Time-Honored Path to Success
Cover Story, by Mark Robertson, Managing Partner March 1st, 2010
As strategic long-term investors, we embrace a time-honored philosophy and reach for the medals of excellence realized when our results are "better than average".
Time-Honored Path To Success in Investing (Part One)
We seek Opportunity as a tribe. The 2010 Winter Olympics logo is named Ilanaaq the Inunnguaq. Ilanaaq is the Inuktitut word for friend. Investment clubs and study groups have a strong heritage of “investing with our friends …” pooling financial and research resources to reduce cost and increase awareness of opportunities. An inuksuk is a stone landmark or cairn built by humans, used by the peoples of the Arctic region of North America. The inuksuk may have been used for navigation, as a point of reference, a marker for hunting grounds, or as a food cache.
I’m not sure if it’s the reflective moments following our fifth birthday here at MANIFEST or enjoying the recently-completed Winter Olympics. It could be the spirit of March Madness as high school and collegiate basketball teams reach for championship trophies. As strategic long-term investors, we embrace a time-honored philosophy and reach for the medals of excellence realized when our results are “better than average.” Over the next few months, we’ll be taking a closer look at what we do, why and how we do it … and why (and how well) our championship approach to investing works.
I was given the opportunity to do some extended soul-searching by one of my favorite airlines following a wonderful day spent with a strong audience in Houston. Snow in Denver meant that my connecting flight spent a couple of hours on the tarmac. I paused and said a prayer of thanksgiving that at least I could roam Midway Airport instead of being trapped. The Houston audience had been very active and asked a number of really good questions. The exchange triggered some thoughts on several levels. I had already been deep in thought about the FACT that the average relative rate of return for our Groundhog contest participants stands at +15.2% after three years.
We’ll put +15.2% in context in a minute. We’ve been hosting a monthly webinar for the last several months on the third Wednesday of each month. The subject is a review of a real club portfolio — essentially gauging their long-term performance while checking their portfolio projected returns and average quality condition. On February 17, our Dashboard Diagnostics session featured the Wolves Investment Club of Central Michigan. The club was formed in 1993. The partners are teachers, librarians, healthcare professionals, and a couple of retail or small business owners.
In fact, I was struck by the frequency of the word, “owner” as we described the team members.
The Wolves have a relative rate of return of +6.6% since 1993.
The club ranks first among all of the managed portfolios that we track (including a few hundred mutual and exchange traded funds) when gauged by RESULTS, RETURNS and QUALITY. The Wolves would be ranked first in the Fund Manifest (page 4) in this newsletter.
We need some CONTEXT for relative return. What would be a superior relative return? Warren Buffett is generally regarded as one of the best investors in history. His Berkshire Hathaway (BRK.A) investment is now worth $114,600 per share and was worth $7455 twenty years ago … for an annualized total return of 14.6%. The S&P 500 has gained 8.3% over the trailing twenty years … so Buffett’s relative return on Berkshire is +6.3%.
Peter Lynch took over the Fidelity Magellan mutual fund in May of 1977 and outperformed the market by a mind-boggling +13.4% per year over the next thirteen years! Buffett and Lynch are far from average … what is the experience of “average investors?”
Defining Relative Returns. The average equity investor achieved a 0.2% annualized return while the average stock mutual fund achieved a return of 1.6% over the last ten years … for a relative return of 1.4% vs. the average fund. Source: Morningstar
Plight of Average Investors
What you’re about to read defies belief for most of us. During that 13-year period when Lynch was racking up 29.2% per year, he actually had friends who achieved negative returns investing in Fidelity Magellan. Lynch has chronicled his pleas to leave the funds alone - particularly during those rough moments that all markets have. But his friends didn’t listen, instead succumbing to greed, fear, temptation and ultimately achieving one of the most unlikely results of buying high and selling low in the history of investing.
They weren’t alone. The respected research firm, Dalbar, studied mutual fund investors from 1984-2005. Dalbar came to the conclusion that “average investors” were victims of terrible timing. During a 20-year period when the average mutual fund gained 11.7% per year, the universe of fund investors achieved a return of a mere 3.7% — trailing the average fund by 8%.
During this period, the S&P 500 advanced 12.5% … so the average fund underperformed the general stock market by essentially a percentage point. This suggests a relative return (versus the general stock market) of 8.8% for the average investor for this 20-year period.
