Monday, June 13, 2011

The Reformed Broker: Stockpicking is Hard

Josh Brown, over at The Reformed Broker blog, has an excellent post out this morning on the difficulties of "the game" in reference to struggles of some high profile mutual fund managers.   The original Bloomberg piece is here, and focuses on 3 managers - Bill Miller, Bruce Berkowitz, and Ken Heebner.  Miller once had a steak of 15 calendar years where he beat the S&P 500, but has struggled the past half decade.  Heebner had far and away the best 3-5 year records in the entire mutual fund universe up through 2008 (and still has some of the best results over 10 years).  And more recently Berkowitz has been the star, only fading in 2011 year to date, which is a very short time frame to judge anyone.  Ironically the latter two both had cover stories in Fortune Magazine that literally marked the top of their performance within a month or two!  [May 28, 2008: Ken Heebner - America's Hottest Investor] [Dec 10, 2010: Bruce Berkowtiz of Fairholme Funds - the Megamind of Miami]  Not unconnected the assets in these funds swelled at an incredibly fast pace as the crowd chased performance.  To show how fickle investors are nowadays - one bad half year and huge sums of money are being liquidated out of Fairholme.
  • Investors pulled $2.3 billion from Fairholme Fund (FAIRX) in April and May, according to Denver-based Lipper. The fund attracted deposits of $11 billion in the four years ended Dec. 31. 
Miller was also being paraded on a lot of magazines back in the day.


Here is what Josh had to say about the piece:

  • Every market cycle creates a new crop of stockpicking heroes.  And often as not, the next cycle puts those heroes to the test.  And just as often, that test finds our pop-star stockpickers wanting.
  • The tragedy in all this is that humans get emotional about aligning themselves with winners, with managers who appear to know what they're doing or have some kind of sixth sense about stocks.  As a result, the assets under management flow in just as the stockpicker is coming off a peak run.  But intuition and catching on to a good story is not a repeatable process and every generation ends up finding this out the hard way.
Bloomberg reminds us of this lesson in a story about three of our generation's most lauded stockpickers and their performance of late:
Bruce Berkowitz, Kenneth Heebner and Bill Miller, three of the best-known U.S. stock pickers, are competing for last place this year after their bets on an economic expansion backfired.   Funds run by Berkowitz of Fairholme Capital Management LLC, Heebner of Capital Growth Management LP and Miller of Legg Mason Inc. (LM) are the three worst performers among large diversified U.S. mutual funds in 2011, according to data from Chicago-based Morningstar Inc. The funds lost 11 percent to 12 percent through June 9, compared with a gain of 3.4 percent for the Standard & Poor’s 500 Index.
“People assume because certain managers have had good streaks that they are always going to be a step ahead of the market,” Russel Kinnel, director of mutual fund research at Morningstar, said in a telephone interview. “It never works out that way.”

A few things to keep in mind...
    1.  The three managers mentioned here are brilliant and will go into the stockpicking hall of fame regardless of a tough start to 2011.
    2.  Brilliance, unfortunately, does not equal success.  If only it were so simple to just turn your affairs over to the smartest guys you could find...
    3.  Not every manager's skills translate into performance in every market atmosphere The holy grail is to try to figure out which manager or strategy makes the most sense given the mood and action in the tape or the economy.  Easier said than done.
    4.  Famous fund managers are not brands of cereal or classic rock bands.  They do not always taste the same or put on consistent live shows.  Stockpickers, even legendary ones, are working under conditions that they themselves cannot dictate.  They are not doing their thing in a vacuum.  There are too many variables outside of their control for us to regard them as being automatic like a Swiss watch.

Stockpicking is hard.  Even for the best stockpickers who've ever played the game.


I think item 3 is especially important.   While I've ceased trading in 2011 to concentrate on fund launch, I can tell from the market action I'd be struggling a lot more this year than the previous few years since the movement is much less linear and choppy, and some of my favorite names had run up so much by February 2011 there were few options that were interesting on the long side.   Also so much of the moves this year have come in the overnight session it is hard to keep up on the upside with the type of cash I'd be carrying.  Only in the past few weeks would I have seen myself outperforming due to caution.  But no one operates in a vacuum and different market conditions fit different strategies....

It should also be noted that all of these managers run concentrated funds.  Hence its much easier to OUTperform or UNDERperform, versus the majority of equity mutual funds which are investing in 150-250 stocks and mostly are index funds in drag.

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