Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 294

What game is your fund manager playing?

An excellent article by Shane Parrish on Farnam Street highlights the necessity of choosing to play the long game in order to achieve success in any given pursuit. Investing is no different.

As Shane points out, when it comes to life (and investing) we tend to overestimate the importance of luck on success and underestimate the role of making the small, every day choices that will eventually lead to success. Too often, we convince ourselves that another person’s success was just luck. We comfort ourselves with the idea that highly-successful investors like Peter Lynch and Howard Marks are merely the statistical outliers found in every game of chance. The reality is they aren’t. They are playing a different game to the rest of us. They play the long game.

Success is simply a matter of luck. Ask any failure. - Earl Wilson

The long game is harder than it sounds

With investing, the long game is hard to play, and frankly, it can be dull. It usually involves meticulous research, countless meetings, fact checking, number crunching, statistical analysis and rigorous peer review. But the results can be exceptional. The long game changes how you think about and conduct your investments.

Doing what everyone else is doing pretty much ensures that returns will be average. Doing something different or contrarian takes thought, discipline and a process that gets the details right and minimises mistakes. Doing the small things well everyday eventually compounds into something bigger.

By contrast, the short game involves forgoing the difficult or mundane jobs for activities which feel productive but are often not conducive to better investment decisions. The share market in particular bewitches investors with the promise of riches every day, but it is a conduit for transferring wealth from the lazy to the well informed. Watching stock prices rise and fall on screens, reading the on-line financial press, chatting to stockbrokers, checking emails and trading a portfolio for no other reason than ‘it feels right’ all look like useful activities. They aren’t.

Many activities are simply distractions

These activities are in fact distracting from what investors really need to be doing. Falling into this trap is easy, even for professionals. The short game offers promises of easy gains through ‘foolproof’ trading systems, hot tips from friends and stockbrokers or just because gut feel says a stock is going up or down. It is the difference between investing and speculating. For example:

  • Why study a company’s remuneration report when I can get my favourite stockbroker’s view on it over lunch?
  • Why try to understand financial statements when the latest research shows changes in consensus earnings forecasts are key drivers of stock returns?
  • Why bother with fundamental analysis when I can add value trading the portfolio all day using price momentum and my gut feel?
  • Why write-up questions before a company meeting when I can ring an analyst and ask their opinion?
  • Why think about where a company will be in five years when it’s the next quarter’s earnings that count?
  • And so on …

In the absence of a big chunk of good luck, the negative effects of the short game multiply the longer it is played. On any given day, the impact is small, but as days turn into months and years the results usually compound into disastrous performance. Fund managers who play the short game don’t realise the costs until they become too large to ignore. By then, it is too late.

Playing the long game may mean some suffering today with no guarantee that it will add value. Finding good ideas takes time and patience. Stock pickers have to kiss a lot of frogs before they find their prince or princess. Most people don’t like to suffer and when they see the ultimate success of others, they do not realise the many arduous steps it took to achieve that success.

I fear not the man who has practiced 10,000 kicks once, but I fear the man who has practiced one kick 10,000 times - Bruce Lee

Sorting out the long term from the short term

Many investment managers will say they play the long game, but how do you really know which game a manager is playing?

Short-term performance (5 years or less) isn’t always a clue because managers can get lucky with their stock selection or ride a wave of a temporary positive thematic. Strong, above average performance over 7-10 years is good and over 20 years is great. It’s much harder to fluke long-term returns.

Stock turnover is another good indicator. Fund managers who are playing the long game rarely have high stock turnover above 60% or more because good ideas are so hard to find and detailed research takes time. Knowing exactly why you own a stock is the key to weathering and profiting from share price volatility. Not having an investment thesis leads to wild and erratic share trading that destroys returns.

Another clue is a clearly articulated investment philosophy and process for beating the market. Do the manager's actions and stock holdings reconcile with their articulations? A good stock picker should not hold a portfolio of 300 names, for instance. Few individuals can know more than 15-20 stocks really well.

Manager incentives can be a good guide. Manager incentives can be heavily weighted towards short-term performance which can lead to behaviour that is in the interest of the fund manager but not in the best interest of the client. An incentive scheme that is weighted towards long-term performance better aligns the interests of both parties.

Firm ownership can also be important. Playing the long game can lead to periods of underperformance. Having an ownership structure that is supportive during periods of underperformance ensures the interests of clients are best served in the long run.

Playing the long game doesn’t guarantee success but it is a key to achieving success. While some people win through sheer dumb luck, they are the tiny minority. Picking a manager who is playing the long game is the best way to maximise the chance of achieving compound investment returns that are materially better than average.

 

Charles Dalziell is an Investment Specialist at Orbis Investments, a sponsor of Firstlinks. This report constitutes general advice only and not personal financial or investment advice. It does not take into account the specific investment objectives, financial situation or individual needs of any particular person.

For more articles and papers from Orbis, please click here.

 

RELATED ARTICLES

Unfortunately, all fund manager presentations are good

Five reasons fund managers don't talk about skill

Smart beta funds complement active without key person risk

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

Avoiding wealth transfer pitfalls

Australia is in the early throes of an intergenerational wealth transfer worth an estimated $3.5 trillion. Here's a case study highlighting some of the challenges with transferring wealth between generations.

Taxpayers betrayed by Future Fund debacle

The Future Fund's original purpose was to meet the unfunded liabilities of Commonwealth defined benefit schemes. These liabilities have ballooned to an estimated $290 billion and taxpayers continue to be treated like fools.

Australia’s shameful super gap

ASFA provides a key guide for how much you will need to live on in retirement. Unfortunately it has many deficiencies, and the averages don't tell the full story of the growing gender superannuation gap.

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Latest Updates

Investment strategies

9 lessons from 2024

Key lessons include expensive stocks can always get more expensive, Bitcoin is our tulip mania, follow the smart money, the young are coming with pitchforks on housing, and the importance of staying invested.

Investment strategies

Time to announce the X-factor for 2024

What is the X-factor - the largely unexpected influence that wasn’t thought about when the year began but came from left field to have powerful effects on investment returns - for 2024? It's time to select the winner.

Shares

Australian shares struggle as 2020s reach halfway point

It’s halfway through the 2020s decade and time to get a scorecheck on the Australian stock market. The picture isn't pretty as Aussie shares are having a below-average decade so far, though history shows that all is not lost.

Shares

Is FOMO overruling investment basics?

Four years ago, we introduced our 'bubbles' chart to show how the market had become concentrated in one type of stock and one view of the future. This looks at what, if anything, has changed, and what it means for investors.

Shares

Is Medibank Private a bargain?

Regulatory tensions have weighed on Medibank's share price though it's unlikely that the government will step in and prop up private hospitals. This creates an opportunity to invest in Australia’s largest health insurer.

Shares

Negative correlations, positive allocations

A nascent theme today is that the inverse correlation between bonds and stocks has returned as inflation and economic growth moderate. This broadens the potential for risk-adjusted returns in multi-asset portfolios.

Retirement

The secret to a good retirement

An Australian anthropologist studying Japanese seniors has come to a counter-intuitive conclusion to what makes for a great retirement: she suggests the seeds may be found in how we approach our working years.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.