Interaction of My Investment Muses by A. Michael Lipper, CFA
Almost every year on the Saturday evening nearest to February 22nd, my wife, Ruth, and I attend the birthday dinner celebration for George Washington, the first and greatest US president.At each George Washington’s Birthday celebration, The Mount Vernon Ladies Association* presents a thought-provoking after-dinner speaker. This year’s speaker was Walter Isaacson, the scholarly author and biographer of great Americans from Benjamin Franklin to Steve Jobs.
He is also the current president of the Aspen Institute, whose summer sessions I have attended. His talk at Mt. Vernon focused on the comparison, contrast, and coordination of George Washington and Ben Franklin.
We all react to various inputs into our daily lives through many filters, but most often we react through the singular vision that guides our intellectual actions. For my sins, I tend to think about my roles as a fiduciary investment adviser and investor in mutual funds and similar vehicles as well as an investor in selected financial services stocks. My reactions to the Mt. Vernon dinner speech are within this context.
While Mr. Isaacson’s talk was about these two great Americans’ political evolution from different starting points, I could not avoid thinking about the inputs these two successful leaders and entrepreneurs would have on my portfolio management and investment challenges of today.
Think about the character of George Washington, the military leader and major farm landowner, who was willing to face unknowns against long odds of success in his search for his own and his country’s growth. In contrast was Ben Franklin, the poor boy who looked for inexpensive strategic investment at bargain prices.
While Dr. Franklin’s successful commercial ventures focused on his editorial and business skills as a publisher, too little attention is paid to his initiation of a colonial postal system where mail could go from Massachusetts to Virginia directly rather than being routed first through London. In effect, this postal system became the glue that allowed the separate and fractious colonies to begin to evolve into a somewhat unified country
Washington: Growth, Franklin: Value
Intellectually, through my narrow eyes, I perceive George Washington as our first growth-focused investor leader and Ben Franklin as our first innovative value seeker. These were the progenitors in the more modern world of Warren Buffett and Charlie Munger as future-focused “growth” investors (both of whom I am looking forward to hearing at their Berkshire Hathaway** annual meeting this year) and Ben Graham and Sir John Templeton as value-focused investors.
Long-time readers of these posts and my book Money Wise have learned that I was first educated about security analysis by handicapping (analyzing) at the race track.
The key to regularly coming away from the track as a winner was first to avoid losers by not having a betting interest in every race and being highly selective in betting on the difference between the probabilities and the odds dictated by the weight of other people’s money. I try to apply the same general approaches to selecting funds for portfolios of funds and individual investment management stocks.
These processes are very different from reading the standard Request For Proposal (RFP), which is a highly quantitatively driven search filter for institutional management mandates. These documents’ authors believe that they are dealing with commoditized skill sets that can easily be selected quantitatively.
Going back to my racetrack education, I recognize that this approach leads to backing favorites. A study of past betting results (past performance) reveals that favorites win a minority of the time, and when they do, the returns are low and usually can not meaningfully offset the losses when the favorites don’t win.
To me, successful selection is much more an art form than a science. The art form has to do with understanding the way particular people work successfully in competition and combination with other skilled players. Thus, to me, the key skills of selection are more akin to the brilliant curators of museums than mathematical screeners. The great curators mix some of the talents of George Washington and Warren Buffett, looking for growth beyond the present, and the two Bens (Franklin and Graham), innovative bargain purchasers.
Understanding the development process
In general, most equity portfolio managers start as security analysts, as I did. Many fixed income managers start off on a trading desk. Why is it that there are considerably more analysts and traders than institutional portfolio managers? Is it the normal pyramid of responsibilities and related compensation within institutional management organizations?
Yes, that is one factor, but it is not the only one. Good analysts and traders — those with winning records of selections — are absorbed by their focus on essential details of particular investments in the current time frame. But this kind of highly competitive knowledge is not enough to make good portfolio managers. The big hurdle that these bright people need to get over is similar to the selectors using RFPs to pick managers.
A collection of securities having very similar characteristics is like a symphony orchestra that can all hit the equivalent of high Cs, or a museum that shows only all the artwork of an artist produced in a single year of his or her development. The risk in such a collection is the likely homogeneity of results when impacted by the unknowns that occur.
George Washington thrived on dealing with the unknowns that others did not perceive. A sound portfolio can survive and prosper under a number of different conditions, including the unexpected. This requires moving away from the comfort zone of intense knowledge and into the spheres of the less known. Many analysts and traders can’t comfortably make the jump.
Just combining securities of different natures is not good enough; portfolio managers need to have an effective knowledge of trading desks. They need to understand what kind of trading orders their traders can execute well, including the difficult trades. Often the trading desk is the first source of the recognition that something is happening in a particular security, sector, or market. I view traders as an important source of market intelligence. Apparently false rumors that could be true are often as important to the future as facts that turn out to be true.
Additional concerns of portfolio managers
A working knowledge of compliance is a necessary set of skills for today’s portfolio manager. Many smart and essentially honest analysts, traders, and portfolio managers stray over the somewhat-indistinct lines of legality and ethics. Their perceived obligations to clients often lead them to inadvertently breach a compliance barrier, which can prove to be expensive for all concerned.
Another skill in the real world is the ability to manage the portfolio to fulfill its marketing position. This is what the customer expects. Part of the commercial responsibilities of a successful portfolio manager is often to become a spokesperson for the particular product or the firm. Some senior portfolio managers move up their corporate ladders and become managing executives with responsibility for managing people, including difficult people like themselves. Most are unprepared for this by their formal education or by the CFA Program readings and exams.
Every now and then, former analysts I have known move up through their organizations and become CEOs of their firms, including some which are publicly traded. As one moves up in this world, one’s