Twilight of the fund gods

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The Independent Online

Another month goes by - and with it another high- profile casualty in the fund management business. This time it is George Soros who has decided that today's markets are no longer a safe or healthy place for the biggest names in the investment pantheon to go about their business. After more than 30 years in the game, Mr Soros has decided to curtail and refocus his hedge fund activities in favour of a smaller, quieter and lower-risk approach.

Coming so hard on the heels of the retirement of another lion of the hedge fund universe, Julian Robertson of Tiger Management, it raises the issue of whether today's markets, with new industries to master, and new valuation techniques, have simply become too difficult for the giants of yesterday.

Could this be the final proof of the "new paradigm" in economics about which so much has been heard in the past couple of years? I don't think so. The problem Mr Soros and Mr Robertson have run into is not that they don't understand what is happening in today's markets, which is what, in their public statements, they seem to be saying. It is simply that they have not found a way of making money out of conditions so different from what has happened before.

In the case of Mr Soros's Quantum group of funds, it is not for lack of effort. Mr Soros and his men decided last year to have a go at punting on hi-tech stocks, just as they have traditionally taken big bets on currencies and markets. For a while it worked well, only for them to get killed this year when they failed to anticipate how quickly the rally in technology stocks would be reversed. The moral of this tale, ultimately, is that no one investment manager is big enough or smart enough to play all the instruments in the market orchestra.

In a world where styles and methods periodically move from failure to success, and back again, it remains the case that, as the investment guru Dean LeBaron puts it: "Markets make managers. Managers don't make markets."

Yet despite this tiresome fact, many investors continue to wish the world was not made this way. This is ironic. You would not go to an ear, nose and throat specialist if your heart or gall bladder was playing up. But investors seem to expect fund managers to be masters of every style and every set of market conditions - in part perhaps because many managers persist in pandering to the futile notion that they do just that.

These unrealistic expectations were evident at last week's annual meeting by the man who has, more than anyone, succeeded in defying the timeless laws of gravity in investment. One of the first questions put to Warren Buffett was why he had put no money into technology shares last year, although they could have produced him much better results.

In fact, in 1999 Mr Buffett had one of his worst years. His investments went sideways as the US market, driven by the boom in technology stocks, jumped 21 per cent.

Over more than 40 years, Mr Buffett has put together a track record of sustained outperformance of the market that has never been matched by any other professional investor. Remarkably, he has never once had a single down year; and only four times in the past 35 years has he failed to outperform the S&P 500 Index on a total return basis. Thanks to the power of compound interest, this has made millionaires out of legions of Mr Buffett's fortunate shareholders.

The way he has achieved this, as anyone who has studied his methods in detail will know, is by never venturing outside his own limited areas of competence. In practical terms, that means he invests only in a relatively small number of quoted securities, sticks to businesses where he can see a long-term sustainable competitive advantage, and rarely trades what he owns, since that is the best way of minimising capital gains tax and transaction costs.

His philosophy is based on the Ben Graham principle of a "margin of safety", one key part of which is putting money only into things which he understands inside out, and a second part of which is having the patience to wait for the market to recognise the value in what he has bought. A remarkable statistic which I uncovered 10 years ago, when I first started analysing his methods, was that after 25 years running his holding company, Berkshire Hathaway, he had never once held a significant investment in 17 out of the 24 sectors in the US market.

So it is no surprise he should give such short shrift to the idea that he should suddenly chuck out the principles of a lifetime and start dabbling in technology shares. It shows a complete lack of understanding of the methods that have made him the most successful investor in history.

As he gently pointed out, it wasn't that he doesn't understand what technology companies do, or even which ones might be successful. Simply, he and his partner Charlie Munger are not well-qualified to pick those few companies which pass a litmus test for his method of investment - namely that they should have a competitive edge that can safely be predicted to endure for at least 10 years.

There is one other thing which marks Mr Buffett out from, say, a George Soros or a Julian Robertson. He does not confine his activities solely to financial markets. He has built up a complex diversified business, of which quoted securities are only a part. Berkshire Hathaway is built around a core of insurance companies and a string of wholly-owned private businesses.

Mr Buffett has been quietly but steadily reducing his overall exposure to the equity market, and adding to his insurance group and the portfolio ofprivately-owned businesses. This reflects his view that investor expectations about future returns in the market are wildly unrealistic.

The reasons were expounded at length by Mr Buffett and Mr Munger at the meeting, with other topical subjects (the impact of the internet, the excesses of executive compensation and so on). Having attended several of Mr Buffett's annual meetings, I have never heard him make such forthright statements about today's market risks.

Perhaps, like Mr Soros and Mr Robertson, he has passed his sell-by date. There is nothing which says investors cannot lose their judgement or skill over time. I rather doubt this is what has happened here.

davisbiz@aol.com

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