Over the past decade, it has become almost fashionable to attack the hedge fund industry and actively managed funds in general. A common argument is that most of these active funds do not manage to outperform the S&P 500. Therefore, it's not worth paying extra to underperform.
This is true to a certain extent. But the problem with using an average is that it hides the best and worst performers. Some hedge funds have performed substantially better than the rest of the industry. Others have blown up.
In my experience, the best performing funds don't tend to boast about it. They are relatively secretive either by design or accident. These managers want to focus on what they enjoy, finding and holding stocks, rather than having to deal with all the additional attention that comes with managing a popular market-beating fund. The more attention a manager gets, the more likely they'll become a slave to emotional and psychological biases, as well as the investment restrictions inherent in managing enormous sums of money.
A top-performing fund
The Nomad Investment Partnership is one such fund. Founded in September 2001 by Nick Sleep, the firm closed its doors in 2015 with an outstanding track record. Before fees, the fund returned 20.8% per annum, which came out to 18.4% after fees, outperforming its benchmark, the MSCI World Index, by 11.9% per annum (in this case, the fees were worth it).
Sleep and his partner appear to have decided to exit the business while they were on top in 2014 to follow more charitable pursuits. However, their letters from the time are still highly insightful. For example, one piece really stood out to me from a letter in 2013 talking about inactivity as a source of value added:
"Our portfolio inaction continues and we are delighted to report that purchase and sale transactions have all but ground to a halt. Our expectation is that this is a considerable source of value added! At the time of our initial investments in Nomad's investee businesses, the firms were, on average, around fifteen years old...the average time S&P500 constituent stocks have been included in that index is twenty-five years...the statistic helps to illustrate how youthful Nomad's firms are. The runway ahead for our businesses may be very long indeed. Inaction on our part is counter-cultural and deliberate, and is easier said than done...[as] Charlie Munger (Trades, Portfolio), says, you make your real money sitting on your assets!"
Many investors might not have felt comfortable being part of the Nomad partnership. The asset manager operated with a relatively concentrated portfolio, and as the quote above explained, rarely traded positions. A side note in one of the company's annual investor letters explained:
"Our Partnership is concentrated in relatively few investments, perhaps more concentrated than many others, and as such our results will be more volatile than many of our peers. Nomad is also a very long-term Partnership. We do not think it is suitable for investors with time frames less than five years... If you are at all uncomfortable then, we suspect, Nomad is not for you."
This approach proved to be hugely beneficial during its lifetime. Inactivity itself does not lead to investment success. Holding onto a losing investment, for example, is usually a big mistake. However, inactivity can have other advantages. For example, one is likely to do more research on an opportunity if one never plans to sell. Multi-year investment horizons also force one to think about the future, plan ahead and consider how a business may succeed in the foreseeable future.
Without this, an analyst may spend too much time concentrating on a company's near-term potential and fail to understand its long-term advantages or threats. A long-term investment horizon can be one way to increase one's chances of success, though it by no means guarantees it.
Disclosure: The author owns no share mentioned.
Read more here:
- Buy What You Know: A Strategy for Any Market
- Warren Buffett: Why IPOs Can Be Painful for Investors
- Case Study: The Fall of Rick Guerin
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