Sunday, June 7, 2015

Picking Winners at the Track and Market


The skills required to pick winning horses and selecting successful funds are very similar. As I have indicated numerous times, despite my degree from Columbia University, my two real institutions of useful learning were the US Marine Corps and the racetrack.

The Belmont Stakes

For those handicappers, or if you prefer, racing analysts, the Belmont takes on great importance. This race is the longest race for American three year old thoroughbred horses. Most US races on the flat surface are give or take a mile, with the Kentucky Derby a mile and a quarter. The Belmont is a mile and a half with a very long home stretch. Few of each year’s crop of young three year olds have the stamina to compete.

Even though in theory the Belmont is the truest race for these young horses, the results are not often as expected. The same is true in picking funds, but I have an advantage. At the track all the attention is on picking the winner, while often one can make the same money (and take less risk) by being correct on the second place finisher. For our accounts the winning selection is beating the average of the competitors.

Ten factors plus one “kicker”

This year’s Belmont provides me with an opportunity to identify the Ten Factors plus One “Kicker” that can be used in selecting the most probable winner. Each factor is followed by a description of how I also apply these items to my fund selection responsibilities.

Breeding (DNA) Does the portfolio manager come from a background of striving and demonstrates discipline?

Training What are the current demonstrations of personal analytical and portfolio skills?

Raced or trained at Belmont How long has the portfolio and analytical teams worked together?

Weather (this year’s starting time was late, did the angle of the sun matter?)What are the fund's characteristics in up and down markets, not just performance but concrete actions taken?
Soil (composition and slope) Within the organization is there a big advantage to good early performance? What is the tolerance of the entire organization for a “come from behind” performance?

Jockey Is this particular portfolio manager critical to the fund’s success and if so what are his/her strengths and weaknesses?

Trainer As all of us are the product of our learning, who were the critical teachers and what did they teach?

Post position (in the starting gate) Most of the time we are not dealing with a brand new fund. What are the carry-forward implications about sources of cash flows and tax considerations?

Likely early fractions of the lead horse What are the critical time periods for the investors as distinct from gate-keepers and marketing people?

Skill of the ride What is the history of making organizational changes of portfolio managers, key analysts, trading people + trading systems, and marketing people?

Kicker:  The kicker is “racing luck”- unexpected things that no one is ready for. For instance: How does the ecosystem around the portfolio handle both good and bad luck?

Good luck on your choices in the race and picking winning funds

The bond side

Any careful reader of these posts will quickly spot that my mind focuses primarily on equities and equity funds. For a long period of time I have been attempting to get balanced accounts to shed long-term fixed income securities and funds. In 2014 this was a mistake as long-term bonds in general performed better than stocks and stock funds.

2015 is different

My old shop now known as Lipper, Inc., has been estimating for almost all of this year that mutual fund investors have been adding to their long-term Corporate Bond funds both of high quality and high yield types. At the same time they have been redeeming their Domestic Equity funds. What is curious is that the total return of all Domestic Bond funds for the year to date through June 4th is +1.62%. While total return measurements are normally the single best measurement of relative investment performance, in this case it may be misleading to the bulk of individual investors that own or recently purchased bond funds. I suspect the +1.62% is largely the interest paid and often spent. The price value of the bonds and bond funds is probably close to or completely negative. In addition if one takes into consideration taxes and over 1% inflation that the Federal Reserve uses in its calculations, bonds have been a loser.

One of the things that I have learned from handicapping is to ask after a race what was it that I mis-analyzed or didn’t even see? Thus, before condemning the public investor for being dumb, one should look at what would make them seem quite bright. Perhaps, the public is more worried about a renewed recession caused at least in part by future US Fed policy.

Lesson from the winner

American Pharoah won and led the Belmont from beginning to end. He did all he had to get home first with a large lead. The handicapper in me noted that the fractions at the quarter mile and six furlongs were acceptable, but not a record (neither was the final time itself, but it was good). The analyst in me noted that the place or second horse, Frosted,  paid the same as the winner did for winning and was a better money bet than the winner due to less risk taken.

In terms of picking funds the lesson may be enjoy the leader, but there is a safer bet with less risk of an unpleasant surprise (always remember luck). 

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A. Michael Lipper, C.F.A.,
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