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Monday, September 17, 2007
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Can intelligence prove profitable?
by Stephen Butler
In a casual chat after a round of golf, my friend, Ashok Vaish,
offered a clue to choosing money mangers successfully.
After arriving from India, earning his doctorate at Berkeley
and then building two engineering companies from scratch to a
combined total of more than 1,000 employees, he said the one constant
predictor of future success in a job-applicant engineer was their
grade point average in college.
Occasionally, he said, someone with less than great grades would
succeed with his company, but it was the exception rather than
the rule. Good grades were "without exception" a predictor
of success for young engineers.
It sure made me wonder about people like President Bush and myself
who made it through Ivy League schools with primarily what were
known then as "Gentlemen's Cs." Since then, we've both
enjoyed varying degrees of accomplishment in spite of our desultory
approach to academics.
Successful companies like Enterprise Rental Car have made it
a practice to hire employees who were not necessarily outstanding
collegiate scholars because they do by far the best job at running
the nation's most successful rental operation.
Ernest Hemingway said, "Some intellectuals are the dumbest
people I know."
So what do we look for in a money manager? A recent study mentioned
in Mark Hulbert's New York Times column Sunday calculates that
hedge fund operators with the best results were the ones who went
to colleges that had the highest average SAT scores. Does that
mean they were smarter, or they were just better connected and
able to gain access to better information?
Unfortunately, the study was conducted on hedge funds, which,
as a group, have not come close to beating stock market averages
over the years (with average annual returns of just 6 percent).
It would be nice to know if this information is relevant where
it would mean something for us -- namely, in the comparison of
mutual fund results.
According to the same survey, mutual fund managers coming from
colleges with low SAT scores did just as well as the "smart"
people. So where does that leave us when we're trying to anticipate
prospective superior results and choose mutual funds that will
beat their competitors.
Leave it to a Polish researcher to come up with the answer. Martin
Kacperczyk, now of the University of British Columbia, has determined
that a concentration of assets allowing a money manager to focus
on just a small universe of companies appears to be a single common
denominator of future success.
Warren Buffett certainly falls into that camp, but I also recalled
the famous Janus Twenty fund that eclipsed most of its competitors
in the '90s. It is back today with a five-star rating utilizing
the same concentration approach.
Now it is focused on 39 companies rather than just the 20 stocks
it once maintained as a limiting factor. Since its inception in
1985, it has averaged 13.65 percent per year, and its current
manager has been running the fund for nine years. Bob Brinker's
most aggressive timing model, by comparison, has averaged approximately
14.75 percent since 1988 -- just to give us some perspective.
Meanwhile, the S&P 500 index has averaged approximately 11.2
percent over roughly the same period.
Kacperczyk also adopted a technique called the "Return Gap"
which is a comparison of stocks purchased versus the rate of return
had the stocks been left untouched from quarter to quarter. In
other words, this was a measure of the value added by the manager's
efforts.
Managers with higher past return-gap figures generated better
subsequent results than average.
To summarize, I think this research indicates that smart people,
focused enough to get good grades, have figured out that you contribute
more value-added benefit when you concentrate on a small universe
of investments.
It's called "having all your eggs in one basket and watching
that basket very carefully."
Those who would get bored by such limitations and who then over-diversify,
are probably the same ones who sat in the back of the class letting
their minds wander.
Regular readers will recall that I generally recommend a spread
of assets over different asset classes -- but with each asset
class being managed by the smartest people we can find. I call
it "quality diversification."
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