Litman Gregory’s approach to fund research recognizes that past performance is useful only as a tool for screening funds to identify those that may be worthy of further research. Value added comes from identifying why a fund performed well in the past, determining if the portfolio management team has an identifiable edge (i.e., do we think the past performance was due to luck or skill), and assessing whether the edge (if one exists) is sustainable. To answer these questions requires intensive firsthand contact with fund managers and their research teams.
Our due diligence process is time-consuming and labor-intensive, and our goal is to select managers with an identifiable edge that we are highly confident can be maintained. We’ve found that successful managers with a sustainable edge often possess common characteristics. While not all the managers we recommend possess all of these traits, most of them are common. Specifically this translates into the following:
The stock picker must have a clearly defined investment process that is also disciplined in its execution. Though there are some highly intuitive investors who are successful, we believe a disciplined process helps to avoid decision errors that result from sloppy, incomplete analysis. We simply have less confidence that highly intuitive stock pickers will be able to maintain their success.
The investment process must give us a reason for believing the manager has an edge.Sometimes the edge is the level of passion that results in an obsession with knowing companies so well that there is an information edge. Other times the process results in a unique way of looking at companies that can lead to better insights. Some stock pickers gain their edge from a combination of factors.
We require that the stock-picking team be highly focused with few administrative, business or marketing distractions. They must not be running too many different investment products that may pull them in too many directions.
We like managers who are independent thinkers, yet able to admit their mistakes and move on. Successful managers do their own research, think for themselves, and are often willing to take a position that is contrary to the market consensus opinion because they have conviction, based on their own analysis, that they are right and the market is wrong, and that eventually they will be rewarded for their patience and discipline. Yet, if it becomes apparent that they are in fact wrong and the market is right, they are able to admit it to themselves and sell the position, take their loss, and move on. Great investors are also dedicated to continually learning from their past mistakes (as well successes).
We must be confident that the team will be fairly stable and that business growth won’t be at the expense of returns to existing shareholders. We don’t care for empire-builders who may force the management team to manage other types of portfolios, reducing their focus on the original fund.
Why Is the Market Still Going Up When COVID-19 Risks Remain?
Even as the rate of unemployment remains high, COVID-19 continues to spread in the U.S., and economists forecast a huge drop in economic activity, the stock market continues to rally. We remind our clients that market prices reflect a consensus view about the future and that maintaining a disciplined investment approach is the best way forward.
Why is the Market Going Up When Economic News Looks Grim?
Our clients, and investors broadly, have been asking this important question: How do we reconcile the recent stock market gains, particularly in the United States, with the poor state of the current economy and the weak outlook? In this post, we explain the variables that impact investor behavior and respond to why financial markets can rally in the face of negative news.