By John Reese (@guruinvestor) —
The days of the star stock picker are largely gone, but aspects of their investment genius live on in other ways.
In the mid to late 90s, the Fidelity Magellan fund was the largest mutual fund in existence. Run for years by the legendary Peter Lynch—during which time the fund’s return doubled that of the market– the fund went from $14 million in assets to $40 billion by the time he retired. Magellan consisted of hundreds of hand-picked stocks that met the criteria of Lynch and the managers, including Jeff Vinik, who managed the fund after Lynch. Today, the largest mutual fund is a far cry from the likes of Magellan. Rather, it’s the passively managed Vanguard 500 Index Fund, ($224 billion in assets), which simply tracks the market cap-weighted S&P 500 index.
Besides Warren Buffett, you probably would be hard-pressed to name another great active investor or stock picker. But there are investment managers with incredible long-term track records that you might have not even heard of; Fidelity’s Will Danoff, who manages the Contra Fund, or Joel Tillinghast, manager of Fidelity Low-Priced Stock fund (whose compounded returns for the last 28 years are 13.8% compared to 9.6% for the Russell 2000 and 9.7% for the S&P 500 over that same time period). There’s also the money management firm PRIMECAP, which is one of the larger active managers for Vanguard. But even the great Warren Buffett has shifted from stock picking to buying entire businesses and rolling them up into Berkshire Hathaway. Although we still hang on to every stock endorsement Buffett makes, what will matter more for Berkshire’s stock (and Buffett’s record from this point forward) will be the companies he buys outright.
The long-term evidence against stock pickers is significant, one reason why the attention has shifted away from them over the last 15-20 years. Data provided by S&P, which tracks the outperformance of managers over the market for various time periods, shows that the vast majority of active managers tend to underperform their benchmarks. As of the end of 2016, less than 8% of large-cap fund managers outperformed the index over a 15-year period, according to the S&P SPIVA report. Reasons include; high fees, closest indexing, the second-worst bear market in history clobbering those who took more risk, underperformance of value stocks, an ultra-competitive environment, and the massive migration to passive investing — to name a few.
Bloomberg recently analyzed data from the industry’s three biggest conferences—Robin Hood Investors Conference, Sohn Investment Conference and SkyBridge Alternatives Conference—to see how hedge fund manager “calls” translated into share price movement. Findings showed that, “while the managers’ pronouncements consistently moved shares of the companies they targeted, their influence has been on the decline.” One example is Greenligh Capital co-founder David Einhorn who, according to a Reuters article from 2016, “has built a reputation on his ability to crater a company’s stock.” It goes on to explain, however, that the day after his comments regarding Caterpillar Inc. at the 2016 Sohn conference, the stock opened only 1% lower.
But while it’s clear that universe of revered stock pickers has dwindled considerably, what isn’t clear is how to identify the strong performers. If, for example, you were to go back 15 years and lined up 100 managers randomly, only about 8 of them would likely beat the market based on the S&P data. Most investors don’t have the time, expertise or resources to understand the inner workings of a manager’s process or their investing edge, so the majority rely on recent past performance (over the last 3 to 5 years), but this is usually a recipe for underperformance. The stock market is in a period of trifurcation right now. You have passive investing, which is largely just buying the market in the lowest cost way possible, active investing, which relies on human portfolio managers, or the stock pickers, and the in-between area of what I will call quantitative investing, which is largely computer-aided asset management.
The area we’re mostly focused on here at Validea is the third area, the quantitative corner of investing. We run investment models (approximately 40 of them) that take the methodologies of successful investors and capture these in computerized models. So the models we run are built on the investment criteria outlined by the Peter Lynchs’ of the world, and we deploy these fundamental strategies systematically and adhere to them over long periods of time.
So next time you hear that “stock picking is dead” remember that the stock pickers that seem to be slowly fading away are the ones who laid much of the groundwork for the stock picking methods of today and the future.
John Reese is founder and CEO of Validea.com and Validea Capital Management, LLC. Validea is a quantitative investment research firm and Validea Capital, a separate company from Validea.com, which maintains this blog, is a asset management firm offering private account management, ETFs and a robo advisor, Validea Legends and Validea Legends Income. John is a graduate of MIT and Harvard Business school, holder of two US patents and author of the book, “The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies”. Follow John on Twitter @guruinvestor.