the business of money management vs. the craft of portfolio management

Charles Ellis once famously wrote that the average portfolio manager is just that–average.  This is an observation that, however true, still grates with me.  But it really doesn’t explain what is commonly believed that it does, namely, why average performance by experienced professional investors virtually always falls short of benchmark target.

I think there’s another explanation for the latter.

It’s that money management firms assume clients prefer a warm and fuzzy working relationship with a financial adviser over strong investment performance.

In a sense it’s only natural that firms should think that way.  Most are run by the head marketer, with the head investor having the CIO (Chief Investment Officer) title and has little to do with strategy (this is the same jocks vs. nerds issue that has the traders controlling Wall Street firms, not the analysts). And the conclusion was probably also correct until about a decade ago.

In practical terms, the thinking went like this:

–why hire an extra analyst, even if that would mean a higher probability of matching our index vs. falling, say, 50 basis points below it?  Better to hire an extra marketer who can bring in more assets.  After all, we earn our fees based on a percentage of assets under management, not on outperforming, and our clients don’t care anyway.

–similarly, why cap the assets our star managers manage at a level where they’re more certain of outperforming?  If they manage 2x or 3x as much, they may be forced into buying larger-cap stocks than they’re comfortable with, and the chances of their beating their benchmark may be lessened by their lack of maneuverability.  The answer: clients won’t notice that, either.

However, clients have noticed    …and are leaving active managers in droves.

More tomorrow.



for-profit universities

The stocks of for-profit universities were incredibly hot in the midst of the market meltdown from the Internet bubble of 1998-early 2000.  That’s partly because they had almost nothing to do with Technology, Media or Telecom.  It was also because they were experiencing a period of strong revenue and profit growth.  The story was that these colleges were: accredited; cheaper than traditional schools; the online instruction they offered was more flexible than bricks-and-mortar-based teaching; students could get a degree in a relevant area while still working.  To top everything else, the for-profits made money, and were piling up income gains at an accelerating rate.

It’s been mostly all downhill since then, however.

How so?

–traditional schools have responded with job-relevant, online course/degree offerings of their own

At the same time, detractors have pointed out that the for-profits:

–are highly dependent on students taking out government loans to finance their studies

–have insufficient resources devoted to keeping their non-traditional students in school

–as a result, they have unusually high numbers of dropouts, many of whom end up defaulting on their (large) student borrowings

–have sales strategies that target members of the military and low-income students, groups with the weakest defenses against inflated sales claims.


Over the years, regulators’ attempts to rein in for-profit abuses have centered on controlling their access to government-funded student loans, based on graduation rates and repayment histories.  Recently, however, the efforts appear to have been upped several notches.

Officials have called on the federal government to remove the credentials of the Accrediting Council for Independent Colleges and Schools, the body whose seal of approval  confers legitimacy on the for-profits and which, more importantly, is the essential step in securing access to the government’s education loan program.

Brexit looming

Voting takes place a week from today in the UK on the question of whether the country should remain in the EU or leave.

If the vote is in favor of Brexit, the government will presumably inform Brussels of its intention to depart, which will start the clock on a two-year waiting period before Britain can officially withdraw.

Recent polls have begun to show for the first time that a majority of citizens favor severing ties with the EU.  This is the reason for recent weakness in London stocks.

My thoughts:

–polls on issues like this are notoriously unreliable.  Some are either tacitly or overtly political, with question design (on the order of “You do favor leaving the EU, don’t you?”) slanted to one side or the other.  As far as internet surveys go, it’s impossible to know whether the respondents are a representative sample of likely voters.  During in-person, and especially during phone, interviews, respondents often tend to be less than truthful, giving instead what they perceive to be expected responses

–Pro voters, who seem to think that exiting the EU will return Britain to its eighteenth-century glory, are delusional

–the two-year waiting period gives both sides time to renegotiate trade agreements (almost half of Britain’s exports are to the rest of the EU).  It’s reasonable, I think, to assume that new agreements will be less favorable than the current ones.  But it’s hard to know whether they’ll make a significant practical difference

–non-EU multinationals who have located operating divisions and general headquarters in the UK because of its being inside the EU will presumably begin to shift operations elsewhere (Ireland?)

