The Globe and Mail, Report on Business
Published August 22, 2009

Being an analyst or portfolio manager means you are destined to make lots of mistakes.

They say the great ones are right 60 per cent of the time, which means they're wrong 40 per cent of the time. There aren't too many professions where you're allowed to miss that often. Baseball or basketball players, perhaps, but if you're an air traffic controller, heart surgeon or goalie, you won't last long at 60/40.

When I'm hiring a portfolio manager, or monitoring one, more than anything else, I'm studying their temperament and investment process. That's because I assume that all candidates have the technical skills and experience, but the ability to deal with failure and keep to a discipline in good and bad times is a rare trait.

Temperament covers a lot of ground. It means having the confidence to stick to your convictions in the face of noise and distraction from clients, media and other industry players. It's difficult to prevent extraneous information from obscuring the important variables in a decision. For instance, if poor short-term earnings or management changes are negatively affecting a stock, it may be an opportunity to buy at a lower price rather than a reason to abandon a long-term investment thesis.

A manager with the right temperament has the ability to buy stocks while others are panicking and sell when they're euphoric. It's easy to say that the best opportunities occur when the consensus is strongest, but at such times of great certainty, it takes a special person to go the other way. The analysis might point toward bold action, but when it comes to moving on it, there's no support or reinforcement from others. The manager feels as though he or she is totally on his or her own.

To get a sense of a manager's temperament, it's important to look at how she's dealt with adversity in the past. I'm referring to periods when returns were negative and/or performance was poor relative to the indexes and other competition. Did she stick to her philosophy and decision-making process at a time of maximum stress? Or did she make matters worse by bending her own rules or implementing major changes at the bottom?

The great managers don't let a bad patch freeze them up. They know that if they're going to have good calls in the future, they have to continue making calls. If they get too focused on trying to eliminate the bad, they miss the good.

In addition to temperament, I want managers that know how they are going to succeed. There are plenty of ways to skin a cat and a manager needs to know how he is going to do it. Essentially, I'm looking to see if he is analyzing his own business and personal franchise with the same skill and intensity he brings to his portfolios. It's always been surprising to me how many managers dive headlong into annual reports and spreadsheets and forget to assess what their competitive advantages are, in which sandbox they want to play and how they are going to win at the game.

That was particularly evident to me when I interviewed firms to manage the Steadyhand funds three years ago. Two of the short-listed candidates for the global equity fund used the same stock (Tesco, a British grocer) to demonstrate their investment process. In both cases, the work was impressive and thorough, but it was a stark reminder that there are a whole bunch of smart people out there doing the same thing. It's hard to consistently out-analyze, out-spreadsheet or out-interview the competition, especially when it comes to large, well-covered companies.

Since last fall, I've been asked many times what I'm watching for in our fund managers. As always, results are important, but the analysis has to go further, especially in extreme markets such as the one we've been going through.

I'm looking to see if the investment process is being followed — is it still bottom up, stock by stock, or are economics and technical analysis suddenly having greater influence? In light of the fact that everyone in the industry is beaten up, I'm watching to see if our managers have lost their nerve - is their assessment of value reflected in the trades they're making and the positioning of their fund? And, specific to the recent period, I was watching to see if they had more risk in their portfolio after the meltdown (when there was less risk in the market).

In this always perverse profession, managers are going to get many things right, but they'll make lots of mistakes in getting there. That's why the right temperament and an entrenched investment process are so important. For my money, the next best thing to being right for the right reasons is being wrong for the right reasons.