Sunday, July 31, 2016

The Critical Difference Between Experienced and Expert

Selecting winners is part of my game. I am essentially a student of other's investment experience. The general failures to be ready for Brexit and the success of extreme politicians is a wake up call to understand the critical difference between experience and expertise which are also found in the art form of selecting long-term investment winners.

I have spent many enjoyable hours attending classical musical concerts of the New Jersey Symphony Orchestra and other great orchestras and too many painful hours at Operas. Both of these are experiences, but in no way could I become a professional musician. Time spent on an activity lengthens one’s memory of experiences.  Note that the combination of a great orchestra leader and a great orchestra can make the rehearing of a familiar piece seem new and exciting.

We never know what the future brings to us. Will it be an exact repeat of the past or something quite different? The difference in terms of satisfaction and progress can be quite different. Thus we build portfolios of mutual funds and other managers that have experienced experts who have the wisdom to recognize that something is quite different than the past. 

Experienced, Not Expert

The so-called "experts" who predicted the English would vote to remain within the EU and the political pundits who had extreme confidence that the central political forces would keep centralists in political power proved to be experienced not experts. They are not alone in this distinction. Today numerous professional investors including many of the bright analysts and portfolio managers that I have known for over fifty years are very frustrated by the current stock and bond markets. One regularly hears that this is the most unloved bull market. Based on past experience, the current levels are not only unattractive but close to being beyond "nosebleed" levels because past standard ratios are flashing danger signals. The reasons they stay invested are the two abbreviations “TINA” and “FOMO.” (There Is No Alternative and Fear Of Missing Out.)

I like attending repeat performances of music, politics, and investments. I get unnerved with the new, that for which we are not prepared.

Perhaps sharing a Marine Corps tradition with my battle trained Marine Recon. (Reconnaissance) brother has caused me to expect and look for change. In addition, being a senior trustee of what has been recognized as the world's leading research university, Caltech, has very much focused me on looking forward to dramatic changes.

Dr. Simon Ramo

An example of the type of leaders that Caltech has produced is Si Ramo who was entrusted by the US government along with his partner to create a company that developed the intercontinental ballistic missiles which not only gave us many years of strategic security but was an important contributor to our space program. This past week the University, where he was a trustee, celebrated his life having recently died at 103. 

As Dr. Ramo was a globalist, an entrepreneur as well as a member of Caltech's investment committee he might well had noticed that in the first half of 2016 the S&P500  had a small gain of +2.69%,  where Brazilian Dividend Aristocrats were up +82.34% and an index of Low volatility Bovespa stocks were up +77.74%.  Not only did some Latin American stocks do well but many Canadian stocks were up 20% or more. I believe he might have brought up to the investment committee whether these results were just recoveries from deeply depressed markets or had some future portents.

Let me give examples of a very successful experienced portfolio manager with a leading ten plus year record and a single stock that proved that most investors were not the experts that they thought they were.

Many Thought He Was a Great Manager

In the 1960s there was a mutual fund manager whose picture was on various magazine front covers and was world renowned. I studied his portfolio over the years. With rare exception he picked stocks from a list of 120 large cap stocks usually having a portfolio with a list of 60 names. His record was such that he was able to leave one of the strongest mutual fund management houses and start his own fund company that subsequently went public. In the 1970s the market changed as did the market structure and in the end his company disappeared. My analysis is that he was well experienced for the markets of his time, but did not have the expertise to recognize the changes that were occurring or know how to play the new game. (Sound familiar?)

The single stock was one that could well become an entire course in a business school. Started in a garage, the company produced a differently focused computer and developed many new pioneering products, thus creating new market segments over several year, but its financial picture suggested that probably it would go bankrupt.  Its president was fired. Over the next several years he learned to be a businessman and a technological leader and his newly founded company was acquired to bring him back to the company he founded. 

Over the next two decades the company created new products for markets that didn't exist until the new products opened the doors to new markets. As the company became recognized for its technological, stylistic, and business successes, it became the single most valuable company in the world's stock market. This was surprising to many professional investors who came to the party late and as often happens sold out when normal cyclical patterns emerge.

This month, while down from record levels, its earnings came in better than was expected by the virtual cottage industry that now follows the stock. Thanks to dumb luck I have owned a few shares of Apple since the 1970s in part because of the life-changing attitude that my late daughter who was learning-disabled daughter had with the Apple II computer I bought her. She enjoyed working on a device that was intuitive and patient as well as forgiving. The ability to change people's lives suggested to me that this was something different than a number of other computer companies that have subsequently disappeared.

Both of these examples illustrate the difference between experienced and expertise. (Not mine, but Steve Jobs and Tim Cook.)

To some degree we are all captives of our and other’s experiences. However, as investors we should be looking forward to finding elements of expertise.

Are you doing this, and will you share how you are doing it? 


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