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.

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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? 

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

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