Sunday, November 30, 2014

Thanksgiving and Investment Performance


Most cultures have a harvest festival where people give thanks for what they have gathered. I am particularly blessed by the opportunity to communicate with such intelligent people globally through both this blog as well as through my investment responsibilities. One of my investment blessings is uncertainty as to the future. Contrary to many people’s belief, uncertainty is the arena where most investment gains are made; as various elements sort themselves out prices will react appropriately. However once things become crystal clear the vast majority of the price movement has been achieved. Thus I am thankful for levels of uncertainty as I attempt to deal intelligently with expectations.


Faithful readers of these posts know that I visit the nearby Mall at Short Hills each Thanksgiving weekend. My report this year is mixed. By far the biggest attraction with long lines of grandparents, parents, and children was an expansive display of products and photos based on Disney’s “Frozen.” I marvel as how successful the “House of Mickey” has been with a product that was in public domain that they didn’t invent, but brilliantly promoted. The other big winner was apparently the iPhone and related merchandise. The large Apple* store was jammed, but did not have outside lines. A much smaller Verizon store was quite crowded. AT&T’s much too large store had a sprinkling of people within it. While this mall ranges from mid price points to high prices, the high-end stores looked quite empty. My walking conclusion is that it will be a good season for Apple and not so good for high-end shops. I do not have a big feel for the purchases over the Internet. Some retail groups have jumped on to it, Macy’s claims that it is the fifth largest seller on the net.
*Owned by me personally and/or by the financial services fund I manage

From an economic viewpoint the absence of many “must have” purchases may mean that the savings (not spending) ratio will not retreat from its current 5% level. The use of debit cards is probably not going to soar.

Liquidity concerns

One set of expectations on the part of members of the SEC is the rapid redemptions in bond funds and ETFs when interest rates begin their “inevitable” rise. Quietly they are asking leading fund groups and their independent boards about plans to handle the expected tidal wave. Curious to me they do not appear to be as concerned about equity liquidity which I believe under the present shortage of trading desk capital could react just as quickly. In terms of investment performance in both the debt and equity markets, it has paid off to invest in large, but illiquid positions. We will be watching intently as to how those portfolios that have been more illiquid than others handle any significant squeeze on liquidity. (More on this relating to performance below.)

Longer term economic expectations

Pensions & Investments magazine (P&I) and Aberdeen Research conducted a poll on Macroeconomic expectations over the next ten years by region. The majority of respondents would improve as shown in the following ratios of improvement vs. decline:              

Market Location
vs. decline
Emerging Markets
47% vs.13%
Frontier Markets
36% vs.
33% vs.
31% vs.
16% vs.
non-US dev.
11% vs.
9% vs.

Other major regions including US, UK, and Europe were expected to have deteriorating macroeconomics over the ten year period. I have little confidence that these projections will work out as expected. However, I believe that they are useful in understanding current price/earnings ratios in these markets.

Performance analysis

One of the elements that I am thankful for this holiday is that we are in deep discussion about managing one particular new account’s money. A vital key to a high level of satisfaction is to agree as to what is important to be measured. I have difficulty determining a worse measure to make decisions as to hiring or firing a manager than raw absolute performance or even relative performance to some securities index. These are not the primary tools we use in selecting funds for a portfolio of funds. As J.P. Morgan himself stated, he only loaned money on the basis of the borrower’s character. Thus we want to understand the managers as individuals.

We also recognize the need to be patient and that is why we look at long-term developments.

There have always been some spectacularly performing managers often with very successful sales people attached that I do not believe. Many times when I dig into their records I find a particular, undisclosed relationship that is the main engine of their success. Some of these engines can keep functioning for a number of years until they are found to be wanting. One of the keys to our analysis is to try to determine where the good and bad performance come from. In some cases all of the extreme performance comes from a limited number of securities. I remember one quite ordinary fund with a skilled portfolio manager salesman touting its good performance. When I looked further into the fund’s performance I noticed that all of the truly great performance was coming from a single analyst. I suspected that he would quickly find better employment elsewhere. When that happened the air was let out of the fund’s good numbers which eventually led to the sale of the management company.

The significance of turnover and fund flows

A rapid turnover producing a good record is not as valuable to me as one whose portfolio is turned over more slowly. The first fund may possess trading skills which are often relatively transitory while the second one may have real selection skills. As even the best investment managers have periods of significant underperformance, we need to understand both the causes of the underperformance and what the manager does about it. The impact of cash flows and how they impact the portfolio has a distinct implication to evaluating the result. Often a surge of money coming in can overwhelm either the position size or the number of holdings. (An important corollary of the surge is what the organization does with its increased profitability. Does it change the life style of the key investment personnel?) Withdrawals or redemptions can reverse some of the behavior changes. However, we are not disturbed by the outflows. I have never seen a portfolio that couldn’t benefit from some pruning.

The question that I am currently grappling with is how to introduce sound judgment into the investment performance question. With the large group of very intelligent investment professionals and sound investors reading these words, I appeal to you for help. Your assistance will give my accounts and me something to be thankful for.
Comment or email me a question to .

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