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The Stress to Perform

January 13, 2014 | About:

Investing might be simple, but it sure isn’t easy—especially if you do it for a living.

In addition to spending hours reading annual reports, leafing through trade journals, and studying financial statements, investment professionals have many other challenges to overcome.

A recent book, Fund Management: An Emotional Finance Perspective by David Tuckett and Richard J. Taffler[1], highlights interviews with 52 traditional and quantitative equity portfolio managers. These managers controlled a total of more than $500 billion, and each had, on average, 15 years of experience. 

Academic literature suggests it is difficult for many money managers to outperform consistently. According to Tuckett and Taffler, almost all fund managers are required to outperform either competing funds or an index, but relatively few of them are able to do so on a consistent basis.[2]  The authors refer to these unrealistic targets and expectations as “dysfunctional pressures.”

Many of the money managers stated that the edge they had for beating the stock market was having a long-term investment horizon, which was defined as three years or more.

You would think that these professionals, after adding a stock to their portfolio, would not bother to check the stock price daily or even weekly. If they were buying a stock based on how it would perform three years in the future, what reason would they have for checking the stock performance by looking at their computer screens? In fact, it wouldn’t come as a surprise to know that many of them didn’t even have a spreadsheet with updated tick-by-tick price information.

Unfortunately, that wasn’t the case at all. 

Can’t be both bold and old

The environment in which money managers earn their weekly paychecks has many of them addicted to constant online monitoring of their positions.

One manager explained this:

“We try to focus people on more than three-year numbers, because that’s the time horizon we’re looking out at when we’re buying stocks. Unfortunately, we live in a world where you get measured on a daily basis, sometimes … So, yes, there’s definitely a certain amount of pressure. It affects morale; it affects your sleep, a lot of things.” [3]

With their clients and their firms breathing down their necks about performance, these managers have to adapt in order to survive. So, while they might start out picking stocks based on three-year horizons, other influences steer them off course.

Managers are constantly thinking about the risks to their livelihood and financial well-being should they underperform.

The bulk of managers’ take-home pay is made up of their bonus. It’s not uncommon for as much as 50 percent of their combined gross wages to consist of the bonus. Determining bonuses is more art than science, with more weight given to subjectivity than to objectivity in the final decision.

Three main factors determine the size of a bonus:

  1. The overall success of the fund management firm.
  2. The amount of new business generated.
  3. The manager’s current investment performance.[4]

If a manager underperforms over several quarters, it will have major financial implications, both for the manager and the firm.

Not only would underperformance hit the manager in the pocketbook, but there is also a likelihood that he or she would be replaced. Such a scenario, as a function of recent (short-term) underperformance, is not unheard of.[5]

Knowing the pressures that they face, it should come as no surprise that most managers have a greater incentive to follow the herd and buy whatever their peers are buying or selling. Those who track an index usually have a portfolio that looks very similar to the index being tracked.

The old Wall Street saying—that there are bold traders and old traders, but no bold, old traders—could be applied to fund managers. To be bold and own a stock in an industry that is currently in Wall Street’s unloved and unwanted pile could be the investment that sends the manager to the unemployment line.
 

Your edge

If you’re an individual investor and manage your own money, you don’t have these additional pressures. Instead of worrying about underperforming and getting fired, you really can focus on the long term. 

Your stock selections don’t have to be based on tracking an index or what professional money managers are buying; instead, you should buy stocks that are financially sound and only when they are trading at bargain prices. 

This opens up tremendous opportunities for you, the nonprofessional investor. We can go anywhere and buy anything without restrictions—something professional investors can’t do.

Instead of worrying about a smaller bonus or possibly losing our jobs, we are able to hold on to our positions and let the stock price catch up to the underlying worth of the business. Instead of facing the emotional threats of underperformance, which can result in a manager getting fired or seeing his or her year-end bonus shrivel up, our concerns are directly related to the stocks we buy.

Money managers have to sweat out fears that don’t take into account their previous track record. Our focus continues to be on buying financially sound companies when they trade at bargain prices. And we ignore the short term, something the pros can’t afford to do.

By Charles Mizrahi

www.hiddenvaluesalert.net


[1] Tuckett, David, and Richard J. Taffler. Fund Management: An Emotional Finance Perspective. Research Foundation of CFA Institute, 2012.

[2] Ibid., 24

[3] Ibid., 24.

[4] Ibid., 29.

[5] Ibid., 31.

About the author:

Charles Mizrahi
Charles Mizrahi is editor and publisher of Hidden Values Alert newsletter, which focuses on finding stocks trading significantly lower than their underlying business value. He has over 30 years experience in the financial world as a money manager and investor.

Visit Charles Mizrahi's Website


Rating: 3.6/5 (7 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 6 months ago

"Instead of worrying about a smaller bonus or possibly losing our jobs, we are able to hold on to our positions and let the stock price catch up ..."

Many investors face similar fears.  They are over exposed to equities. That is, in the case of job loss or severe illness, they may need the money they have invested in volatile securities, thus fear rather than rejoice at price drops.  Should a major price drop coincide with a job loss (and oddly, they sometimes do) that volatility might not be their friend.  

Once retired, the situation becomes ever more persistent and theatening. A deep long lasting equity price recession can put a retired couple in a dire straight with no hope of recovery as they liquidate investments and cant hope to find work and almost certainly face rising health care costs.  (Think of what various Japanese went through over the past two decades had they been heavily invested in Japanese equities.)

 

* the over-exposure risk may also relate to bonds in coming years should inflation return and coupon cash flows prove insufficient. 

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