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"What Makes a Guru Manager"
Excerpted from the No-Load Fund Analyst, June 1995
For mutual fund investors, the search for the next Peter Lynch is eternal; and what seems like a never-ending stream of articles in the personal finance magazines fuels this obsession with superstar fund managers. Despite all the coverage, not much attention is paid to what's behind the greatness or what it takes for a stock picker to perpetuate top performance over the long term. Because this is something we think about a lot, we'd like to share some of our insights.
Our approach to evaluating fund managers melds the quantitative with the qualitative. The numbers fascinate us. We want to know how a manager has done relative to his or her peers in different market environments, and how consistent the performance has been. We also want to know what's behind the numbers. Did the manager make big sector bets or choose a few great stocks? But while we closely examine the record of each fund we recommend, we are obsessed with more than the numbers. We apply a qualitative overlay that we believe is also critically important. Over the years our many conversations with fund managers have given us insights into the common traits of great stock pickers. This article outlines these traits.
Common Traits Among Gurus
What do great stock pickers have in common? We apply three general criteria:
1 We look for great long-term record relative to style peers. The proof is in the pudding, so the numbers have to be there. A long record raises our conviction level that these managers really are superstars.
2 Exhibiting traits that our experience has taught us make great investors is also critical. The traits we've keyed in on are based on years of insights gleaned from talking to many top managers.
3 Finally, we are focusing only on managers, we believe can maintain their guru status. That means we must have a high level of confidence that they will remain focused.
What Makes a Great Stock Picker?
Stock pickers we have identified as Agurus@ are extremely bright and work very hard. But there's more. Despite huge differences among the great stock pickers, including different investment disciplines, there are common elements that keep popping up. These can be split into personal characteristics, which many standouts in other fields including business and the arts also share, and learned investment principles that govern their investment decisions.
Personal Characteristics
Passion: All the greats love what they do. When discussing their life's work, they say things like AIt's been a journey@ and AInvesting is in my blood.@ They clearly find the work fascinating. Most are observers of the world, who glean investment insights from their fascination with life. We believe that this passion is critically important, because the investment business is incredibly demanding. Such a highly competitive and information-intensive endeavor can easily lead to burnout. And the huge wealth accumulated by successful investment managers means great managers have to love their work to maintain the high level of motivation after their financial independence is assured (as it no doubt is for all our gurus).
Energy Level: Hand-in-hand with passion, is a high energy level. This goes beyond just work ethic (although that's important too) to effectiveness. In this very dynamic business, a high energy level is critical to figuring out what's important, dealing with the unexpected, handling a multitude of issues and ultimately maintaining productivity.
Obsessiveness: Casual knowledge is never enough for the great stock pickers. This seems to be a universal trait. There is an obsessiveness about getting all the information that might lead to better decisions. Foster Friess talks about being an investment detective: His team scours every item on the income statement in a quest to understand exactly what determines the earnings for each company. Mason Hawkins is relentless in his quest to know management. Chris Davis (Shelby Davis' son and now Selected American Shares manager) talks about his dad sneaking in company visits when he was supposed to be dropping him off at boarding school. In a business where lots of smart people are analyzing the same information, a relentless effort to get the best information possible can make a big difference.
Inner Strength: There are no wimps in this crowd. All the great stock pickers have great confidence in themselves. This allows them to stand apart from the crowd when their analysis says they should. They don't second-guess themselves when there is no fundamental reason to. Confidence allows them to act without being unduly influenced by a fear of being wrong, and it helps them maintain perspective in bear markets. Exceptional inner strength is a precondition for success in this business.
Independent Thinking: All the greats are also fiercely independent. They make up their own minds, and it's difficult to shake them. There is no group-think or index mentality in the bunch. It is interesting that most in this group developed their investment approaches early in their careers and pretty much on their own. Thus their independence has driven both their specific investment decisions as well as the development of their investment processes. The ability to think differently, along with the inner strength to have convictions and act on them, is what allows the greats to channel their obsession, passion and energy.
Skepticism: The great stock pickers tend to be skeptics. Shelby Davis talks about separating the bluffers from the doers. These guys take nothing at face value. Their obsessive nature drives them to get past their skepticism and base decisions on conviction.
