One of the most important factors of investment success, and one of the most overlooked, is the thought process that governs the portfolio management itself. Ultimately, this thought process resides in the brain of a single individual for any given portfolio, and yet most investors have never met that individual or had any opportunity to learn the outlines of the thought process that governs his investments on their behalf.
We have explained the reason for this ignorance before, implicating the intermediary system common in the financial service industry, whereby a "financial advisor" or "wealth manager" sends his investors money literally all over the world to be managed by people the investors never meet and whose process they cannot possibly know.
While many complacently accepted this system during the past twenty or thirty years in which it spread throughout the investment world, after the events of 2008 investors (and their financial advisors or wealth managers) are reexamining what they believed to be true about investing.
How many of the investors who had significant sums of money being managed by Bernard Madoff knew what his process was? Obviously, none of them had any idea what his process was and did not understand it whatsoever. Neither did their advisors.
While that is a particularly egregious example, involving a confessed criminal who was actively trying to harm his clients, millions of other investors send money off to be managed by people they never meet, without much more understanding of the process being used.
Even if they do take the time to meet the manager and understand his thought process, that manager will probably be someone else five or ten years later. The investment approach followed by the new manager may share some common elements with the previous process, but unless there has been a long and close association between the predecessor and the successor, the more common result is that the investor will have a new process for the next five or ten years, until the next change of command.
The history of the management of the well-known Fidelity Magellan fund illustrates this reality quite clearly:
1990 - 1992.......Morris Smith......2 years
1992 - 1996.......Jeffrey Vinik.......4 years
1996 - 2005......Robert Stansky...9 years
2005 - present..Harry Lange....will be 4 years in October 2009
When you consider that the investment journey of an individual or family may span many decades, from their 20s or 30s into their 80s or 90s -- and when you take children into consideration the span of time becomes even longer -- this kind of manager turnover is akin to taking a long plane trip and seeing a new captain walk into the cockpit to take over the controls every forty minutes!
It may be argued that no manager can be expected to work for seventy years or more, so arguing over turnover is all relative, but the real issue here is that these changes of managers were specifically seen as a way of "setting a new course" for the fund, as the 2005 article referenced above makes clear.
There is a clear distinction to be made between bringing in a manager who is long and carefully trained in the thought process and discipline that governs an investment portfolio (a process that we would argue takes over ten years to fully inculcate), and bringing in a completely new manager with the intention of "setting a new course." Unfortunately for investors, it is this second type of manager change that is more typical in the investment world.
Less well-known funds with less prominent managers often have even higher rates of manager turnover and shorter manager tenure than the above example. Many funds today will obscure their rate of turnover by claiming that their funds are managed "by committee." While a fund may indeed have an investment committee, ultimately someone must be in charge of deciding differences and making the ultimate decision, just as a military staff may have many different individuals giving input, but one commander must ultimately make the final decision.
Also, this problem is not isolated within the world of mutual funds -- the management histories of separate portfolios tell a similar story, as do the records of the strategists at large brokerage firms who are hired to provide "model portfolios" which brokers can then replicate in their clients' accounts.
While that is a particularly egregious example, involving a confessed criminal who was actively trying to harm his clients, millions of other investors send money off to be managed by people they never meet, without much more understanding of the process being used.
Even if they do take the time to meet the manager and understand his thought process, that manager will probably be someone else five or ten years later. The investment approach followed by the new manager may share some common elements with the previous process, but unless there has been a long and close association between the predecessor and the successor, the more common result is that the investor will have a new process for the next five or ten years, until the next change of command.
The history of the management of the well-known Fidelity Magellan fund illustrates this reality quite clearly:
1963 - 1977.......Ned Johnson....14 years
1977 - 1990.......Peter Lynch.....13 years1990 - 1992.......Morris Smith......2 years
1992 - 1996.......Jeffrey Vinik.......4 years
1996 - 2005......Robert Stansky...9 years
2005 - present..Harry Lange....will be 4 years in October 2009
When you consider that the investment journey of an individual or family may span many decades, from their 20s or 30s into their 80s or 90s -- and when you take children into consideration the span of time becomes even longer -- this kind of manager turnover is akin to taking a long plane trip and seeing a new captain walk into the cockpit to take over the controls every forty minutes!
It may be argued that no manager can be expected to work for seventy years or more, so arguing over turnover is all relative, but the real issue here is that these changes of managers were specifically seen as a way of "setting a new course" for the fund, as the 2005 article referenced above makes clear.
There is a clear distinction to be made between bringing in a manager who is long and carefully trained in the thought process and discipline that governs an investment portfolio (a process that we would argue takes over ten years to fully inculcate), and bringing in a completely new manager with the intention of "setting a new course." Unfortunately for investors, it is this second type of manager change that is more typical in the investment world.
