How to Be a Really Bad Portfolio Manager

Intuitively, most people would think that portfolio management should be more science than art right? After all, the two words: portfolio and management just sound so scientific! In reality, portfolio management is probably more art than science. Yet most professional fund houses like to approach portfolio management scientifically. Hence the no.s speak for themselves. 80% of all portfolio managers cannot beat an index like the Straits Times Index, or the Dow Jones.

Good portfolio managers* are a unique breed. Especially those who had been humbled by the markets time and again. They spent their entire careers learning about markets, trying to beat the index only knowing that they somewhat succeeded because they never let cocksureness get into their heads. Their faces seem to show their market war stories and they never truly smile. The pic below shows Stan Druckenmiller, #2 for George Soros and probably one of the best portfolio managers of our time. He never had a down year for 30 years and compounded returns north of 25%pa. His recent interview with Kiril Sokoloff is a must-see for every reader here.

Stan Druckenmiller

Portfolio managers are artists, but also much more. They tend to possess the ability to synthesize a lot of information and come up with a Big Picture of the investing world. But this Big Picture in their mind is never completed. It is constantly adjusted to better reflect newly discovered truths and bets are taken to express views to make money when these truths are found out later by the markets. This requires rigor. It's backbreaking hard work. Portfolio managers do mental aerobics ten hours a day and then sleep and dream about markets. When they wake up, they eat and breathe stocks, bonds, rates. 

So, how to be bad at all this? Just slack. Relax in your comfort zone and focus on your own little bubble. Come up with your Small Picture of your world and think you will always be right. Then go watch Netflix and spend time mindlessly. Eat, sleep and breathe Korean drama. That's the first step. That's also perhaps the only step most professional fund managers take. To most, portfolio management is a job, not a passion. When it's not a passion, it's difficult to be engaged all the time. That's why most fail. They were just not passionate nor rigorous enough.

But it takes more than passion and rigor while seeing the Big Picture. The last trait of strong managers is the flexibility of their minds. They are never stubborn. During the abovementioned interview, Stan Druckenmiller, the best portfolio manager of our time, just kept admitting his mistakes. He also shared how he always tried to reconfirm his views and if they are off, readjust the way he invests to continuously make money. After 30 years, he saw it time to call it quits as algo trading disrupted the way he used market signals to make money. He decided it's time to move on.

This is flexibility. 

Portfolio management is an art, but it does not mean that artists are good portfolio managers. Artists are usually strong characters and can be very stubborn. This is their Achille's Heels. Portfolio managers need to think laterally, think at a higher level and even invert their thinking when necessary. They need to admit mistakes fast and be flexible to changes. This can be inherently difficult for some people.

We all know these people.

They talk by negating everything that is said. I believe most of us met these folks time and again. They cannot seem to agree with anything. One gets tired just taking to them. Every discussion is a debate, or an argument and they have to win. Every request is rejected. Let's get coffee at Starbucks, no, too expensive. How about Yakun? I prefer gourmet coffee. How about Coffee Bean? No coffee there is bad. Nespresso at my place then? I prefer cafe. Fuck.

Yakun Toast Set - Singapore's Default Breakfast

It's hard even to get them just to give a Facebook Like to your new venture that needed some support. They ask a thousand questions, give a thousand reasons and then say no, they are not going to like your venture's FB page. But then they expect you to like their Hokkaido tour pics. So these people can really make the baddest portfolio managers look good.

They can never see stock ideas or investment themes holistically. They will always be blindsided because when they like something, they cannot see the downside. When they hate something, they cannot flip their minds to buy when the stock rallies. Because that's admitting that they were wrong. They are binary people - people who think only in ones and zeroes. You are either friend or foe. This idea is good or bad. This stock is either in or out. There is no such thing as a 50bps position. This stock is either 50% of the portfolio or nothing. Hence they are always missing out or they hold on to their losers for too long.

Yet portfolio management is never binary. It is always analogue, with gradients and shades because we are never sure how things will pan out. So we have 50bps, 1%, 2% and our highest conviction bets 4-5% positions. And the 5% positions can become a 1% position when the stock rallies and the upside is no longer attractive. It's always incremental moves, never cocksure, always ready to admit mistakes and never believing one's right and the markets are wrong. Portfolio management is more an art than a science and hence there's always more right perspectives than wrong answers. 

How to be a really bad portfolio manager? To summarize, here's the three ways to really suck at portfolio management:

1. Try not to see the Big Picture
2. Don't be Rigorous
3. Be as inflexible as possible

Happy Good Friday and Huat Ah!

