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One common thread among great investors who get featured in books is the fact that almost every one of them got rich by managing other people’s money for a fee that allowed their own capital to expand over time.
William Green in his recent book has written about the process of some well known fund managers and a couple of not so well known fund managers. What appealed to me was that this work did not come out after one year of extensive reaching out to fund managers but something the Author has done over 20 years and more and it shows in the depth he is able to go into.
The commonality I could find among all of them,
Most fund managers, featured here or otherwise, are generally rich enough to not worry about where their next meal is coming from. They continue to manage funds though not because the next million dollars they earn will change how they live (though it doesn’t harm to have a few million dollars more) but because they like the challenge that the market throws at them. This quote from another book, The Money Game puts that into perspective
Almost everyone, other than John Templeton advise that while they have achieved greatness through active investing, an ordinary investor is better off with just an Index fund. Given that these guys are the cream of the fund managers society, this showcases their belief of how tough it is for a small investor to be able to generate returns that are greater than what could be achieved much easily by way of a low cost Index fund.
Keeping costs low is another piece of advice and one that goes well along with Index funds. Yet, costs are the most ignored aspect by a lot of investors. Mutual Funds are seen as Expensive while Advisors are seen as cheap while it’s actually the other way for most small investors.
Interesting Trivia: Joel Greenblatt started Gotham Capital in 1989. After 5 years in running, the fund returned half the investor’s money, at 10 it gave back in full, preferring to manage their own fortunes. With a 50% CAGR during the first 10 years of operation, the performance fee would have added up to a capital the partners would have felt sufficient to trade / invest on their own without having to be answerable to anyone else.
Likewise is the emphasis on Risk Control. As McLennana says,
The future is “intrinsically uncertain” that investors should focus heavily on avoiding permanent losses and building “a portfolio that can endure various state of the world ”
Of course, it’s not that they all believe in similar things. Mohnish Pabrai follows and believes in the art of holding a concentrated position in line with his guru Charlie Munger. McLennana on the other hand believes that concentration enhances risks and would rather be well diversified. His fund has a portfolio of around 140 stocks.
The chapter “High Performance Habits” could have been a book in itself. While there is the tendency to boost things and the small thing about only winners being profiled, it still showcases what it takes to win in the competitive world of investment management.
If you are looking to learn something new, you may be disappointed but the book is an attempt at reemphasizing what many a time we know in our hearts but one that we tend to ignore when the sentiments of the crowd start to crowd out our thoughts. The book is dense at times, but well worth the time spent.
Overall I would rate the book 4 out of 5. A worthy read for both new and experienced investors.
The other day I received an email from someone who is currently a student but wishes to pursue a line of work that one day will lead to him becoming a fund manager. While everyone of us have their own reasons as to why to become a fund manager and take the trouble of not only having to manage our own emotions that come tied with the funds but the emotions of others, one uniform reason many choose that route is the leverage, something I touched upon in a short Twitter thread a few days back.
Common Thread among all Great Investors
Have a very strong conviction to a process you believe in. It may be Value or Growth, Concentrated or Diversified, Top Down or Bottoms up. The choice is yours, but choose one
When we talk about Leverage, we always think of Derivatives for that is how the majority of investors perceive and are able to access. A secondary way is margin trading and finally leverage by way of personal loans and commitments.
Most traders go bust – the odds of long term success is incredibly hard. This is more with traders whose capital is too small to start with and hence are forced to take higher leverage to make it work. A single losing streak of trades is enough to destroy them even if the strategy they are following has a long term positive expectancy.
A few, just about go on making money and losing money with little to show overall for the efforts and time spent. Success is always so close and yet so far for these folks – it’s like the Carrot and Donkey. Always visible just across the horizon, but unable to reach. Yours truly belonged in this camp for a really long time.
Then there are the Unicorn’s, the true blue real deals (and not just Twitter Screenshots). They are incredibly successful (the money of the losers have to go somewhere) and barely wish to be seen. Even with these folks, it’s normal to see some of them just burn out from the day to day pressure that trading forces upon oneself.
How rare are these folks? Well, Nitin Kamath of Zerodha had this to say about Successful Option Traders.
The number of people I know who have traded options profitably for over 10 years = People I know who have started and run a business successfully (adjusted for tougher entry barrier to start a business) for > 10years. Approximately 1 in 10000 or 0.01%. 1/2 https://t.co/dz4LGrTLRohttps://t.co/6UR4wtzzQ2
Which reminds me of this scene from the movie, The Mask
While it’s not Luck that takes you from being no one to being someone, Luck is a very important catalyst that you cannot do with. For starters, assume you are both lucky and not lucky. Even the most successful traders have seen very hard times including bankruptcies but have been able to overcome them all.