–as far as portfolio investors like us are concerned, the main direct economic effect of Britain leaving the union will likely be the weakening of the currency that’s happening now.  So far there has been no counterbalancing positive movement by stocks where the costs incurred by the underlying companies are primarily in sterling but where revenues are in euros or dollars.  Such firms, however, should be star performers if the vote is for Brexit and as the currency stabilizes.


My conclusion:  prepare to buy multinationals traded in London on a further selloff that will likely occur if the vote next week is for Brexit.

UPS survey of online shopping

A week ago, UPS released its fifth annual survey of online shopping.  The main results:

–for the first time ever, more than half of the purchases made by survey respondents are made online

–over three quarters use smartphones for their buys

–a third use social media sites to gather information; a quarter have bought things through social media sites

–a third start their shopping either at Amazon or eBay

half of online shoppers take delivery at a physical store.  Almost half make additional purchases when they go to pick their items up

–60% of returns go through physical stores.  Again, consumers frequently buy additional items once they’re inside

–almost a third of purchases in a store are smartphone-guided, meaning buyers use their phones for product information, price comparison or download discount coupons

–35% of packages not sent to a store go to non-home locations, a trend that has been steadily rising recently

pure physical-store shopping, meaning no online involvement in either search or purchasing, is down to 20% of all buys in the US.


No wonder traditional retailers, especially mall-based ones, are taking such a beating.  No wonder Amazon is aggressively beefing up its own shipping operations, while starting to tiptoe into opening physical stores (as a better way of processing returns?).

Microsoft (MSFT) and LinkedIn (LNKD)

Before the open in New York yesterday, MSFT and LNKD announced that the latter has agreed to be acquired by the former in a friendly all-cash deal for $26.2 billion, or $196 per LNKD share.  Satya Nadella, the MSFT chairman, describes the merger as the coming together of the professional cloud with professional networking.  The acquisition price, a 50% premium to where LNKD was trading beofe the announcement, represents a bit less than 7% of MSFT’s market capitalization.

The most interesting aspect of the deal is that MSFT shares only fell by 2.6% in trading yesterday, in a market that declined by 0.8%.  To me this is indicative of the tremendous positive mindset change that has happened by investors about MSFT since the end of the disastrous Steve Ballmer era.



value investing and mergers/acquisitions

buy vs. build

When any company is figuring out how it should grow its existing businesses and potentially expand into other areas, it faces the classic “buy or build” problem.  That is to say, it has to decide whether it’s more profitable to use its money to create the new enterprise from the ground up, or whether it’s better to acquire a complementary firm that already has the intellectual property and market presence that our company covets.

There are pluses and minuses to either approach. Build-your-own takes more time.  The  buy-it route is faster, but invariably involves purchasing a firm that’s only available because it has been consigned to the stock market bargain basement because of perceived operational flaws.  Sometimes, acquirers learn to their sorrow that the target they have just bought is like a movie set, something that looks ok from the outside but is only a veneer.

when the urge is greatest

Companies feel the buy/build expansion urge the most keenly at times like today, when they are flush with cash after years of rising profits.

so why isn’t value doing better?

Many economists are explaining the apparent current lack of capital spending by companies by arguing that firms are opting in very large numbers to buy rather than to build.

The beneficiaries of such a universal impulse should be value investors, who specialize in holding slightly broken companies that are trading at large discounts to (what value investors hope is) their intrinsic value.  Growth investors, on the other hand, typically hold the strong-growing companies with high PE stocks who do the acquiring.

On the announcement of a bid, the target company typically goes up.  The bidder’s stock, on the other hand, usually goes down.  That’s partly because the bid is a surprise, partly because the target is perceived to be priced too high, partly simply because of arbitrage activity.

All this leads up to my point.

Over the past couple of years, growth investing has done very well.  Value has lagged badly.  How can this be if merger/acquisition activity continues to be large enough that it is making a significant dent in global capital spending?