*Investors are essentially portfolio managers. We kept to the terms "portfolio managers" and "portfolio management" in line with the title and theme of this post.

Investing Lessons from Ngiam Tong Dow - Part II

This is a continuation from the previous post.

The second lesson from Mr Ngiam's book is something pretty well repeated in many circles but I think it's worth re-learning. It can be surmised into the following five words: there are no sacred cows.

Mr Ngiam recounted the early days when Singapore was supposed to merge with Malaysia and the economic blueprint of the day was the creation of a Common Market where domestic industries would enjoy protection from imports via tariffs and restrictions. Many countries still practise this today as this was thought of as a good way to let small local players grow without excessive global competition.

However when the merger broke down, the Common Market was gone. Dr Goh Keng Swee, our economic architect quickly realized that Singapore could not afford to remain as a closed economy. We got kicked out of Malaysia but we must continue to fight to live. Nobody owe us a living. Together with our UN advisors, one of the most important persons in Singapore history but rarely mentioned, Dr Winsemius and Mr I.F. Tang, put up an economic plan to open our markets and invited foreign large corporations to invest in Singapore.

Dr Goh then taught Mr Ngiam that there could be no sacred cows. So in one swoop, Singapore removed all import tariffs so that our economy would quickly adjusted to compete in the global arena. This greatly helped prepare Singapore for its next step: attracting MNCs to invest here. In one of the most famous stories about Dr Goh, he designated Jurong, a swamp at that time, as the key site for MNCs to build their factories. Dr Goh himself joked that this could prove to be Goh's Greatest Folly. Of course, it didn't. Jurong today is a major economic muscle powering various sectors for the country.

Time and again, seemingly sacred cows would be slaughtered if that proved to be the solution. Mr Ngiam would say that we should take the bitter medicine in one gulp. So we cut the CPF contribution during the crisis of the 1980s, we drew on the reserves during the Global Financial Crisis and currently we are taking measures after measures to cool the red hot property market.

As with politics, I think investing shares the same philosophy: there are no sacred cows. Or rather, there should not be any sacred stocks in your portfolio and you must open your mind up to all the possibilities.

After investing for some time, you would accumulate a few stocks in your portfolio, some would be making money, others showing red. If you are reasonably good, you should see slightly more blue than red. But as I have blogged before, the winning ratio is probably just 60%. For every 10 stocks you buy, 4 will show red. So the question to keep asking ourselves would be: are we keeping any sacred cows?

As humans, it's very natural to rationalize ourselves into thinking that many of our losing stocks would come back. It's just a bad patch, the business is inherently okay. Or it's the CEO's fault and he's now being forced to leave, so things should turn. We will come up with 1,001 reasons why we should not sell our losers.

Portfolio management is about finding a better stock to replacing an existing one. There is no room for sacred cows. If the stock is not performing for some time, review the thesis to see if it has changed. Sometimes we could be too early and if so, we have to continue to wait. But if the thesis has changed, then it's time to kill the sacred cow.

On the other hand, we should also adopt a "never say never" mindset. Some investors would have certain biases. Like maybe never invest in an airline, or the cash burning semiconductor sector. But if we close our minds too quickly, we might miss out interesting opportunities. The apt example here would be SIA Engineering or SATS.

So while we all know airline is a crappy industry and they burn money faster than you can blink, some of the airline-related businesses are great cashflow generators. SIA Engineering, one of the largest aircraft maintenance and repair company in Asia, operates a great business that generates high return on capital.

You see, airplanes needs maintenance all the time. When the economy is good, they fly more often and needs to be maintained. But when the economy is bad, people travel less and airlines send their idle airplanes to be maintained! It's a recurring business with a relatively strong moat as you wouldn't want any fly-by-night guy to repair your airplanes.

More interestingly, since SIA owns a big chunk of all these related businesses, it could become a sum-of-parts argument ie we are buying SIA because it owns all these subsidiaries and at the right price, we could get its main airline business for free. Of course the argument then becomes whether the main airline business is just free or should it be negative value. That's second level thinking for the seasoned investors here.

Back to Mr Ngiam, I would again highlight that the book is full of interesting anecdotes for Singaporeans to enjoy. Some of these mantras are timeless. There are no sacred cows. Nobody owes Singapore a living. Take the bitter medicine in one gulp. Hard Truths!

