Monday, March 15, 2010

What Might Be Different Now?

After reviewing a fund's performance track record, within the context of the current portfolio, the No Load Fund Analyst analysts next ask themselves the important question, "what might be different now?" Focusing primarily on funds whose fund managers have provided excellent performance in the past, the issue becomes whether or not the investment process remains capable of providing above average returns in the future.

To start at the beginning of the Investment Heresies eBook, click here

As is typical in the investment world, the list of important factors to consider is probably endless! Analysts are never done asking questions, but at some point a decision is required to overcome analysis paralysis, which results in opportunity costs as well.

Some examples of changes which might raise a red flag for a fund analyst include the size of assets under management and the changing responsibilities of team members. Managing $25 million is a much different task than managing $25 billion! In the fixed income sector, I would argue that managing a billion dollars is easier than $25 million. In the equity markets, that is not necessarily the case. There is also a big difference between managing a $1 billion large cap portfolio and managing the same amount of money invested in small cap companies. Finally, managing a billion dollars at Fidelity is more challenging than at a stand alone company where you don't have to share analysts with fifty other equity fund managers who may also be interested in buying the same stocks that you want to buy.

Ken Gregory and others generally prefer to invest with portfolio managers whose primary responsibility is money management. The best portfolio managers that I've seen love stock picking, and little desire for the administrative side of the business. Most good shops split these duties as much as possible. A senior person may handle most administrative and marketing details, while the Chief Investment Officer focuses primarily on investment tasks.

But responsibilities always change, and usually the most successful managers find themselves becoming more involved in marketing and management. Investors need to ask themselves whether analysts are still analyzing, or have they moved on to other duties. A key analyst may move up to become the portfolio manager of another fund. Has the portfolio manager graduated to levels of greater responsibility and, consequently, been forced to delegate investment decision making responsibility? Even past success, and particularly the rewards which accompany this success, can become a distraction, taking fuel away from the "fire in the belly" which drove the manager to his or her past success.

Garrett Von Wagoner was a case in point. Von Wagoner compiled a stellar record while at the helm of Govett Small Companies, and then left to start his own fund company. Ken Gregory noted that Von Wagoner always had a reputation for doing his own research work, so leaving behind the research infrastructure of Govett was never really an issue. Von Wagoner was used to operating on his own, and had proven himself to be a bright, instinctual investor. However, when he decided to open his own company, he added an enormous amount of work to his daily workload. Instead of just being responsible for selecting stocks, Von Wagoner was now busy managing press releases, hiring analysts and traders, moving the office and attending to the details of opening a business, as well as picking stocks.

As Gregory and the No Load Fund Analyst team considered investing money with Von Wagoner, Gregory felt that Von Wagoner was probably a better investment manager than he was before he started his own firm, however the No Load Fund Analyst wasn't likely to recommend investment in any of his funds until they were convinced that Von Wagoner was capable of repeating his past success in his new environment.

Liz Bramwell provides another good example of why investors should ask the question, "what is different now?". While managing Gabelli Growth, Bramwell compiled an excellent track record. Starting in the late 1980's, her portfolio outdistanced virtually all of her peers. However, much of that excellent performance was compiled during the early years, when assets under management fell below $10 million. In later years, when assets under management mushroomed up to between $700 and $800 million, her performance record was pretty mediocre. While the tremendous early years resulted in a stellar long term performance record, Gregory's research team had to ask themselves whether or not that record would be relevant since Bramwell was managing a much larger portfolio. Does it make sense to use the long term numbers given the different composition of the portfolio?

Invesco Industrial Income Fund provided a third example. That fund also compiled an impressive track record during the 1980's. Its fund manager, John Kaweske, also happened to manage Invesco's sector fund that invested exclusively in health care companies. Perhaps as a result of this special focus on the health care industry, much of Industrial Income's success resulted from its heavy portfolio weighting in a number of very successful health care companies, at a time when the entire health care industry was achieving above average returns. One question Gregory's research team had to ask itself was whether the fund's health care emphasis was a "smart" bet, or merely a natural outgrowth of the fund manager's additional responsibilities of managing a special sector fund. In other words, should Kaweske get "credit" for making a successful sector bet on purpose, or was it happenstance? Did he have a built in bias that happened to work out well, or had he made a good call?

