It’s Not You, It’s Me

As a portfolio manager, I’ve been hired and fired by clients many times. Similar to investors trading stocks and bonds, advisers and consultants trade portfolio managers – some are hired, some are fired, and many are analyzed. Advisers and consultants have processes and disciplines as well, with the manager selection process customized to meet their investment objective. During this process, managers are screened, interviewed, and ultimately selected. It’s not very different from an analyst or portfolio manager performing due diligence on a company. It’s a continuous process, with constant review and varying degrees of manager turnover.

Most portfolio managers, including myself, would prefer clients stick around for a complete market cycle. Of course not all capital is that sticky or patient. In reality, from what I’ve gathered over my career, the most popular time allotment granted to managers is approximately three years.

Depending on the market cycle and when a portfolio manager is hired, a three year evaluation period may be insufficient and possibly counterproductive. For example, imagine being an asset allocator in 1999 and you’re considering hiring or firing portfolio managers based on their 3-year performance. The data would suggest firing managers avoiding tech and hiring managers that were about to incur significant losses. Or how about 2005-2007? Judging 3-year performance over this period would encourage rewarding managers invested in financials and punishing disciplined managers refusing to overpay.

My 3-year relative return numbers have ranged from outstanding to horrific. Given the extreme equity valuations we’ve experienced over the past twenty years, my absolute return process and discipline has required very unique and contrarian positioning. As a result, significant swings in relative performance were common and expected. High tracking error and my willingness to look different often landed me in first or last place in the relative return derby. In fact, on more than one occasion I’ve been called Ricky Bobby, referring to the Ricky Bobby in Talladega Nights who eloquently said, “If you ain’t first, you’re last!”

When in last place, it wasn’t unusual for certain clients and assets to leave. While disappointing, I understood. Manager changes and shifts in asset allocations are a natural part of the investment management process.

Although manager turnover should be expected, I found the timing of certain inflows and outflows interesting. Assets would often flow into my strategy after periods of strong performance and leave after periods of weak performance. It was classic rearview mirror investing.  In hindsight, I was often fired when I should have been hired, and hired when I should have been fired.

Again, it’s similar to buying and selling individual securities. Have you ever been so frustrated with a stock that you sell it and it goes on to double or triple? Or how about buying a stock that never declines, only to watch it crash a few months later. Advisers and consultants battle the same tendencies and emotions as portfolio managers. Furthermore, they are just as susceptible to the dangers of extrapolation and career risk. Whether you’re an adviser, consultant, or portfolio manager, buying low and selling high sounds easy, but in most cases it is not.

In my attempt to buy low and sell high, I’ve often been required to invest in out of favor stocks and sectors, such as energy in 2009 and precious metal miners in 2014-2015. My absolute return portfolio’s energy weight peaked near 20% in early 2009, while the miner position ranged from 10-15% in 2014-2015. When taking such large positions in underperforming assets, effective client communication is essential.

Buying and holding the precious metal miners was particularly challenging and required frequent and thorough client communication. During this period I had many conference calls and meetings explaining the portfolio’s positioning and my decision to own the miners.

I remember one meeting in particular in 2015 with a large and sophisticated client. The lead consultant was very smart and was known to ask tough, but fair questions. Considering the miners were the largest weight in the portfolio and were performing poorly, I was certain we’d spend considerable time discussing the position. And we did.

I started the discussion by reviewing my valuation methodology and reasoning behind the precious metals position. I explained my belief that miners were a classic contrarian investment and were selling at significant discounts to their net asset values. I argued miners were an area value investors should be swarming over, not avoiding – especially in a market with limited volatility and opportunity. I called the miners a gift and was surprised more value investors weren’t interested. I suspected the position was simply too embarrassing to hold for most professional investors, carrying unbearable levels of perception and career risk. I explained this was why miners were so inexpensive relative to their difficult to replace long-lived assets.

I should have stopped there. Instead of wrapping up my argument based on facts and sentiment, I did something I rarely do. I pulled out an old Warren Buffett quote and said, “As Warren Buffett likes to say, be greedy when others are fearful and fearful when others are greedy.” Nice closing, I thought. How can anyone argue with that? But then came a quick and sharp response, “Well then, does Warren Buffett own the miners?” Oops. He did not and I knew he never would. I responded with the unfortunate truth, “Hell no, Warren Buffett would never own these things!”

I was lucky. Instead of getting fired on the spot, everyone laughed. Even better, the client stayed with us and eventually benefited from the strong rebound in the miners. Thankfully the consultant did not sell low and buy high as emotions and career risk would pressure most to do.

Interestingly, after performance improved, we eventually lost the account due to a firm-wide asset allocation decision. In the asset management business, when you’re fired due to an “asset allocation decision”, it’s the equivalent of “It’s not you, it’s me” in dating. In reality we all know it probably was you (or in this case me)! 🙂

In conclusion, asset managers are hired and fired regularly – turnover is a natural part of the investment management process. Ideally, portfolio managers are allowed a full cycle to achieve their investment objectives; however, as we know, evaluation periods are typically shorter than desired. Like stocks and bonds, managers can be traded too frequently, or at inopportune times. Short evaluation periods, extrapolation risk, and career risk, can all amplify the urge to flock into the best performing funds and managers. Asset allocators should be alert to groupthink, concentrated flows, and the risk of buying managers high and selling them low. Currently in the ninth year of one of the most expensive market cycles in history, I can’t help but wonder where today’s risk is most concentrated. Is it with portfolio managers who are being fired or hired?