buffett at Berkshire Hathaway* stands for buying good
companies at reasonable (not cheap) prices and holding them forever. Remember
Buffett closed his successful hedge fund to use his own capital to buy a failing
textile business at what he thought was a cheap price. (This flirtation with
bankruptcy is similar to the absolute need to fire Steve Jobs from Apple*.)
Luckily for Warren soon after that experience of being an operating
entrepreneur he got hooked up with Charlie Munger who taught him to buy good
companies with good managers and let them manage all of their companies, except
capital allocation in which he became expert. The biggest advantage that he had
was that he could invest the leveraged float created by his wholly owned
insurance companies. These dollars were used to buy other operating companies
who had unique and strong competitive positions at currently reasonable prices.
With the excess dollars he built a portfolio of investments; some proved to be
short-term like airlines or high income investments that took advantage of
distressed situations which would be paid back quickly if the companies
survived (Goldman Sachs*, General Electric, etc.) In his large cap portfolio he was able
to buy shares of American Express*, Coca Cola, and Moody’s*.
He is selling Moody’s after seeing it has become a much stronger company. His
relatively new two internal managers have a much more eclectic appetite and are
use to higher turnover rates.
Because I don’t have
the advantage of a generally growing float, wholly owned companies carried at
historically low purchase prices in an investor focused book value measure; I
can’t play the same game.
Mutual
funds and other performance-oriented accounts are measured differently
While mutual fund
marketers and regulators try to focus present and future potential investors on
various time periods of 1, 5, 10 years and since inception, the daily prices of
funds drive toward different time period considerations. Any given day can be a
peak or bottom to an important trend which should be measured. The change of
portfolio manager or investment approach could cause a reappraisal as to what
are ongoing significant time periods. Most importantly of all is the relative
performance of competing funds for investors’ dollars. In each period the
relative performance of individual securities takes on different aspects in an overall
portfolio’s performance. A stock price that is flat in a downturn is positive
to performance; whereas the same flat performance is a negative in a rising
market.
The
classical way to teach analysts
Analysts trained
academically, including through the CFA exams, or by large organizations are
taught to find and promote good companies particularly with so-called moats
(impenetrable competitive positions). Notice that these “good guys” are
preferred regardless of price and without any significant attention to
disruptions in the economy, market or sector. As analysts and portfolio
managers get older the attraction to these “good guys” become greater as so
many lesser lights have failed as stocks. Soon the portfolio is a collection of
surviving “good guys” as the other positions have been liquidated. I am
sympathetic to this condition as my personal portfolio is disproportionately
invested in these collection pieces. Luckily for my clients a price/value
discipline keeps both “good guys” and cheaper and hopefully more potentially
promising investments in their portfolios (particularly of funds).
Most
funds are managed by analysts
Most funds are managed by analysts, though in many cases they
still have direct analytical responsibilities. In most cases the portfolio
manager views her/himself as a super analyst and spends the bulk of their time going
over and sharpening the analytical views expressed. All too often analysts
stubbornly believe in their models that produced their list of “good guys” regardless of what the current
market is saying. The super-analyst-portfolio manager having the same training
and attitude as his analytical staff goes along with their views and hence the
portfolios take on the aspect of a collection not a vehicle addressed to the
current market.
The
further training of portfolio managers
I maintain that just
being a good analyst is not enough to be a good portfolio manager. The PM needs
to understand the current and likely future markets; this is learned by
spending time with good marketing people as well as good and bad investors. The
PM has to learn how to use his trading desks not only to get the correct
executions, but a source of market and competitive intelligence. All PMs should
study competitive portfolios and performance, not to copy them because the student
will be late. The key is to understand how the competitors reacted to presumably
the same information that she/he received; given that perspective what is their
likely actions in the future based on different scenarios? PMs as operating officers
should be concerned with the development of analysts, traders, and
administrative people including the compliance forces. The PMs should start to
anticipate changes of direction for her/his own firm. Thus, I believe there is
a lot more to being an effective portfolio manager than being a super analyst.
In
summation
I believe that stubborn
analysts can lead to stubborn portfolio managers who like a stopped clock will
only be correct twice a day or once in the military. The portfolios will not be
in a winning position most of the time. I worry when I see a poorly performing
fund with low turnover rates that we could be experiencing one of the big,
untaught, risks in portfolios: stubbornness.
How
do you correct for your own stubbornness?
*Some shares are owned in our
financial services private fund or personal portfolios.
_________________________________
Posts
No comments:
Post a Comment