The average mutual fund investor achieved a 3.7% annualized return while the average stock mutual fund achieved a return of 11.7% from 1984-2005. Source: DALBAR
Morningstar recently took a look at “the lost decade” of 2000-2009, documenting an annualized total return for the average equity fund of 1.6%. For the first ten years of this century - based on cash flows and investor returns gauged by Morningstar — the average investor managed an annual return of a mere 0.2%. The total stock market (Wilshire 5000) staggered to an annualized total return of 0.3% during this “lost decade.” Hence, the average investor actually netted a +0.5% relative return over the last ten years.
These results represent both ends of the spectrum … from a +0.5% relative return to lagging the general market by 8-9 percentage points over an extended period. The bottom line is that a relative return of negative 4-5 percent is not unusual for “average investors.”
Imagination & Ownership
" … a group [of investors] heeding the lessons of Graham, Babson and Nicholson has at least one leg up on the crowd and a better than average opportunity to generate exceptional returns."
The average relative return for the Solomon Select features (since inception, February 2005) is +13.3%.
The relative return for the Tin Cup demonstration portfolio is +15.2% since 1994 and +2.9% over the trailing five years.
The most widely-followed stocks in our Community, our MANIFEST 40, have an annualized relative return of +6.2% for the 4-years ending 12/31/2009.
The average annual return to stock investors during the modern stock market (post 1941) has been approximately 10%. If “average investors” achieve a relative return of negative 4-5% … their long-term returns are on the order of 5-6%. Yet we aim for relative returns of +5% … targeting 15% over the long term as our objective and we frequently witness positive relative returns.
How do we do it? What do we do? Why?
One of our favorite workshops for the rest of this year (and beyond) is entitled: Imagine. What We Do. Why We Do It.
We adhere to a time-honored method. Our stock selection and analysis is NOT a paper form. It is NOT a recipe. It definitely is NOT a piece of software nor a software development project. It is NOT a black box.
Instead … think in terms of a consistent philosophy, or a process … a process that serves as a guide involving patience, discipline, awareness and imagination. These are all key to a successful long-term investing program.
Over the next couple of months, we’ll “unpack” the components of our strategic approach, showing how each element contributes to our collective advantage. Don’t obsess so much over the absolute numbers, though we’ll be using empirical results to justify the relative size of each component.
How does our approach enable a higher potential return when gauged against the “average investor?”
The Pieces of Our Relative Return Advantage. Assuming ownership and implementing your own self-directed investment strategy means that you can avoid 1.5% per year of management and administrative expenses. Combine that with a 2.0% impact of steady, disciplined investing and we’re already almost back to a relative return of 0% (back at the benchmark.)
1. It All Starts With Ownership. Own it.
“When you buy a stock, you become an owner of the company. There is just as much reason to exercise care and judgment in being an owner as in becoming a stockholder.” - Benjamin Graham, The Intelligent Investor, pp. 498-499.
You transcend “average investors” when you put as much energy into owning an investment as most people do when seeking a stock.
Become a self-directed investor. Discover hunger. More importantly, learn how to become a self-feeder. This is not to say that there isn’t a place for an effective fund manager, money manager or registered representative or investment advisor. But if you include any of these as members of your investment committee, seek the best and most effective.
The average expense ratio for equity-based mutual funds was 1.31% for 2009. If you become fully self-directed (as most investment clubs and many individual investors in our Community are) you start the game approximately 1.5% better than the “average investor.”
2. Invest Regularly.
One of the most powerful attributes is the discipline delivered by the notion and implementation of investing regularly. We covered this recently in our discourse with Santa. In “Best Season To Invest?” (cover story, December 2009) we showed that regular investing from 2000-2009 achieved an annualized total return of 1.5% during a decade that delivered -0.4% … for a relative return of nearly 2.0%.
This was also covered in an article I wrote entitled, The Throwing of Towels. (Check it out in the MANIFEST Forum) During the lost decade of the 1970s, investing regularly was part of some powerful differentiated performance for our Community.
Cy Lynch leans on research that demonstrated a +1.8% relative return from 1999-2005 … and keep in mind that this is before selectivity enters the equation. We’ll cover strategic selectivity next month.
Mark Robertson
Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.