In the early days of the founding of modern Singapore, Mr Ngiam, led by Mr Lee Kuan Yew, together with Dr Goh Keng Swee, Mr Hon Sui Sen and the core of the civil service officers contributed immensely to the success of Singapore today. They have my full respect. Salute!

Thank you Mr Ngiam!

This video has nothing to do with the post. 

But it's a nice catchy CNY song by Super Group's subsidiary Owl International. 

Enjoy and Happy CNY to everyone!

Portfolio Management for Retail Investors

Ok so much so for institutional portfolio managers. On average, they are crap. Once in a while, you find stars like Peter Lynch, Seth Klarman and Warren Buffett. But these exceptional people are far and few in between.

The interesting story about Seth Klarman is always about this book that he had written like ages ago, called “Margin of Safety”. It talks about value investing and it didn’t sell well at all. So it went out of print. But recently, some Wall Street people started to bid for it on Ebay and it was sold for US$1,000!

Well, I got a free internet copy and am reading it. Cost me like S$10 to get it printed and binded.

Anyways, today we talk a little about portfolio management for the retail investors. How can a retail guy like you and me try to do some portfolio management?

Well, first, we must have like a couple of tens of thousands to start with. If you only have $10k. Then you can basically only buy 1 or 2 stocks. There is not much portfolio management to talk about. Just buy the blue chips or maybe buy an ETF and wait for it to grow to like $50k.

The reason why $10k can only buy 1-2 stock is bcos if you divide $10k up buy 10 stocks, you will be paying $40-60 of transaction cost for each stock, which makes the cost 4-6% for each stock and this will eat too much into your return per stock (which is like 8-10%pa).

So for those who do have $50-100k, then you might want to think a bit about which 5-10 stocks you want to buy. Here are some guidelines... Well actually it’s the same guideline, which is to diversify across everything. You definitely don’t want 5 stocks all in airlines or airline related industries.

1. Diversify across industries

So first we think across industries. If you are a conservative guy like me, you may want to allocate like 50% or more of your money to defensive industries like staples, food, utilities, telcos etc. Of course there are some megatrends happening in our lifetime, so maybe put some into resources, China related, or even tech. But you must definitely understand the risks here.

2. Dividends

This is one big criteria for me. I would want to put 70-80% of the stocks into good dividend stocks. Stocks with rising dividend over time, these are the best. Actually, these stocks will usually come from staples or food. So there is no contradiction bet 1 and 2.

3. Geographical exposure

China and Asia are the darlings of the stock market for the next 10-20 yrs. It makes sense to put money with exposure to these regions. This also means that you should look for Singapore co.s with such exposure. I would put maybe 30-50% in Asia, but also provided I can find cheap and good stocks. This might be the hardest thing to do today.

4. Asset Classes

For those who need more security, you can definitely consider 10-20% of the portfolio into bonds. However, since bonds usually pay 4-5% interest only, which you can get with some stocks in Singapore. It really doesn’t make too much sense to buy them, unless you can buy them like 80c to the dollar or something.

5. Structure

So just to round things up, if you can have a 10-12 stock/bond portfolio, it may look like this:

5-6 stocks in staples/food/telco, which includes 3-4 dividend stocks
2 Asia stocks/ETFs
2 Resource/Energy stock
1-2 bonds

One last note, unless you are really good at market timing, it pays to avoid value destroying industries like most of the tech industry, airlines, container shipping, oil refining etc and industries in secular decline like newsprint, general textile etc.

Hope this helps!

How to Fail in Portfolio Management

Portfolio managers as a group has not contributed anything to the society at large. I mean a barber helps to cut people's hair, a doctor saves lives and a teacher educates our children. Lawyers, politicians, portfolio managers, as a whole, subtracted value from the society, if you ask me.

The famous stats is this, and I must state again: more than 80% of all fund managers fail to beat market indices over long periods of time. Some of them do beat the index for like 1 or 2 yrs, only to falter in the 3rd or 4th.

The market is really terribly efficient. The S&P500 has returned 10%pa on average over the last 80 years. Most other indices don't go that far back but academic studies have shown that stocks or equities, returned high single digit to low double digit per annum, on average.

Hence it is not easy to beat the market over the long run. Yes you may have a lucky trade, like buying BP at 250p and now it's close to 400p, a 60% return in 2 mths. But to replicate this for 10 years is another story.

Value investors don't fare too much better. Some studies showed that 20-40% of value funds outperform market indices. That still means that majority of so-called value investors still fail to beat their benchmark! Although they are about twice as good as the average fund manager.

I think there are several factors that explain why portfolio managers fail so spectacularly and it serves to remind us that if we can just adopt the right philosophy, we can avoid most of their mistakes.