Leverage as implemented using Derivatives is a double edged sword. You make it good when things are going your way but can end up losing a substantial part of your capital. With the odds of success being as it is, it’s not surprising to see thousands of books, hundreds of seminars and talks and a variety of tools that promise that you can become a better trader. But the truth is that it’s more profitable to sell dreams aka shovels to enterprising traders than become a trader oneself.
The people who made the real money in America's gold rush were those selling the shovels, picks and pails.
— Jim O'Shaughnessy (@jposhaughnessy) July 5, 2020
So, how to get leverage without running the risk of personal bankruptcy if things go south? One way is to become a fund manager. Of course, becoming a fund manager is neither a simple process or a cheap one these days, but who said it’s easy.
Let’s take the case of one Mr. Warren Buffett. We all know his story of how he started earning money delivering newspapers and invested the same. As much a success he was in other ventures such as PinBall machine operator, his big bet on Geico where he invested 65% of his wealth in 1951 among others. He was incredibly talented as well as lucky in many ways. But that was not what provided him the foundation that led him to become one of the richest men in the world.
Between 1949 to 1956, his net worth (Income from Salary / Business) grew at a phenomenal rate of 70% per Annum. But what transformed a substantial (for those times) sum of money to being a Millionaire and later a Billionaire was his partnerships.
In 1956, Buffett started his first of the many partnerships he would have over the coming years. He himself invested $100 while raising 1,05,000 from family and friends (as he has said himself, he had won the Ovarian lottery). To give a context, in 1956 the average income of all families was estimated at $4,800.
Forget for a moment that he had another 100,000 of his own money (but not invested in the partnership). The partnership had no Management Fee but charged a Performance Fee of 25% of the returns above 6%.
Before we get any further, the most important factor to note is that he out-performed the markets massively. Today such out-performance is as rare as an Oasis in the Sahara Desert. Just look at the table below. Literally zero years of negative performance and only in the last year was performance in single digits.
Want to learn more about his Partnership Days? Do check out this book (Link)
From 1957 when he started with his first partnership and later added more on the way to 1969 when he liquidated the same, he grew his Networth from a mere 100 thousand Dollars to 25 Million Dollars.
Would he have been able to grow his wealth and one that was later invested into Berkshire Hathaway if not for his managing other funds? Assuming the same 100,000 was invested in the same way he did for the Partnerships and recorded the same returns, in 1969, he would have been worth nearly 2.9 Million. That is huge but is 90% below where he eventually ended up with.
Okay, so we know that the path to Riches lies in being a Fund Manager, what is the path?
First – A strong Education. Today, nothing less than an MBA with a CFA. The foundation this gives can shave away years of learning on the ground.
Second: Okay, you are done with the Education – what next. Can I become a Fund Manager now?
Well, not so fast. As Yogi Berra says
In theory, theory and practice are the same.
In practice, they are not.
In the MBA class you may for instance learn about the fact that markets are efficient only to come to the real world and see that it’s really not so efficient after all. But the theory from ability to learn about businesses to knowledge about how to read and decipher the complex financial statements will come in handy for the rest of your life.
The common path for many is to join a fund house as a Research Analyst and work one’s way upwards till either he or she becomes a fund manager. While this takes more time that what you may be prepared for, it’s important to have lived through one complete cycle before you get the confidence of managing others people’s money in bad times you may encounter later since you have already passed through the Agni Pareeksha.
Research is categorized as Buy Side Research and Sell Side Research. If you were to join a PMS firm or a Mutual Fund house as a Research Analyst, you are basically a Buy Side Research and one that is the more coveted of the two.
Joining a Brokerage house on the other hand would make you a Sell Side Research. Basically, your Research is not for the firm to buy stocks on its own books but to sell to their clients.
A Sell Side Research report is for instance never complete without a price target. After all, when you ask someone else to buy a stock, they also wish to know at what price to sell. In the buy side, while it’s nice to have a broad target, that is never the focus.
While today we have PMS / Advisory firms from all over the country, I believe that if you really wish to grow in this field a stint in Mumbai will give an impetus to your career that is not possible in most other cities. It’s similar to the fact that if you want to grow in the technology sector, especially in the product side, you are better off in Bangalore than anywhere else even though today we have a lot of product firms outside Bangalore. Once again, the advantages the ecosystem offers can cut down the learning curve substantially.
Most Analysts do not rise to become a fund manager for various reasons. One reason that you can avoid is to become an expert on one particular industry or segment. As much as it’s nice to have a very deep insight into a single industry, do note that most successful fund managers tend to be multidisciplinary.