Less well-known funds with less prominent managers often have even higher rates of manager turnover and shorter manager tenure than the above example. Many funds today will obscure their rate of turnover by claiming that their funds are managed "by committee." While a fund may indeed have an investment committee, ultimately someone must be in charge of deciding differences and making the ultimate decision, just as a military staff may have many different individuals giving input, but one commander must ultimately make the final decision.
Also, this problem is not isolated within the world of mutual funds -- the management histories of separate portfolios tell a similar story, as do the records of the strategists at large brokerage firms who are hired to provide "model portfolios" which brokers can then replicate in their clients' accounts.
The sad reality is that the possibility of having the same thought process governing their investments for thirty years or more is very remote for the vast majority of investors.
This is a huge problem for investors, because an individual's or a family's wealth is not determined over one year or even five years, but rather over a period of thirty, forty or even fifty or more years of investing. Research has shown that over these long periods of time, the haphazard process that is practically guaranteed by the intermediary arrangement in the financial services world today has served investors very poorly.
We urge investors to consider the central importance of basing their investment upon a consistent thought process for many decades. We have previously referred to the document written by Mr. Thomas Rowe Price in which he emphasized this critical point, while emphasizing that this does not mean holding the same companies forever.
What we are advocating is consistency of the principles which underlie the selection of the investments. The investments themselves can and must change over the years. Furthermore, Mr. Price himself always emphasized the need for flexibility in dealing with "new eras" of political and economic reality, without abandoning the core process. In fact, we would argue that operating from a consistent foundation of well-tested core principles enables greater flexibility in the face of change -- indeed, it may well be necessary for true flexibility.
Where can an investor today obtain a consistent thought process to govern his investments for thirty years or more?
One sure way is to use one's own process, without farming his investment decisions out to mutual fund managers or anyone else. This is a valid option, and one we touched on at the beginning of 2009 in this post.
For those who do not want to become their own portfolio manager, we would advise looking for an investment firm that does adhere to a consistent process, and can demonstrate that they have been doing so for a reasonably long period of years and that they have a system in place for reasonably ensuring that will continue to be the case for many decades into the future. We have discussed some of the criteria investors should examine in this previous post.
Being able to have the same thought process of investing for thirty-plus years is such a rare situation that today most investors don't even think about it or know how important it is. It is an idea that simply gets no discussion in the traditional financial media. Nevertheless, it is an idea with which all investors should become familiar, and one whose importance to investing has never been greater.
For later posts dealing with the same subject, see also:
Subscribe to receive new posts from the Taylor Frigon Advisor via email -- click here.
This is a huge problem for investors, because an individual's or a family's wealth is not determined over one year or even five years, but rather over a period of thirty, forty or even fifty or more years of investing. Research has shown that over these long periods of time, the haphazard process that is practically guaranteed by the intermediary arrangement in the financial services world today has served investors very poorly.
We urge investors to consider the central importance of basing their investment upon a consistent thought process for many decades. We have previously referred to the document written by Mr. Thomas Rowe Price in which he emphasized this critical point, while emphasizing that this does not mean holding the same companies forever.
What we are advocating is consistency of the principles which underlie the selection of the investments. The investments themselves can and must change over the years. Furthermore, Mr. Price himself always emphasized the need for flexibility in dealing with "new eras" of political and economic reality, without abandoning the core process. In fact, we would argue that operating from a consistent foundation of well-tested core principles enables greater flexibility in the face of change -- indeed, it may well be necessary for true flexibility.
Where can an investor today obtain a consistent thought process to govern his investments for thirty years or more?
One sure way is to use one's own process, without farming his investment decisions out to mutual fund managers or anyone else. This is a valid option, and one we touched on at the beginning of 2009 in this post.
For those who do not want to become their own portfolio manager, we would advise looking for an investment firm that does adhere to a consistent process, and can demonstrate that they have been doing so for a reasonably long period of years and that they have a system in place for reasonably ensuring that will continue to be the case for many decades into the future. We have discussed some of the criteria investors should examine in this previous post.
Being able to have the same thought process of investing for thirty-plus years is such a rare situation that today most investors don't even think about it or know how important it is. It is an idea that simply gets no discussion in the traditional financial media. Nevertheless, it is an idea with which all investors should become familiar, and one whose importance to investing has never been greater.
For later posts dealing with the same subject, see also:
- "Some lessons from 2009" 12/28/2009.
- "The growth theory of investment works" 01/14/2011.
Subscribe to receive new posts from the Taylor Frigon Advisor via email -- click here.
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