As an industry, we are blessed with big personalities. Some of them so big, they crowd out the others. After more than 30 years of working with, managing, comforting, and selecting these individuals, I like to think I have seen it all. I hope, also, that I have learned some useful lessons, such as how to sort the wheat from the chaff.
Finding good fund managers, while the day job of a CIO, is also critically important to wealth managers and investors, and I hope others may learn from my experience.
The common trait shared by fund managers is self-confidence, in varying degrees. If you will allow me some pop-psychology, perhaps I can explain why.
Start with the assumption that most of the people in the industry are above average in intelligence. They may have been used to getting 80% or more right in their schooling.
Suddenly, they find themselves in a profession where being right 55% of the time makes one an absolute genius. Surviving that drop in accuracy requires a hefty amount of self-confidence.
However, I have found that understanding how they internalize the other 45% (or more) is the key to separating the good, the bad and the ugly.
Starting with the worst, ‘the ugly’, there is a type of fund manager who manages the 45% of the time they are wrong by simply ignoring it. Listening to them, you would think that they are never wrong. The internal gauge of their accuracy is stuck somewhere at 90%. They don’t see their errors, they don’t question their theories, and the more the evidence builds that they are wrong, the stronger their egos grow.
In my experience, far from being wrong 45% of the time, they end up being wrong 55% of the time or more and often with spectacular consequences. These individuals are also usually the biggest and loudest personalities on the floor.
I once saw one such individual screaming on the investment floor that one of their colleagues was an idiot for thinking a certain stock would fall. One month later, when the stock collapsed, that same individual proclaimed that he had been negative on the stock all along. These individuals distort truth, make rational discussion impossible and have no place in your investment line up.
In contrast, my experience suggests that the best portfolio managers, ‘the good’, are honest with themselves. Far from ignoring their mistakes, the best of them do not sleep when things are going wrong. They focus on them and want to understand why and learn from their mistakes. They constantly ask ‘am I early, or am I wrong?’.
They check their research, evaluate new facts, and many have a very specific approach to how they judge value in the markets. They often have a defined investment philosophy, believing good investments have specific characteristics, and they test things against that backdrop relentlessly.
Prices can take a long time to reflect value, and these tend to be very difficult periods for these individuals, as their estimate of market value and market pricing may differ substantially. Listening to their arguments at this time is important to ensure clear rather than wishful thinking prevails.
My favorite example here is an individual who over lunch told me exactly how he invests, what he believes in and was honest enough to admit he was difficult to manage as an individual. He convinced me that his approach had been consistent through both over- and underperformance periods and that he believed in it thoroughly.
While he was highly confident in his abilities, he was hungry to engage in discussion on his views, seeking to test them, rather than to browbeat others with them. I was convinced he was a star, and indeed now he is. I remain in his fund to this day.
Somewhere between these two extremes we have ‘the bad’. This grey area is sadly inhabited by the vast majority of investors in my experience. Having no real investment philosophy of their own, they flit between fad and fancy. New stories catch their eye, popular trends drive their views, and they follow the consensus in their valuations. They deal with being wrong by being ‘in the pack’.
They are easy to spot. No great insights, no distinct view and little if any contribution to the process. While there is safety in numbers, there is rarely any alpha.
The most they can hope for is that momentum will carry them for a while. The most damning thing I have heard was when a fellow CIO commented that most of his portfolio managers were ‘just a bunch of gamblers’.
It should come as no surprise, although I think in practice it does, that in evaluating the good, the bad and the ugly, one finds very few that qualify as ‘good’. Investing is not an easy thing to do, and we should not be surprised to find that few do it well.
To me, the truly good investors all share two characteristics. They are passionate about markets, often to the exclusion of all else, and they are self-aware and honest with themselves, constantly learning from their mistakes. They are rare; they are out there, but whatever the marketing material may say, they are unlikely to all be at the same firm.