Finally, keep a public time stamped track record of your investments. Unless you have become a very famous Analyst, when the time comes to ask for money from others, this can help convince them that you are not just one of theory but also have practiced what you preach for years.
The biggest thing I have liked about the Industry is that even if you are not extremely successful or even as successful as some of your peers, the learning this industry provides is unmatched elsewhere. Make your goal one to constantly learn and evolve and who knows what doors open when.
End Note:
Sometime back, I started a Free Slack Group to discuss markets and strategies with like minded investors. If you are interested, Join here
In the world of me too’s, the only way to stand out is to be different and it’s no different in the world of investment management where your only standing is why you are different from others and hence are attractive as a place to park your capital.
Motilal Oswal whose motto is, Buy Right – Sit Tight for example claims to invest its money following QGLP parameters – Quality – Growth – Longevity and Price.
Parag Parikh Mutual Fund on the other hand claims to be a firm believer in the concept of Value Investing and buy companies that are low on debt, high on cash and are good managements who can be banked upon.
Porinju Veliyath, a small PMS fund manager running a PMS fund from Kerala (Quick, Name the Capital of Kerala) too wanted and for a time has been different. While others swear by quality managements, Porinju believed in investing in companies that had good business but bad promoters / managements.
The concept in itself isn’t new for in developed countries, Hedge funds try to build stakes in companies handicapped by an indifferent management but one which otherwise has a great business. Once they acquire a significant stake, the next move is to try and get into management to enable them to change the behavior of the company.
From Bill Ackman to Carl Icahn to Daniel Loeb, activist fund managers for a time have been a huge hit in the United States as they went about breaking down the old companies in search for the elusive alpha.
Porinju model in my opinion was quite similar with the only difference being that in India, promoters own much larger stakes and it’s tough to take on an activist role. Yet, he was able to generate returns way above what could be gained by an do it yourself investor in the markets.
Here is the snapshot of his returns from the Disclosure Document
While Nifty is not the ideal benchmark given his penchant for investing in small cap and micro-cap stocks, the fact remains that, his fund returns are higher versus the correct benchmark – Nifty Small Cap 100 Index.
Unfortunately, great returns also meant that more investors got attracted to the fund. More the investors, tougher it’s to deploy and generate returns of the past.
One of the most quoted busts in history has been Long Term Capital Management. While there were many a wrong with the fund, what actually cooked the goose was the fact that they had reduced capital while continuing to hold positions which meant leverage ratio went up even further & one small spark and the whole empire came tumbling down.
The reason much of the active fund industry in America can hardly beat the Indices is that with huge money at their disposal, it’s tough to be different.
To be different means to take risks out of the ordinary – when it clicks, one is hailed as the next god of finance but when it fails, everyone is happy to take pot shots at how stupid (in hindsight) the strategy was.
Assume for a moment Soros went bankrupt in his campaign against the British Pound. Rather than being called the man who broke the Bank of England, he would have been consigned to history as a fool who tried to take on the Central Bank.
Micro Cap Investing comes with its risks and if the investor isn’t prepared for that kind of risks, he is invested in the wrong place.
DSP BlackRock Small Cap Fund (Erstwhile DSPBR Micro Cap) was the top performing fund a few months ago – but go back 10 years earlier and you will see that the fund was very nearly wiped out in the bust of 2008. While most investors would have dumped their holdings seeing such a loss, notional it maybe, they were again begging to be let in when the fund delivered humongously in this bull run to the extent that the fund house had to close new subscriptions.
Value funds under-perform in strong bull markets, Momentum funds under-perform in bear and sideways markets, Quality stocks of today can turn out to be Fraud stocks of tomorrow. But since they are all different from a plain vanilla market capitalization based Index fund, the probability is that they will turn out different results – hopefully for the better but could be worse too.
The reason for money getting attracted to Hedge Funds / Portfolio Management Schemes are for the reason that the fund manager has much more independence versus mutual fund managers who are mandated on what they can buy, how much they can buy, how much cash they can keep among others.
Difference is also the reason for funds to charge a higher fee than plain vanilla Index Funds or ETF’s which come at a fraction of those. If a fund behaves like a closeted Index fund, why pay 10x the fees?
Fund Management is no fun. It’s tough to manage one’s own emotions, let alone manage the emotions of hundreds of investors who have their own views. While wrongs need to be pointed out, mocking when one is down helps no one.
Disclaimer: I work as a Compliance Manager at a Portfolio Management Company. Views expressed here are my own. Consider me as biased in favour of Active Management.
