Portfolio Management - Part 2
Strategy Drift
One could argue against me writing and tracking funds each month because as investors, we all have long (5-year?) time horizons. And that covering things month by month and drilling down into what works and what doesn't work each quarter means I pretend to have 5-year horizons, but rather I unfairly mock or denounce investors who may make an erroneous statement or comment in the near term.
Maybe, maybe not. I think it is critical, writing an update such as this as an allocator allows me to cover off near-term performance because I can pick up on red flags at funds if comments or performance deviates against what I think I know to be true.
There are some funds that had a rough time in early 2022 and despite portfolio managers outright telling me nothing has changed with their process, when I actually run through processes and compare against historical notes and what I have been told before, processes at many funds are changing. And changing to beyond what I perceived to be the core competency of the manager.
Whenever I hear Portfolio Manager (equities) telling me about new macro-overlays or quant filters/models to help with decision making, this has turned into an absolute red flag for me. No longer true to form. An equity managers job is to pick stocks. Full stop.
What about the other stuff (macro, etc)
Valuation plays a big part in decision making. The following is a view that I have held loosely in the past but recent experiences I have had has made this more apparent to me. Something I believe is worth qualifying and testing with vigour.
- All equity Portfolio Managers (PMs) run an inherent underlying factor bias (growth vs value, small cap vs mega cap, momentum vs catalyst, tech vs energy) and very few are truly blended managers.
- I put this down to behavioural traits and experience.
- The strength of the bias to these factors is usually like voting Left or Right, to be asked to defend or even contemplate the opposing view is usually plainly offensive.
- I find an easy yet crude method of observing a funds underlying bias is whether their holdings are cheap (value) or expensive (growth) which signifies the limits of potential stocks within their funnel.
- This trend is more pronounced in international equities managers compared to the domestic ASX managers.
- Usually, funds will invest in the best names from their funnel as they believe they can observe time arbitrage (they believe the market perception of a stock is incorrect over a certain period), then it makes me wonder whether the valuation factor is irrelevant.
- If a Portfolio Manager cannot control their underlying bias of value vs growth, then perhaps the only ones who have any determination over valuations and entry points are allocators.
- So should we then say that valuations (which arguably is simply systematic risk) is not the job of PMs, instead they simply pick their stocks.
We bemoan managers for performing poorly when in reality the capital they manage is exposed to underlying factors which they usually have no control over due to their underlying biases. Even if they are aware of their biases, most of the time I find PMs are incentivised to defend their position and their reasoning. Billion-dollar tunnel (funnel?) vision.
So, it makes me wonder, is it even fair to go after PMs for valuations? Especially when you go through a market valuation recession like the last 18 months? Technically PMs are simply selecting the best stocks from their funnel - macro be damned.
There is a caveat, what I like to call "stupid investing". What is "stupid investing'?
I personally think nothing good happens over a PE of 50 (2% NPAT yield anyone?) and I will absolutely fight you if you try and argue with me on this point. Low rates has meant a proliferation of "stupid investing" and many funds have been hiding in high market beta/high PE names because that is where momentum lived. Now many of them are talking about macro and other things unrelated to their holdings, but really, they've just picked those stocks while being unaware nothing good happens over a 50x PE.
(Don't argue NVDA to me, that has largely traded with a fwd PE of 35-50x for as long as I can remember. Still below 50x).
I have also been finding that "stupid investing" and PMs who size stock positions based on conviction (based on how positive they feel about a stock) are almost a complete circle on a Venn diagram. Be wary when your manager starts talking macroeconomics to justify their positions. The circle of competence is an important concept.
Stale Portfolios – A tale of black dogs with golden leashes
I caught up with many value and long/short managers at the start of 2022 on their portfolios, talking about the worries of rates/inflation and the potential in the market. The excitement was palpable from everyone I spoke to - talks of the energy crisis, reopening trades, and stock market dispersion due to central bank action all meant that there was an abundance of ideas. There was money to be made. For these kinds of managers, it is less about momentum and more about catalysts, and boy were there some catalysts in 2022.
In writing the above commentary and reviewing the flop-flip that was FY23, there is an observation that I had both actively made and sometimes commented on inadvertently, yet the significance simply had not clicked with me until now, and in hindsight is so obvious.
I caught up most of these funds again at the end of last year and something that stuck out to me at the time was, for the lack of a better description, a scarcity of ideas. The drums of near-term catalysts had gone quiet and everyone was talking about the 3 year view. Everyone spoke of the same names and everyone spoke of the same ideas - long copper, long lithium developers, short lithium explorers, long China, long healthcare.
The thing that surprised me was the relative crowdedness of trades, the lack of turnover of ideas and just how stale some of these portfolios had gotten.
The one thing that was no longer on the lips of anyone was the talk of tech. Some were short tech names, but absolutely everyone was underweight. It seems clear now, but when the tech isn't even mentioned once at most of these meetings, this was the obvious trade. A catalyst (cost control) + positioning (everyone underweight) = rapid mean reversion (tech rally). Now most of those managers are lagging the benchmark (equity indices) again.
Did anyone learn anything? Probably not.