1. Herd Mentality

Just a simple analogy. In a shopping mall, when we see crowd gathering near certain stores, bcos there is some event, we gravitate towards the crowd. If we see everyone running for the exit, bcos there is a bomb threat, we run! The market is a transparent place. Prices move every day as investors buy and sell stocks. Portfolio managers eat, breath and think prices daily. Hence when prices move up, they want to follow, and when prices move down, they avoid. Most retail investors also do the same. Maybe some kind of wiring in our heads tries to follow this flawed logic with prices but I think the analogy with the crowd sort of makes sense.

2. Short Investment Horizon

This is a very amazing trend. In the 1980s, the average holding period for a stock on NYSE was 5 yrs, as derived from the turnover volume. ie annual turnover was 20% of NYSE total stock volume or something. Today, the turnover is 200%! The average holding period is then 6 mths! As we know, institutions make up the bulk of trading volume. Hence portfolio managers are the main culprits here. Every one of them is just looking for the next BP trade. Long term investing is for the dinosaurs. But true value cannot be realized in 6 mths. Franchises take time to build. Firms take years to grow. Sadly, nobody is interested. Buy-and-hold value investors are a dying breed on Wall Street.

3. Information overload

Portfolio managers are bombarded by useless information daily. In today's world, we are talking about probably 300-500 emails from brokers, analysts, colleagues etc. Most of these are daily reports of newsflow happening in the world, analysts' upgrades or downgrades and other non-relevant stuff. But PMs, being paid to do some job, are basically salaried workers and couldn't just delete all these emails right? So they spend significant amt of time reading junk emails when they should be reading the real good stuff like articles on this blog. And seriously, when you hear a hundred opinions about a stock, you lose track and get confused.

4. Misaligned incentive

PMs are being judge by their annual performance and not long term performance. If they make money this year, they get the fat bonus. If they lose money, they eat grass. So this scheme basically drive their behaviour to find a 6 mth trade that works. Value stocks that will make you money in 3-5 yrs? Sorry, talk to my hand. Hence it's not a big surpise why the average holding period is 6 mths.

So I guess these are the major reasons why portfolio managers cannot beat their benchmark over the long run. Bcos of the strange nature of their job, some inherent human biases and perhaps most importantly, misaligned incentives that shaped their behaviour. The rest of us, we should do exactly the opposite and generate good long term return!

Portfolio Management: The Job

So basically portfolio management boils down to over or underweighting some benchmark stocks. Now that doesn't sound too difficult, why should the portfolio managers or PM be paid exorbitant salaries? And despite getting paid so much, they FAIL to deliver the results?

Well first we talk about the skills needed. The portfolio manager needs to know a lot to do his job. And I really do mean A LOT. If you think in terms of those 300 page university textbooks, it's probably 30-40 of them (CFA has 18 for 3 levels). Plus, 10-20 years worth of global news material, that is maybe volume to fill another 5-10 textbooks.

On academic subjects, first, he needs to know about security analysis, that is the basic bread and butter. Then the financial statements, ie accounting. Of course there are the relevant subjects like economics, finance, business, statistics etc. Well most these are covered in CFA, but CFA just gives a basic flavour. To be well-versed takes years more and there are also subjects outside CFA, like psychology etc.

Then on the non-academic side, there are the 6 major industry groups: Financials, Resources, Industrials, Staples, IT and Utilities. The portfolio manager needs know the dynamics/drivers/issues of all of them. Not to mention there are perhaps close to 100 different sub-industries and businesses in all. On top of that, he needs to be in tune with global current affairs.

Of course, you don't really need to learn and know everything to be a good portfolio manager or PM. Warren Buffett knows nothing about tech and the 21st century new glamour industries right? Though he reads a lot.

Well, you can get away with that when you are your own fund manager and people beg you to manage money FOR them. Alas most portfolio managers are salaried employees and they need to show senior management that they have the knowledge and experience before they get the job. But they certainly are not required put 50% of their net worth in the fund that they manages for others.

That perhaps also partly explain why they are so good at failing to meet their KPI!

Anyways, PMs need to know a lot and be capable of continuous learning in order to make better investment decisions. In most global fund management houses, their jobs go beyond just portfolio management. They need to do marketing, recruitment of analysts, monitor trades and settlements, prepare reports etc. All these perhaps partly explains their high pay. If you ask me, maybe it justifies like 20% of the total package!

Yeah, no matter what, we can never forgive them for not delivering the most basic result right?

