celebrity deathmatch: Bill Miller vs. Jon Corzine

the importance of fixing mistakes

My earliest mentor as a portfolio manager continuously pounded into my head the need to find and fix mistakes before they get out of control and destroy your performance.  This is crucial, she said, and she was right.

In her view (I’m simplifying), a good stock might get you 10 percentage points over the index return in a year.  A bad stock, on the other hand, might cost you 30 percentage points before you admit to yourself that you’ve made a mistake and sell.  Therefore, it takes three good stocks to offset the damage done by one bad one.

In other words, common sense says that you’d better spend a lot of time on the lookout for underperforming names in your portfolio.

Why the 3:1 relationship?  Why not 1:1?  I don’t know.  I do know that the bad stocks are uglier than good stocks are pretty.   As to reasons, it may be the professional investor’s disease.  Every time he buys a stock he thinks he knows more than the consensus.  That takes a huge ego.  But the same ego can get in the way of recognizing that you’re wrong.  Or it may just be that when an unfavorable event occurs, holders all rush to sell.  This activity itself depresses the stock significantly.

In any event, it’s PM 101 that you can’t fall in love with your holdings.  You have to develop some way of identifying the clunkers (everyone has them; it’s a fact of life) before they wreck your portfolio.

Miller vs. Corzine

Bill Miller and Jon Corzine are recent instances of famous Wall Street figures who forgot this lesson, with disastrous consequences.

a difference

There is a crucial difference between the two, however.

Every manager knows his asset size, his cash position and his daily inflows and outflows almost to the penny.  A professional trader working on margin knows the size of his equity in real-time and monitors it just as closely.  I find it extremely difficult to believe that an “extra” $600 million or $1.2 billion could plop down into accounts you’re managing without your noticing it.  That’s doubly true if the money is needed to stave off a ruinous margin call.  You’d have to know, in my opinion, and would immediately want to understand where it came from.


What do the two managers have in common, other than their inglorious ends?

Both were very successful for an extended time within the long period of interest rate declines in the US that occurred between 1982 and, say, 2005.  That period, which is over now, taught managers to expect that even extreme risk-taking would eventually be bailed out by lower interest rates.  Neither man seems to me to have understood that this strategy no longer works.

Both appear to have forgotten to play defense.

My guess is that Mr. Miller regarded the recent financial crisis as a replay of the savings-and-loan meltdown that he successfully navigated in the early 1980s.  So he had reason to believe that he had an edge over other, less experienced stock market investors.  Mr. Corzine, on the other hand, strikes me as being more like a professional athlete who returns to the field after a decade working in an office and assumes that he can perform at the major league level from day one.  He seems to me not to have noticed that the other guys were faster, stronger and had instincts honed by never having fallen out of game shape.

In a lot of ways, professional investors are like kids playing video games.  Firms that employ them typically recognize this and install checks and balances that either force them to consider the business consequences of their actions or set portfolio parameters beyond which they are not permitted to go.  Both Miller and
Corzine seem to me to have been so deeply entwined in the management of their firms, however, that the firm’s risk controls were overridden.

Both are cautionary tales for investment professionals.