Should Reputations Have A Sell Date? - Weekly Blog # 562

by: Mike Lipper, CFA
Summary

We have enjoyed a wonderful month; the January Effect has worked so far, with an up first day, first week, and first month. Whether that will deliver an up year is yet to be determined.

The gains achieved in January recovered a good portion of the losses sustained in the fourth quarter.

We will soon have completed a thirty-five-year bull market in bonds, where are the successful bond bear market managers?

Originally published on February 3, 2019

Remember, the way we make judgments is by comparing the new with our memories. Most of what we remember are the results and perhaps the broader conditions of the event. Thus, we remember that Peter Lynch, John Neff, and Sir John Templeton were great equity mutual fund managers. In the US, this Sunday evening, many Americans and others around the world will watch the Super Bowl, which is the game in which we crown the best US football team for the year. For more than a few years, my wife Ruth and I attended these games as part of our responsibility as investment adviser to the defined contribution plan of the National Football League and the NFL Players Association. Because the teams, players, and owners were all our indirect clients, we had to appear neutral. That is why when asked who we were cheering for, my answer was for the black and white team, the game officials. All I wanted was for them to be correct with their calls. Thus, I saw the game differently than a very large majority of the fans. My memory is of the close calls and the correct decisions, where the play needed to be looked at from a number of different angles (One can easily see that I often view things differently than most).

The reason to bring up the LIII Super Bowl this early Sunday morning is not to predict the results, but to use it as a guide in the selection of investment managers and mutual funds. Come what may, one of the key people or perhaps the most important player in today's game is Tom Brady, the 41-year-old quarterback for the Patriots. I believe his first Super Bowl was in 2002. He has been playing this game longer than the majority of portfolio managers. Most winning managers keep on doing the same things that generated their winning season. What makes Tom Brady different is that he modified his game as he aged, as rules changed, and as competitors played differently. In other words, conditions change.

Recently, I was examining a very nicely performing portfolio of equity managers. The bulk of the long-term performance of this portfolio came from a subset of four quite different managers. In some ways this recognition introduced a new future risk element to the portfolio. All these positions had for a long time, not as long as Tom Brady's, generated an above-average record, and their share of the overall portfolio has risen since the decision to add them to the portfolio. Clearly, these decisions had worked. But would they be as productive in the future as they were in the past? One of the lessons from working within the NFL environment was the recognition that on any given game day almost any team could beat another, as a result of conditions changing. This is the same lesson I learned in handicapping my bets at the New York racetracks. While it was comforting to bet on the horse that had the best record, it didn't always produce a winning ticket. Thus, I became less reliant on winning streaks. For me to be comfortable betting on a good record, I had to believe that current conditions were very similar to those that produced past victories.

All too often in selecting managers or funds, almost all the attention is paid to a particular portfolio and its allocation, specific positions, and the portfolio manager. As someone that invests in publicly traded investment management stocks, I am conscious of the benefits and pressures that management organizations place on the manager and therefore the portfolio itself. The owners of the management company can earn money, not only from the investment performance of portfolios, but also from the sales and redemptions of all their vehicles. One of the symptoms of a prior good performer reducing its chances for future performance success is a significant increase of flows into the fund. Although this is generally recognized, all too often the concern is not extended to the management company itself. Political changes evolve along with the flows of money, impacting talent allocation. One of the parallels with Tom Brady and his Patriots team today is that he is the only current player that was also on his first Super Bowl team. This means that the skills of his receivers and defense are different. This also happens more subtly within management organizations through aging, personnel turnover, and technology. Most importantly, the competition changes.

What lessons are learned from these concerns in the selection of good professional investors and mutual funds?

  1. There is no certainty; successful investing is a series of art forms.
  2. Many non-statistical factors should be considered that are perhaps more important than the current excessive focus on fees and investment performance rankings.
  3. What time period is to be used for measuring future success?
  4. What is an acceptable comfort level for a permanent capital loss and the resulting sting of self or external criticism?

Where Are We Today?

  1. We have enjoyed a wonderful month; the January Effect has worked so far, with an up first day, first week, and first month. Whether that will deliver an up year is yet to be determined.
  2. The gains achieved in January recovered a good portion of the losses sustained in the fourth quarter.
  3. What are the chances that we have a repeat of 2018, where a strong January was followed by a problematic February and a volatile year?
  4. We will soon have completed a thirty-five-year bull market in bonds, where are the successful bond bear market managers?
  5. There has been an increase in the number of investment management company mergers and acquisitions. The sellers have a less optimistic view of the future than do the buyers. Talented people throughout the asset management industry need to be reassured that these changes will not affect them negatively, whether their companies are directly involved or not. Most importantly, these changes need to benefit investors for the industry to progress.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.