Who Is Your Portfolio Manager (or CEO)?

Many college campuses have what is called a “Greek System,” where groups of men and women gather together in organizations called fraternities and sororities. While sometimes (okay, rarely) the aim of these organizations is philanthropic, more often than not it is an entirely social endeavor. While this has the potential to give certain 20 year olds an outlet of sorts (usually negative), or probably more poignantly a group of “instant friends,” it also offers the opportunity to observe how large groups of folks tend to think, and can also be construed as an early-age microcosm of Corporate America.

In most fraternities—or hell, any large organization of people--decisions are typically made by what is deemed to be the most popular or accepted among the majority of members. One or two folks will first throw an idea or two out there, which will tend to be safe ones, as they typically don’t want to offend anyone. This will then serve as the anchor, as almost all other ideas will tend to be a modified version of the first few. The ideas will then be narrowed down and analyzed not on a rationale basis where one examines the potential outcomes (both positive and negative), but rather on who the sponsor of the idea was (popularity contest in a way), or what people believe is the safest and least offensive of the ideas. This, my friends, is what is called “groupthink.”

Maybe in college where some folks seek a sense of belonging above all else, groupthink actually serves its purpose of making people feel like they are bound together in some way. But in almost all other aspects of life, groupthink often produces the safest--and worst--possible outcomes of decisions for almost any organization. If we take most larger investment management—or almost any financial services—organizations as an example, each management, investment, or strategy decision is often made for the benefit of the person making the decision, not the strategy, not the organization, or most importantly, not the client. And if you need proof of this, just observe how many large organizations tend to have both average performance and average clients.

It’s so odd to me that people and organizations, while of course stating that they want to be the best (sounds good, doesn’t it?), are really through their actions trying to be average. Like all things, though, there is a silver lining. For some folks that have the ability to think rationally and independently, they can constantly exploit this drive of large bodies of people to be average, by having the freedom to make rationale, and often unpopular, decisions. And if you need proof of this too, just look again at the investment industry, and ask yourself why so many smaller and independently owned investment management firms have both the performance and clients that continually trounce the performance of the big name brands, where groupthink is so much more prevalent.

But there is another element to this story that also ties right back into college life. The person in most fraternities, and later in life in corporate organizations, that is administering these decisions is the president of the particular organization. And while I readily acknowledge that some presidents have genuine and strong leadership skills (typically from battlefield promotions—no popularity contest there), the majority of presidents are people that are generally likeable, and not offensive in any way. Said another way, they are often not the smartest, not the strongest, not the best leader, but the safest person who relies on groupthink to make decisions.

In college fraternities, they tend to be the person who doesn’t say much, doesn’t have many opinions, has a cherub face with smile, and drinks a lot. Ironically, these are the same people that are often CEO’s or highly compensated portfolio managers at larger organizations. Their skill is not in running an organization or client assets, but just bumping along and not offending anyone, which I might add is the key to getting promoted. And if you need proof of this, just look at how many moronic financial services company CEO’s—and portfolio managers for that matter—were forced out in the last year in the market downturn. They had no idea what was going on or how to lead, they were just the least offensive one living by groupthink and sitting in the chair.

So when you are examining your financial managers, it might behoove you to look for people who have real opinions, and have the emotional temperament and confidence to make unpopular decisions, rather than just the guy that smiles and most everyone seems to constantly pat on the back. He just might be your typical fraternity president.

You might also be interested to know that this blog was mentioned in a Reuters article, which I have linked here, and a Bloomberg article, which I have linked here.

I welcome dialogue with my readers so please do send me any questions or comments you may have.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.

Do You Believe In Magic?

In the Old West certain salesman would travel by covered wagon from territory to territory selling oils, potions, and other elixirs. They hailed their products---which apparently they only had the recipe for—as cure-alls for almost anything that bothered the average frontier settler. It took not long for many folks back then to realize that these “salesman” were, in fact, praying on peoples’ fears and emotions to simply make a buck or two. They were quickly labeled “snake-oil salesmen,” and often run out of town soon after they arrived.

As I think through the last year or two, which included the fire sales of Bear Stearns and Merrill Lynch, the failures of Lehman Brothers and Washington Mutual, and the nationalization of Fannie Mae, Freddie Mac, and AIG, could it be that the financial services industry simply got chalked full of modern day “snake-oil salesmen” who only wanted to make a buck or two off of their clients?

Think about it. Many folks—aspiring first-time homeowners (frontier settlers in a way)—were conditioned to believe that homeownership--at whatever the cost--was one of the only ways that they could fulfill their American Dream. Thus, up from the dust, arose a group of enablers that sold people things that these folks didn’t have a chance of understanding, which didn’t even matter to the purchasers, because their emotions told them they were so close to achieving their dreams. Option-arm’s, pick-a-payment mortgages, and CDO-Squareds, to name a few were all modern day forms of snake oil. The only difference was that unlike the Old West, nobody seemed willing to run these enablers out of town.

Now that the financial system has come back from the proverbial abyss, it would seem that the resultant shakeout should have thrown a lot of these salesman out of the industry, or at least forced others to run them out of town. Perhaps this has occurred in the mortgage industry to some extent, but in other aspects of the financial services industry, these “snake-oil” salesman are as strong as ever.

Let’s take the hedge fund or investment industry as an example. Anyone who takes the time to sit down and read seminal books like Security Analysis and The Intelligent Investor, or even better, the writings of Warren Buffett, should quickly realize that investing is not rocket science. Running the basic numbers, making conservative projections, and valuing and learning about various businesses is not overly difficult, though it does require long hours of reading. What is more difficult about investing, but not impossible, is having the emotional temperament to think and do things independently, and to wait for attractive prices.

While it seems so simple, I rarely hear any investment manager explain what they do in such clear—and understandable—terms. Instead, I hear not all, but many explain that they have a proprietary market model, or that they have spent decades developing a black box that crunches numbers, or that they are currently pursuing a leveraged beta trade (whatever that is), to name a few of the forms of “snake-oil” currently being promoted. What’s more, many further purport that they are the only ones who could have developed these so-called magical tools for creating wealth. Sounds a bit like the Old West now, doesn’t it.

What is even more surprising, though, is that legions of folks seem to blindly buy into this marketing stuff without ever being skeptical. It is as if you can envision a group of folks huddled around the lunch table (covered wagon), eyes glazed over, taking in everything the salesman says as gospel. But to be fair, even if these folks are skeptical, they typically don’t ask poignant questions about what some of these managers really do. Perhaps they are scared to do so, or perhaps they just believe the purported magic of these promoters at face value.

Unfortunately, there is no sure fire way to ferret out what is snake oil or what is legitimate in the investment industry. One thing to think about, though, is that if there is something that you don’t understand after it is explained to you, ask yourself if it sounds like “magic”, and if it does, send the promoter off in his covered wagon in a cloud of dust.

You might also be interested to know that this blog was mentioned in a New York Times article, which I have linked here.

I welcome dialogue with my readers so please do send me any questions or comments you may have.

Justin

Copyright © 2009 BuffettInsights

The content contained in this blog represents the opinions of Mr. Fuller. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business. This content is intended solely for the entertainment of the reader, and the author.