The Globe and Mail, Report on Business
Published February 6, 2010
A consequence of being a non-benchmark manager and running a transparent shop is that we are asked direct and incisive questions. At a presentation last week, a client asked what criteria I would use for changing a manager on one of our funds.
After talking about performance, personnel and investment philosophy issues, I concluded by saying that we endeavour to be our managers' most patient client. I added the last comment because if my 27 years in the business have taught me anything, it's that the performance cycles of portfolio managers - the inevitable periods of good and bad - are often longer than the patience threshold of their clients.
To be clear, both the greats and also-rans have a performance cycle. It results from the fact that they're not always right. Indeed, a manager at the top of the charts may only be right 60 per cent of the time.
The strategies that make up the other 40-plus per cent fall into two categories: the "flat-out wrongs" and the "too earlies." The former are ones the manager will never get back - names such as Nortel, Enron, Citigroup and Timminco come to mind. The latter refers to strategies that eventually work out, but take longer than clients and partners can stand. There is an industry adage that says being wrong and being early are the same thing.
Warren Buffett once said, "In stocks, it's very hard to know when something will happen, but very easy to know what will happen." I'm not sure any of it is easy for us mortals, but it's sure tough being offside with a strategy and waiting to see if it's going to work out.
In my view, the difference between a poor track record and one worthy of the hall of fame is how a manager handles the "too earlies." Consider for a minute the ordeal a portfolio manager goes through when he or she is too far ahead of the curve. Their personal diary might read something like this: "I have the portfolio where I want it. I have a big bet on health care and own almost no consumer stuff. I just don't believe the hype about the consumer renaissance. ... A few of my health stocks have been weak lately and I've been adding. Meanwhile, the consumer trend is fuelling the market ... My stocks are looking cheaper, but I'm lagging behind. Last year was a tough one - I was 5 per cent behind the index - and this year isn't going any better. Sales in my mutual fund have slowed to a trickle ... There have been a ton of positive research and media reports on why the consumer is back. Yuk.
"And now the consultants are asking. XYZ Pension Advisers came in yesterday to talk about our approach and philosophy, but they really just wanted to know why I own health and no consumer stocks. ... What will the catalyst be to turn this around? Certainly today's conference call with the management of my largest health care holding didn't do it. Boring.
"My classmate from McGill is on the cover of the ROB Magazine today. She has made a killing on consumer stocks. ... I told a client today that when we're struggling we need to stick to the plan. It didn't work. He wants to see changes. Meanwhile, my fund is in redemptions now and my bonus is heading toward zero. Maybe I'm wrong on this health care thing. ...
"It's official - the consumer recovery is the consensus view. It was referred to as the 'new normal' in the Journal today. Now my partners are asking about it, and suggesting stocks I should look at ... I can't take it any more. I'm going to lighten up on health care and get half-weighted in the consumer sector. If the stocks roll over, I'll still benefit. And we can show the clients we're doing something."
Performance is posted for all to see. Clients and consultants know how portfolio managers are doing at every moment. So being early can be psychological torture, especially when the manager is running counter to a strong consensus. There's nothing worse than being wrong alone.
What makes dealing with the "too earlies" even tougher is the fact that we're all wired for action. In response to the noise and pressure, we want to be pro-active and do something. All of which makes a manager more prone to abandon a strategy at the time when it's most compelling. Or cause a client to turf a manager when his performance cycle is about to turn positive.
When looking for a manager who can beat the indexers, perhaps the best strategy is to hire a highly regarded veteran who has been struggling for a while. Someone who is old enough, rich enough and confident enough to be oblivious to the pressures around him or her, and who shows no sign of changing the approach. A manager who is patient enough to turn some of the wrongs into rights.
When Jeremy Grantham, chairman of investment firm GMO, was asked the secret of his success, he said: "It was simply being willing to lose more business than the others." In other words, he was more patient with his strategy than some of his clients.