Keep a Calm Head in Battle

Dan WilliamsDan Williams, CFP, Investment Analyst

The Battle of Thermopylae, dramatized in the 2007 movie 300, is the story of how a relatively small group of 7,000 disciplined Greeks in 480 B.C. held off a group of 100,000-150,000 invading Persians for three days. Due to the size disadvantage of the Greeks, their eventual defeat at this battle was inevitable. However, this group kept a calm head in battle while the Persian leader Xerxes was said to become so enraged by the delay these Greeks had caused his army that at the battle’s conclusion, he decapitated and crucified King Leonidas of Sparta, the fallen hero of the Greeks, elevating his status as a martyr. While the Greeks lost this battle, at the Battle of Plataea in 479 B.C. the Greek forces won the war. The manifestation of this Greek discipline was the Phalanx formation which lined up troops in close order to form a shield wall defense that marched forward using spears to take down any army in front of them. Given that the Phalanx was only as good as the weakest point, discipline was crucial to its success. This concept was later further refined and improved upon by the Roman legions that used it to great effect to build their empire.

shutterstock_141582367_collegeMay and June mark the end of another school year and the arrival of almost 20 college interns to Brinker Capital. These college students, the most successful not being strangers to discipline, have been exposed to the science of investing in their college courses but have come to Brinker in many cases to help fill the gaps regarding the art of how to identify good investment strategies. To help lay the groundwork for this understanding, we encouraged them to read Money Masters of Our Time by John Train, a book profiling 17 different investment managers of the 20th century.

While all investment managers have proven successful, there was no one right process identified. T. Rowe Price had a process of identifying leaders in very fertile growth areas and holding them long-term until they become mature businesses in a mature industry. Benjamin Graham on the other hand focused on systematically buying the stocks that were thrown away at less than two-thirds of their net current assets and selling once they returned close to intrinsic value. Warren Buffet took a Benjamin Graham initial approach to valuation but then overlaid it with attention given the quality of the businesses and patience to hold these higher quality companies long-term like T. Rowe Price. John Templeton brought a similar attention to valuation and patience but was more willing to go global to find his bargains. George Soros went global as well but speculated more than invested with much more frequent trading in an effort to time the market. This is just to name some of the “money masters” this book discusses.

shutterstock_38215948-soldiersIt is clear that, although all of these managers have been very successful on their own, if hypothetically a super investment management team was able to be formed with these members, the fund would likely suffer from way too many and way too different processes. Like an army with too many generals, having more leaders is not always better. The only element that they seemed to have in common is the fact that they had processes in place that were fundamentally sound and that they stuck to in times of short-term market stress. Some ignored the market swings, some used it as buying opportunities, but all found success by putting their emotions in check when many market participants were caught up in fear or greed. In other words, they had discipline. Like a Roman Phalanx facing down an enemy, a steadfast commitment to a sound plan in the heat of the battle wins the day more often than not.

As such when we evaluate managers this is exactly what we look for. That is to say we need managers to have an effective, sustainable, and proven investment plan and ability to stick to the plan. Much has been made of how individual investors chase performance in good times and break rank at exactly the wrong time in times of stress. While very few of us will prove to be as successful as Warren Buffet, if we can all strive to at least have a plan and stand our ground to keep emotions out of investment decisions we all can be better off.

Simple is Better

Jeff RauppJeff Raupp, CFA, Senior Investment Manager, Brinker Capital

Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple. But it’s worth it in the end because once you get there, you can move mountains. ~Steve Jobs

If you can’t explain it simply, you don’t understand it well enough. ~Albert Einstein

As an aspiring young basketball player in my pre-teens, I was fortunate enough to have my dad coach my township basketball team. When watching him draw up and teach a play for our team to execute, I decided I, too, could design a play for us. I guess I had always been a bit of an analytic. I went home and proceeded to design what might have been the most complex play ever developed, involving multiple players setting multiple picks, variations depending on how the defense reacted, and multiple passes that required each player’s timing to be nothing less than perfect. I proudly showed it to my dad. He appropriately praised me for the effort and then, to my dismay, declined to implement it Play Callingat the next practice. Naturally, I bothered him incessantly about it, as only kids can do, until he finally sat me down and walked through the play. He pointed out that while on paper the play looked great, if the execution or timing was even slightly off for any of the players, the entire thing broke down. As a team, we were still grappling with the idea of executing a simple pick and roll, so a play this complex was destined for failure. For our basketball team, simple was better.

