Secrets of Success: Watching the world's greatest investors
Saturday 12 June 2004
There are some interesting new insights in the most recent edition of the American fund manager John Train's collection of essays about the world's best professional investors, recently published in a collected edition as
Money Masters of Our Time. Mr Train can lay claim to being one of the first to draw attention to Warren Buffett's remarkable achievements.
There are some interesting new insights in the most recent edition of the American fund manager John Train's collection of essays about the world's best professional investors, recently published in a collected edition as Money Masters of Our Time. Mr Train can lay claim to being one of the first to draw attention to Warren Buffett's remarkable achievements.
That was more than 20 years ago, when anyone who took his advice and put some money with Mr Buffett would have long since been able to retire in comfort. He has followed up with thoughtful pieces about several other "legends" of the business, such as Fidelity's Peter Lynch, Sir John Templeton and the inimitable George Soros.
In his conclusion to the latest edition, which was completed last year, Mr Train offers some useful perspectives on the craft of investing, though I detect in his writing a slightly more critical tone than in the earlier versions, perhaps because in the 20 or so years that have passed since the early Buffett essay we have come to learn a lot more about what fund managers can and cannot realistically expect to achieve.
Professional investors today have to operate in a much more and transparent environment than was the case 30 years ago, and it has undoubtedly become harder to outperform the market than it was when Ben Graham, the so-called father of modern security analysis, was still in the business. If you allow for the hidden leverage provided by the cash flow from his insurance companies' premiums, even Mr Buffett, says Mr Train, has only managed to beat the market by a modest 3 per cent per annum in recent times.
When you look in detail at what the most successful investors do, he says, in essence there are only four valid approaches. One is to buy fast-growing companies and hold them as long as their profitable growth continues (growth stock investing). A second approach is to wait until certain types of investment are at rock-bottom prices and then buy and hold them until they return to fair value or better (value investing).
The third approach is to specialise in one new or relatively obscure field of investment where you have a reasonable chance of becoming either a leader of fashion or the acknowledged expert in that field. And the fourth way is to do what Mr Train calls "reverse engineering", namely making a study of what the most successful professionals are doing and putting your own money to work the same way, either by buying and selling the same things as them, or simply by owning their funds.
These different approaches all require different disciplines and suit different temperaments, which is why there never is - and never will be - a single surefire way of doing better than the market. Value investors, Mr Train points out, tend to lose money towards the end of bull markets, while genuine growth investors need the courage and confidence to hold on to the shares even when the market turns sour on them. In the case of both growth and value investing, you cannot really hope to succeed unless you have a deep and thorough understanding of the intrinsic values of the stocks you own.
"It seems absurd to suppose," Mr Train comments, "that an investor would buy a stock without forming an accurate impression of what the underlying company was worth as a business: whether the management was competent and the research effective, whether there were competitive problems, how up-to-date the machinery was, whether the company was prosperous or strapped for cash, and so on." Yet very few amateur investors have this capacity. The giveaway sign of a weak investor is tending to focus entirely on the prices of shares, and rarely if ever on the underlying business.
So what about the idea of following the best professionals and getting them to do the work for you? This is clearly Mr Train's preferred route (as it is mine), but there are obvious traps to be avoided here as well. One is the common one of buying a fund that has been successful and is now "hot", the one that everyone is pushing you to buy; all too often you will find that you have bought a dud.
The reality is that you cannot avoid making some judgments about the current investment climate even if you have decided to subcontract your money management to a professional. Different styles and different techniques work better at different times, and the funds you want to buy are those which are run by good managers whose style or sector is currently out of favour. Very few funds do well over all time periods.
Next, you want to avoid funds with high charges and high turnover: 25 per cent turnover in a fund manager's portfolio is more than enough. Anything higher can easily cost you 2 per cent per annum in lost return. Then, on average, it is better to buy a fund that is still relatively small and part of a manageable business. George Soros is just one of several investment geniuses, observes Mr Train, whose businesses simply got too difficult to manage once they reached a certain size.
Finally remember with funds that while superior performance is what you are looking for, consistent performance is even more valuable. The reason is our old friend compound interest, which can do wonders with a consistently successful track record. Sadly of course the majority of funds cannot even manage to keep pace with their relevant market index, largely because of transaction costs and charges.
Best of all, argues Mr Train, is to discipline yourself to monitor and imitate some of the specific stock selections that the best professionals are making. A company share is a more transparent and simpler thing to understand than a fund. If you have the tools to track the portfolios of the experts, you have a good chance of doing quite well, especially if you remember that it is company specifics, not economics or complex formulae, that ultimately drive returns.
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