One who deceives will always find those who allow themselves to be deceived. – Niccolo Machiavelli
With the heightened focus on world politics, it comes as no surprise that The Prince by Niccolo Machiavelli is seeing a material increase in book sales. We have spent some time reviewing his writings and the centuries of debate surrounding his perceived intentions. His writings are a staple of the current political process and are no less relevant to the corporate world. The constructive elements of his writings, such as, “Entrepreneurs are simply those who understand that there is little difference between obstacle and opportunity and are able to turn both to their advantage,” are referenced less frequently. Instead, many people focus on his more pessimistic thoughts, as expressed in the top quotation.
We will follow their lead…
We have been vocal to a fault (here, here, and here) about our belief that a good investor is one that concentrates efforts on areas of the investment market where large, exploitable inefficiencies exist. Empirical results have found that inefficiency lies with investor behavior in mistiming market movements (i.e. when to be in the market and when to be out or defensive). The results also point to little inefficiency in the traditional mutual fund industries’ focus on individual stock selection. One would think that after 20+ years of evidence in good markets, bad markets, momentum markets, and value markets, this would no longer be a point of contention. Even Charlie Munger, credited by Warren Buffett as the brains behind Berkshire Hathaway’s investment success, stated on Wednesday, “I would hate to manage [money] in the big stocks and try to beat the indexes. I don’t think I could do it.”
High conviction investing is a term adopted by managers that rely on stock selection to describe buying more concentrated positions in fewer companies in an attempt to outperform their benchmarks.
With a large number of assets and people in the mutual fund industry targeting this fleeting golden ring, there is little surprise they ignore empirical evidence and instead focus on selling a false promise. This strategy is on display at one of the larger, active mutual fund complexes, which uses the tagline “Why Invest in Average?” to denigrate passive investment and emphasize its focus on high conviction investing. This would make sense if stock selection-based managers demonstrated a record of success, but with the “average” consistently beating over 80% of all active managers, it is difficult to understand why they hold their skills in high regard and promote them with such conviction. Conviction should be tied to the level of demonstrated skill, otherwise, it is simply a new way to add risk to investing and to suffer a performance drag relative to the opportunity.
We try our best not to focus too much on the messaging of our competitors, hoping to live by our elders’ mantra, “If you don’t have something good to say, don’t say anything at all.” However, we cannot let this pass without some analysis and reflection.
Why this time? This mutual fund complex’s own performance in almost every actively managed domestic fund was below the average across multiple timeframes. This brings us to a question: If success has not been demonstrated, why is high conviction a good thing? The answer may be that it only benefits the firm, not the funds’ participants.
We find their entire message to be misleading to the public and those that fall for their siren song. The table below compares the domestic stock mutual funds’ performances that, according to Morningstar, represent over half of their assets, to the respective benchmarks.
|3 Yr Annualized Return
|5 Yr Annualized Return
|10 Yr Annualized Return
The industry’s established participants continue to promote self-enriching schemes as a means of self-preservation—that needs to change. In our view, promoting fishing at a well-known pond where there is little room to cast a line is not the way to add value, especially if one’s job is to find those ponds that are rich in opportunity and light on those exploiting it. And, as shown in this firm’s advertising campaign, to pitch a bad idea with high conviction will not make it any more valuable.
The one who adapts his policy to the times prospers, and likewise that the one whose policy clashes with the demands of the times does not. – Niccolo Machiavelli
We have been steadfast in our belief that to gain an advantage in investing, one must find inefficiencies. Empirical research has consistently shown the inefficiency is small in stock selection and large in adapting to investors’ mistiming of markets. It emboldens us that many of the large firms continue to promote “another pond,” allowing us to continue a peaceful and exploitable experience at ours.
 For illustrative purposes only, we selected all unique domestic funds of the undisclosed mutual fund family which totaled over 50% of all managed assets. Performance, as presented by Morningstar, was for the trailing 3, 5, and 10 year periods as of the end of January, 2017 and compared against the primary benchmark as presented in the funds’ prospectuses. Calculations are only for those funds where manager tenure eclipses.