Years later, I have found this lesson to be applicable in so many cases, particularly in investing. When you think of all the factors that can affect returns—economic factors, geopolitical issues, company specific factors, investor sentiment, government regulation, etc.—the tendency is to think that to be successful in such a complex environment you need to come up with a complex solution. Like my basketball play, complex investment solutions can often look great on paper, but fail to deliver.

I’ve interviewed hundreds, if not thousands of investment managers covering any asset class you can imagine. One of the things I’ve learned over the years is that if I can’t walk out of that interview with a good understanding of the key factors that will make their product successful and how that will help me, I’m better off passing on the strategy.

An instance that stands out to me is the time I visited a manager where we discussed an immensely elaborate strategy that tracked hundreds of factors to find securities that they believed were attractive. We visited the floor where the portfolio was managed by computing firepower and a collection of PhDs that rivaled NASA. You really couldn’t help but be impressed by the speed at which their systems could make decisions on new data and execute trades, and the algorithms they used to optimize their inputs used just about every letter in the Greek alphabet.

Raupp_Simple_3.28.14_1The conversation then went towards discussing how all of this translates to performance and it hit me—all of this firepower didn’t produce a result that I couldn’t get elsewhere from cheaper, less-complex strategies. So while I could appreciate all the work that went into putting the strategy together, I had a hard time seeing how the end results helped our investors. I felt that in creating an intellectually impressive structure, the firm had lost sight of the bottom line—delivering results to their investors.

This isn’t to say that all complex investment strategies aren’t worthwhile. We use many in our portfolios and over the years they’ve added significant value. We spend a lot of time analyzing the types of trades and opportunities that these managers look for and use. But I’ve found that if I can’t step back and articulate why I’d use a strategy in three or four bullet points, I’m better off walking away.

Most of the time you’re better off with the simple pick and roll.

The views expressed are those of Brinker Capital and are for informational purposes only.

Reading The Fine Print – Part Two

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

In part one of my blog post, I discussed how important it is to read the fine print when selecting the right managers. “Things are not always what they seem, and by doing a little bit of digging, you can unearth some red flags that hopefully help you make a more educated decision, or at least ask the right questions.”

I left you with three warning signs of sorts that I’ve run into throughout my years of selecting investment managers:

  • Backtested numbers
    When you take a particular portfolio, or a process, and ask, “How would this have performed over a certain time period?”—that’s backtesting. There’s merit in doing this, but you really have to be careful on the value you place on the data. Anyone can build a portfolio that looks great using backtested data. If it’s a portfolio of mutual funds, just pick the ones that did the best. If it’s a quantitative model or a tactical model, just pick the algorithm that worked the best. You’ll never see a backtested quantitative or tactical model that doesn’t have a good outcome in recent markets.Not surprisingly, I have yet to come across a quantitative or tactical portfolio that has performed in actuality as well as it performed in backtesting. A backtest is good for telling you how the strategy would perform in various markets to help develop your expectation levels, but should not be used to decide if the strategy adds value.
  • Seed Accounts
    4.26.13_Raupp_FinePrint_2Firms will often start seed or model accounts to get a track record of performance started. These typically have little or no client assets and are often funded entirely by firm assets. While the firm can make the claim that they’ve been running money that way for a number of years, the reality was that their clients didn’t experience the front end of that.There are a few risks in play here. The firm could have run multiple seed accounts, discarding the ones that didn’t work and promoting the one that did. The objective itself or the universe of eligible securities may have changed before the strategy was offered to clients. As with backtested numbers, there is value in looking at seed performance, but if the backbone of a strategy’s pitch is great performance in 2008 and there were minimal assets that benefited, you have to ask, “Why?” Would the firm make the same decisions with billions of client assets that they did with $100,000 of seed capital?
  • Merged Track Records
    When firms combine, or merge products, often from multiple track records comes one track record. Ideally, the track record from the product that was most reflective of the surviving product would be used, but, more likely, the best track record will be the one that wins out. Knowing whether the track record is reflective of the current team, process and philosophy is vital.

Whenever you look at the performance of an investment strategy, you should always give careful consideration of exactly what you’re looking at. Reading through the disclosure is a necessity, as is asking questions about things that are unclear. The fine print can often help you make more educated decisions of where to invest.