Self-Knowledge: These managers all know themselves. They manage their own careers to enable themselves to focus on what they like to do and avoid what they don't. This is probably one reason they aren't burned out. It may not be a coincidence that most have almost total control over their work environments. Dick Weiss's group has total autonomy within Strong. This gives them the control they need to do what they want. Shelby Davis knows he's a loner and Aprobably not a great team player.@ So, although he has incorporated analysts' research into his approach, he's pretty much worked on his own over the years. In recent years, his sons have become very involved after working elsewhere.
Ability to Learn from Mistakes: Although the gurus are generally a stubborn bunch, they do learn from their mistakes. While they hate mistakes, they are secure enough to put success, which demands continuous learning, above their own egos. They don't wallow in failure. If they make mistakes, they accept them, learn from them and move on.
Gut-Level Optimism: With all the great stock pickers, there is an underlying optimism that the world is not going to end and that their approach will continue to work. Although this is not rare in the investment business, it is worth noting that few successful stock pickers got that way by heeding doomsday scenarios of serious bear markets. It's worth noting, however, the gurus' attention to downside risk, which we discuss later in this article.
Drive to Win: All the greats are very competitive and have an incredibly strong drive to win -- to be the best. When asked about their goals, performance almost always comes up first.
Rules to Invest By
Focus on the Knowable: The greats don't speculate on what might happen. They don't waste time trying to figure out investor behavior. None uses technical analysis in his approach. These investors have learned to focus intensively on analyzing what is knowable. Part of this analysis is getting to know company management extremely well. They tend to view the managers of the companies they invest in as partners, and, naturally, it is essential to know a partner well. Because their analysis is not built on hope, it is easier for them to have the conviction to take sizeable positions and stick with them even when they may not be doing well.
Think Long-Term: None of the greats gets caught up in short-term thinking. They refuse to evaluate their performance over the short term. Even Foster Friess, who invests in a much faster-moving arena than the other managers we've identified, emphasizes businesses with strong enough internal dynamics to overwhelm macroeconomic factors. At the extreme, Shelby Davis talks about generational investing, which includes an assessment of the long-term viability of a franchise.
Be Very Cognizant of Downside Risk: All the gurus are keenly aware of risk. Mason Hawkins, Dick Weiss and Jean-Marie Eveillard have their own valuation methodologies and will buy only stocks that are selling at huge discounts to their assessment of value. Shelby Davis focuses on the people and the balance sheet-- he wants to know that his boat can survive a hurricane. Though Sig Segalas seeks good long and short term performance, he's comfortable holding for the long term. Even Foster Friess, who invests in a much more volatile universe, is very cognizant of risk and stays away from fad stocks. His team invests only when they think they understand the company better than the market does. These guys don't guess.
Stick to Their Knitting: All the great managers know their strengths and weaknesses. Each has complete faith in his process and doesn't deviate from it, though the process itself is generally flexible enough to adjust on the margin to changing opportunities. Still, one reason these guys haven't made too may mistakes is that they stick to what they know.
Final Thoughts
Picking great funds requires more than looking for the best records. The numbers tell us about the past. And, sometimes, but not always, tearing the record apart helps us answer the question Was it luck or talent? But in the end, the numbers alone can't tell us for sure how much luck was involved in building the record.
To really raise our conviction level about future performance, we've got to get a sense for whether the manager has what it takes to be great. In our opinion, the most important characteristics are passion for the business, intellectual independence and obsessiveness. All the greats have these traits, and we look for them in managers. Of course, just because we are looking for them doesn't mean they are easy to identify. It usually takes a number of interviews with a manager to start to build our conviction level in our qualitative assessment.
It is also critically important to future success for managers to stay focused. A number of great stock pickers' records have deteriorated as they became distracted by the operating demands of a growing business. In order to perpetuate greatness, managers have to keep their eye on the ball.
This article is borrowed from the reprint in the quarterly report of Masters Select Fund, June 30, 1997 and first appeared in the June 1997 issue of the No-Load Fund Investor.