Leaders vs. Managers

Introduction

In building a portfolio of funds for clients, essentially the choices are to choose leaders, managers or a mix.

Leaders

This last weekend may show my inclination. We spent the weekend with our enlarged family group of forty-seven, some or all participated in visits to George Washington's home in Mount Vernon, the US Marine Corps oldest base at 8th and I street in Washington for the sunset parade and silent drill team demonstration, and the National Museum of the Marine Corps.

One could build an entire leadership course based on George Washington's life and pursuits. While much has already been written on these topics, for us involved with investing, two themes merit our review. The first is aggressiveness. Before and after his military battles during the American Revolution Washington was an aggressive investor in land. At the time of his death he owned some 70,000 acres all the way into the Ohio Valley. Many of the land parcels he had surveyed years before, but some were virgin territory for him. Unfortunately while he believed in both physical as well as financial planning, he died with lots of land and some debts and very little cash, thus much of his assets had to be liquidated without further development in order to meet his debts. As with most leaders he was ahead of his time focusing on the potential of future development. (He could have used a more competent cash manager.)

Discipline

I have often written about the second important aspect of Washington’s leadership, discipline, which I have learned from my active duty service in the US Marine Corps. On this trip the skills and bravery of the individual Marine was an important focus. The National Museum of the Marine Corps in their displays depicted the bravery and fighting skills of individual Marines. In addition to listening to the very talented Marine Band and the Drum & Bugle Corps, one of the highlights was watching the silent drill team's parade. This  platoon of perfectly selected young Marines go through their routines with no audio commands issued. Their memory of endless rehearsals and the discipline to follow ingrown procedures produced a striking tableau. In addition to the Marine Corps Commandant, the honored guests included  a sizable number of members of Congress who one point wore the US Marine uniform. Perhaps it was no accident that the current Commandant, General Joseph Dunford has been nominated to be the Chairman of the Joint Chiefs of Staff  pending the approval of the US Senate. In that role he will become the chief military advisor to the US President.

At the end of the evening the Commissioned Officers marched away and were replaced by the leading Non-Commissioned Officers to march off the troops returning to the barracks. These NCOs are the real managers of the infantry. They get the job done accomplishing the officers’ orders.


Do you want Leaders or Managers Managing Your Portfolio?

I sit on a number of investment committees as well as managing discretionary accounts of portfolios of funds. One of the characteristics of investment committees is that there is a strong desire for them to reach unanimous decisions. Often there are official or unofficial benchmarks that become performance targets. All too many investment committees react politically by agreeing to the least aggressive strategy, with emphasis on beating a benchmark regardless of the nature of the account or composition and management of the benchmark. By adopting this strategy they are really making the decision in favor of managers who will be graded on how close they come over time to the benchmark. As all too often the benchmark is of individual securities that are assembled without management and trading expenses they are also without the auditing standards normally used by professional organizations. In addition, not much attention is paid to component weights and methodology and the timing of additions and deletions. The drags caused by expenses and the desirability for some operating cash makes it quite difficult for most managers over time to beat securities benchmarks.

If you wish to have superior results from specific portfolios which do not have the low expense ability and/or the need for operational cash, one should take the risks of going with leaders. Leaders are managers doing some things differently than the normal (not currently the best) performers. Because of their relative isolation, leaders can often be strong personalities with some missionary zeal. A complicating factor in choosing  a potential future leader is that often they are not the smooth presenting managers that garner so much of the institutional money. Further, most of the time they have little or uneven performance records. The key to their selection rests on their well thought-out, but different investment approaches.

What Do We Do?

We build a mix of managers and leaders. The managers are selected on the basis of their expense control and their ability to reasonably hug the benchmark. These are then combined with managers that we believe will have a good chance to be future performance leaders.

Question of the week:  Can we discuss our approach with you as applied to your investments?

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Financial Services Stocks: Separating the Walking Wounded from the “Zombies”

As regular members of this blog community know I am a “Civilian Marine” (the term used by the USMC Commandant to describe Marines no longer in uniform) and a manager of a private financial services fund. With these two inputs one can see how I tend to view last week’s news on financial services earnings.

Disappointing earnings for Financials

During the week, a number of large financial services companies reported their fourth quarter and calendar 2010 earnings. With the exception of Raymond James Financial, which we own, most observers were disappointed with the results. I was not disappointed as I did not have very high expectations for net interest income and retail volume. My modest views were due to the recognition that past battles have left deep scars that are now only slowly healing. But as an aftermath of prior battles, one can start to see the difference between the recovering walking wounded and the staggering lurches of what look like “zombies.”

The walking wounded

The recovering walking wounded members of the financial community are showing environmental scars of both low investor appetite for some of their products and services, as well as new wounds from less-than-helpful regulations. These firms will continue to recover as the global economy continues its progress. Their cultures are largely intact as are their senior managements who have worked successfully together for many years. Their survival is largely ensured.

The “zombies”

The “zombies” have not only suffered the same elements of damage that the walking wounded have suffered, but have also endured much more serious and perhaps life-threatening rescue acquisitions. The zombies have added failed cultures to their already weak cultures. In many cases they have had to import outside executives to fix their problems quickly. These are high risk maneuvers which did not play well on last week’s earnings pages.

The significance

Why should diversified portfolio investors pay attention to the financial services stocks? First, in a period of paucity of growth opportunities, much of the available merchandise is selling well below its prior peak prices. If one believes that we will eventually equal or surpass past market prices, then large segments of the market are reasonable candidates for current purchase. The S&P 500 Financial Index is selling under half of its former peak levels. Last week’s decline of 1.66%, gives an interesting window. Second, a bull market not including financials is difficult to imagine. This is particularly true in most of the developed markets, where the financials are the largest single market cap components.

As the fog of past battles (read mistakes) lifts the separation of the walking wounded vs. the zombies, the prudent long term investor may receive an unusual opportunity.

What do you think?

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