Are good fund managers all rebels?

Probably yes. In this article Bill Miller points out what I always thought was obvious: that most active fund managers are just closet indexers. Since starting Ten Talents Capital, I’ve often felt the pressure to make money when my benchmark goes up. This creates enormous temptations to stray from my investment strategy and to buy large cap stocks that track the index. Of course, most managers feel this pressure, especially as the end of the quarter approaches. They understand that their biggest risk is what Jeremy Grantham calls “career risk”. In other words, they would rather keep their job than to make their clients any money. They can always explain away losses so long as the market falls as well and everyone else is losing money too. There is genuine safety in herds.

Of course the herd mentality is operating in most professions. Why stick your neck out for the truth when it just puts you at odds with your colleagues? If you want to keep your job, or stay popular with your co-workers, it’s better to think and say whatever is fashionable. This is clearly to the general detriment of the group. And this is why the active management industry is failing investors, and investors are leaving in droves for Vanguard’s suite of offerings and other passive strategies. Active management needs to offer a genuine alternative to passive if they want to become relevant again.

Unfortunately, distinguishing between luck and skill is very hard. If a fund ourperforms one year, it frequently underperforms the next. Investment styles too (eg. value, momentum, low volatility) go in and out of fashion, see here , or here , or here , or here. It’s been said that the most awe-inspiring attribute of history’s most successful fund manager, Warren Buffett, is his discipline. Buffett has remained (mostly) true to his value investing philosophy for more than 50 years, despite this strategy underperforming the market for long stretches.

Most managers would throw in the towel following this underperformance
This graph shows just how bad things got during the ’90s tech bubble. According to Eric Crittenden at Longboard Asset Management, investors in Buffett’s fund would have lagged the market MORE THAN HALF the time. Indeed, Buffett’s investors have endured some terrible years, such as in 1974 when Buffett lost almost half his investors’ money, and 2008 when his fund lost almost a third of its value. Despite these difficult periods, Buffett’s investors have been very well rewarded in the long run for their faith and patience. In fact, it wasn’t only Buffett that was a rebel; his clients needed to be rebels as well.

During the final quarter of 2016, I felt again the pressure to alter my investment philosophy as my small-cap strategy lagged the market. It’s times like this I need to remind myself that, as an active manager, my job is not to be comfortable. My job is to be different from the herd. I’m sure my parents and teachers haven’t always appreciated my rebellious streak. But in this profession, it really is in the best long term interests of my fund and clients to be a rebel. So at the start of this new year, I resolve to follow my systems with iron discipline, without exception. In the end they will pay off handsomely.

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