While uncertainties like the three mentioned here are not likely to be overriding factors, they might be a deciding factor when the No Load Fund Analyst team is trying to decide between two funds, and one of them is burdened with these uncertainties.

Successful portfolio managers stick to a discipline. Fund picking is no different. When asked to identify several characteristics that the No-Load Fund Analyst research team hopes to find in a portfolio management team, Gregory answered.that he looks for fund managers that possess traits which Gregory believes are shared by most (or all) successful fund managers.
  • They look for fund managers who have the self-confidence required to be independent thinkers.
  • They seek consistency between what managers say they do, and what actually happens in the portfolio.
  • They want portfolio managers who are disciplined...but not inflexible. Markets change; sometimes fund managers need to re-evaluate their strategy.
  • Gregory's team also looks for fund managers for a passion for the business.
 "In a business where everyone is smart and the work load is overwhelming, you have to absolutely love what you do to have an edge." They seek fund managers whose work responsibilities allow them to focus primarily on stock picking. They want a fund manager who has access to solid analytical support and research information. They evaluate the clarity of the investment approach ("if it can't be well articulated then it may not be all that well developed") and the depth of the research effort, particularly in the small company sector.

Fund picking, like stock picking, requires a well thought out plan, and a disciplined effort to stick to the plan. In other words, it's just like every other business endeavor. Can luck play a part? Absolutely. It's definitely better to be lucky than smart. But good luck is fickle. Solid planning and disciplined research is what wins, consistently, in the long run.

Can you articulate your own investment strategy? If not, is it because you don't really have one?

Next post: What Fund Characteristics Should Investors Seek? 

To start at the beginning of the Investment Heresies eBook, click here

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

Tuesday, March 9, 2010

The Fiduciary Standard

The financial panic of 2008 begs for a political response.  Congress being Congress, and D.C. being the political cesspool that it is, I have little reason to think that the response we get, the Investor Protection Act of 2009, will actually solve any real problems with the additional government and added regulations that are passed, but the debate itself is interesting.  One of the most important debates is whether brokers will be held to the same fiduciary standard as registered investment advisors, like May-Investments, must currently meet.

A recent Washington Post article summarizes the discussion well, but notes the intense opposition of major Wall Street firms, naming Morgan Stanley and Merrill Lynch, specifically.  Now, why anyone is still listening to the culprits from the last fiasco is beyond me.  The financial behemoths blew themselves up with their recent financial shenanigans (a fate more typically reserved just for clients).  Taxpayers had to bail them out, though neither were supposed to have the financial backing of the U.S. government when they were making speculative bets on derivatives and underwriting sub-prime mortgage loans and selling the toxic paper into client accounts.  But still Washington dances to their tune.  It's rather disgusting, if you ask me, which (of course) you didn't.

Check out the article.  It's a great description of the debate.

The issue involves whether or not brokers will be held to the same fiduciary standard that investment advisors must currently meet.  One option being discussed is holding everyone to a "fiduciary" standard, but watering down the standard so brokers could meet it.  That would be a shame, and a sham, which makes it a very likely outcome.  The article notes that another option is to send it to the S.E.C. and study it to death. 

For my money, either investment advisors meet the current standard and are allowed to call themselves investment advisors, or they are not - and must call themselves investment brokers.  The problem is that brokers don't want to be called brokers, anymore, because of the bad reputation that brokers have.  They want to pretend to follow the fiduciary standard, and call themselves investment advisors, while still acting and being compensated for pushing product.