But let's go back to over or underweighting stocks. So all the knowledge is just the preparation for the most important part of their jobs: to decide which stocks to over or underweight. This is what determines the portfolio return over the long run.

The irony of this all is that PMs don't think or act accordingly to deliver this result. Partly bcos of the institutional imperative that Buffett talks about. Partly bcos PMs are also humans, subjected to peer pressure and emotions.

Let's just have an example: Say we have PM Ah Gou managing the Singapore portfolio with STI as his benchmark. Naturally, NOL our beloved container shipping company, is in the benchmark.

Now the container shipping industry is very similar to the airline industry. Over the past 20 years, if you add up the culmulative profits of the whole industry, it is a negative number. The whole container industry has never made money for two decades, or perhaps even longer. However, in the boom years from 2005-2007, huge profits were made, NOL became a darling of the stock market. But all the profits were wiped out in just 18 mths. And NOL went from darling to dog. Yeah, the biggest underdog. The co. bled money through its hull and finally came hand in hat to investors, multiple times!

If you are even half a value investor, you would have avoided NOL at all cost. Even traders with sense know NOL is a risky trade, you could lose everything with this one. After all, Singapore is moving to value added services. We are talking about bio-tech, financial hub, education centre, casinos and more high end stuff, more service oriented industries. It was mentioned that SIA can be allowed to fail. Even Chartered got sold finally. How many times can Temasek bail out this loser in a losing industry like container shipping?

But if you are a PM Ah Gou managing singapore stocks, the story is different. After NOL lost a billion dollars and then got funding from its rights issue, analysts are shouting BUY bcos the industry has bottomed. Global trade is picking up, freight rate negotiations ended with huge price increase for the shippers. Indeed NOL rallied 80% or more from the bottom. If you did not overweight NOL, how are you going explain yourself?

So that's the dilemma for PMs, in the next post, we explore in depth about why they never beat the benchmark.

Portfolio Management

To be a portfolio manager is a much coveted goal for a lot of people struggling in the financial industry. This position is deemed as being at the top of the food chain. Everyone feeds information to the portfolio manager so that he can make the best investment decisions. The portfolio manager is THE Top Dog.

However, the way that the industry had evolved makes the top dog's job rather stupid. In fact the whole fund management industry doesn't really make a lot of sense.

Just look at the whole management fee issue. For most funds that it out there, 1% is taken out of the asset base to be paid out as management fee. Basically for every $100 of unit trust that you buy, $1 is paid to the fund manager which consist of the portfolio manager, the team of analysts and the support staff that manages the fund for you.

Now 1% may not sound big, but since average investment return is usually less than 10% per year, it means that you are paying out 10% or more to these fund managers every year.

Well, we can talk about this atrocity some other day. Let's look at the portfolio manager's job. His job is to manage the fund such that he beats some benchmark. This benchmark is usually some stock index. Say the S&500, the Hang Seng Index or the STI index etc.

Well, statistically they sucked. Less than 20% of all portfolio managers that ever existed beat their indices over a long period of time, like say 10 yrs or more.

Why is portfolio management such a difficult thing? Well to answer that might take a few more posts. But first we can talk about how the top dog goes about doing his job.

We talked about the benchmark. Basically the portfolio manager's job is to beat the benchmark. ie if the benchmark return is 10%, the PM should be delivering 11% return or more.

The most logical way to do this, according to the fund management industry, is to over or underweight stocks in the benchmark. Now what does this mean?

You see the benchmark is basically made up of stocks with different weightage. For e.g. the STI index has 30 stocks. Singtel has a weight of 8%, UOB 5%, SIA 4% etc (btw all weights are arbitrary, I dunno the real weights and they change all the time). So a portfolio manager who needs to beat the STI would consult his analysts and all other information sources and decide ultimately, what stocks to over or underweight.

Eg. after all his research, he decides that Singtel has better prospects, so he overweights Singtel, ie instead of putting 8% in Singtel, he puts 10%. And similarly he has to underweight some other stock, eg SIA, so instead of putting 4% in SIA, he puts just 2%.

If over time, Singtel does better than SIA, like say over 3 years, Singtel delivered 30% return but SIA only 20%, then he made the right decision. And since the portfolio manager has to do perhaps a couple of hundred or more of these decisions over say a 10 year time frame, he earns his existence if the net result is that his portfolio delivers a return that is higher than the benchmark.

This is, in a nutshell, the job of the portfolio manager. In the next issue, we discuss some issues with his job.