What distinguishes the best performing investment managers from the rest? It begins with a strict adherence to deeply held principles and an unwillingness to stray in the midst of all the daily investment noise. We have been able to identify six traits that are common among these managers. Interestingly, these characteristics have proven constant over long periods of time. We hesitate to call them “timeless” but it is a great starting point as we identify investment managers for our client portfolios.
Hold a concentrated portfolio – While the concentration level of any portfolio will reflect its manager’s tolerance for risk, the level of diversification exhibited by many mutual funds – holding 200 to 300 stocks – is “closet” indexation. Managing to the goal of never doing worse than the market virtually assures that the manager will never do enough relative to the index to justify the effort and fees. Many successful managers concentrate their portfolios around their most compelling investment ideas, often holding as few as 20 positions.
Focused effort on understanding the business, valuation and associated risks – Managers with the most admirable long term track records are not obsessed with market volatility or predictions about the direction of interest rates, inflation, trade deficits, tax policy et al. They ignore political and economic forecasts which are expensive distractions for many investors and businessmen. Forty years ago, no could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points or a Treasury Bill yields fluctuating between 2.8% and 17.4%. None of it, predictable or not, impacted the focus on their investment process and emphasis on the underlying economics of the businesses in which they invest.
A willingness to hold cash – When utilizing a bottom-up approach, significant cash balances are a result of a lack of investment opportunities. To borrow Warren Buffett’s expression, “holding cash is uncomfortable but not as uncomfortable as doing something stupid.”
A long time horizon – According to Morningstar, the mutual fund industry’s average stock-holding period is just one year. Successful investment managers often have holding periods of longer than five years. As Warren Buffett and Charlie Munger have noted on many occasions, “If the job has been done correctly when a common stock is purchased, the time to sell it is – almost never.”
An acceptance that they will have years that they will underperform a comparative index – Even the most successful manager’s experience periods of negative returns relative to a benchmark. They may even see large redemptions of assets from their management during these periods. The renowned investment manager, Jean-Marie Eveillard has said, “I would rather lose half my shareholders than lose half my shareholders money.”
A sense of fiduciary responsibility – Ethically, in a world where managers are usually paid based on the value of assets they manage, the most successful long term managers are mindful that there are limits to the size of funds they can manage. That being said, the best managers have demonstrated the willingness to close to new investment.
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