Now, let me say that "broker" is not, in and of itself, a bad word.  I work closely with Retirement Outfitters, which acts as an insurance broker.  What's make them good isn't the compensation structure, but rather how clients are treated within that structure.  Please know that I wholeheartedly believe that there are good brokers out there.

Still, it would be the ultimate irony if the IPA of 2009 is the instrument that brokers use to finally and officially dumb down one of the last real protections that consumers enjoy.  No new Washington department will ever be able to replace the loss of that legal standard.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.






Wednesday, March 3, 2010

Biden's Retirement Savings Proposal

The Vice-President announced new regulations to try to protect employees' investments in qualified retirement plans, such as 401(k) plans.  I made some comments on KREX (link to story) after they called us for an interview.  (They really called Barbara, but she was unavailable!)

The proposal addresses conflicts of interest which occur when plan advisors also give individual participants advice by making it illegal for one advisor to sit in both roles.

As is typical in the investment field, there are complex issues that arise for which a regulatory fix may not provide the intended outcome.

First, regulators have already been trying to move toward full disclosure on fees for several years, yet still many plan administrators lack a full understanding of the fees they incur, which can be substantial in a big plan, yet may remain hidden in various insurance expenses (check the fine print) and when the products use expensive share classes for the funds.  For example, when the index fund option has an expense ratio of over 1 percent, the provider is hiding fees by using more expensive share classes.

This latest "fix" thinks that you can regulate away a conflict of interest issue.  In fact, all advisors have built in conflicts.  Fee-only providers which charge an asset-based fee (e.g. 1% per year on assets under management), like we do, are not conflict-free, as many "fee-only" providers might claim.  When helping clients consider paying down debt, using money that would otherwise be available for investment, there is an obvious conflict of interest.  What makes an advisor trustworthy isn't necessarily the fee regime they have adopted, but rather whether or not they really place clients' needs first.

The unintended consequence of the current proposal that I was trying to discuss during the KREX interview is the possibility that fewer advisors will step in to serve the retirement plan vendors if they are prohibited from taking on former employees as clients.  That would leave employees out in the cold, with less help than they have now (and that's hard to imagine!) if advisors are afraid that wearing the hat of employee education consultant would prevent them from serving individuals from the company in a more traditional client capacity.

Washington always wants to fix things for us, and nearly always makes things worse, and more expensive, through their efforts.  Employers have the incentive to protect their employees from untrustworthy advisors.  I hope that Washington doesn't make things more difficult for everybody in an effort to appear like they are going to bat for workers.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.






Tuesday, March 2, 2010

Airgas Buyout Bid Tops the List

The May-Investments Index of Western Colorado Stocks surged +4.13 percent in February while the widely followed S&P 500 stock index rose +3.10 percent during the month (total return including dividends). Airgas, Inc. (ARG) rebounded off a weak month in January to be the best performing stock in the index a month later (+51.8 percent) while StarTek (SRT), which fell -11.8 percent during the month, was the biggest laggard.

Airgas received an unsolicited merger offer from Air Products and Chemicals for $60 cash on February 5th. A merger would create one of the largest industrial gas companies in the market, but management has asked shareholders to vote against the deal so it’s not clear that it will go through.  Airgas stock ended the month trading at a premium to the cash bid offered. The market has concluded either that another company will come in and make a higher bid, or at the very least that Air Products will have to pay a higher price to complete the acquisition.

StarTek. reported a fourth quarter profit versus a year ago, but the stock has fallen sharply since the announcement. Earnings of 6 cents were slightly below analyst estimates of 9 cents, but more importantly was a miss on revenues, which declined slightly from last year’s levels as opposed to going up, as analysts had expected.

Over the past twelve months, the May-Investments Index of Western Colorado Stocks is up +49.9 percent through the end of February while the overall market has gained +53.6 percent over the same time period. The index began tracking the performance of local stocks three years ago and is down -5.09 percent since it launched, while the S&P 500 has declined -16.46% during the same period of time.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.