I’ve never heard of Mark Sellers before until I bumped into his speech to Harvard MBAs incidentally. I think this is a great read. Here is the link to the speech:
In the speech, Sellers talked about how hard it is to be a great investor and the chance is less than 2% for a Harvard MBA and 1/50th of 1% for a non-Harvard MBA. While I don’t fully agree that a Harvard MBA is 200 times more likely to be a great investor than a non-Harvard graduate, I am with Sellers with regards to the common traits of great investors. In the speech Sellers listed seven. I doubt that anyone really needs to go to an Ivy League school to acquire those traits. I also think these seven traits are not enough. Below are the direct quotes from this speech regarding the seven traits.
Trait No.1 is the ability to buy stocks while others are panicking and sell stocks while others are euphoric.Everyone thinks they can do this, but then when Oct. 19, 1987 comes around and the market is crashing all around you, almost no one has the stomach to buy. When the year 1999 comes around and the market is going up almost every day, you can’t bring yourself to sell because if you do, you may fall behind your peers. The vast majority of the people who manage money have MBAs and high IQs and have read a lot of books. By late 1999, all these people knew with great certainty that stocks were overvalued, and yet they couldn’t bring themselves to take money off the table because of the “institutional imperative,” as Buffett calls it.
The second character trait of a great investor is that he is obsessive about playing the game and wanting to win. These people don't just enjoy investing; they live it. They wake up in the morning and the first thing they think about, while they’re still half asleep, is a stock they have been researching, or one of the stocks they are thinking about selling, or what the greatest risk to their portfolio is and how they’re going to neutralize that risk. They often have a hard time with personal relationships because, though they may truly enjoy other people, they don’t always give them much time. Their head is always in the clouds, dreaming about stocks. Unfortunately, you can’t learn to be obsessive about something. You either are, or you aren’t. And if you aren’t, you can’t be the next Bruce Berkowitz (Trades, Portfolio).
A third trait is the willingness to learn from past mistakes.The thing that is so hard for people and what sets some investors apart is an intense desire to learn from their own mistakes so they can avoid repeating them. Most people would much rather just move on and ignore the dumb things they’ve done in the past. I believe the term for this is “repression.” But if you ignore mistakes without fully analyzing them, you will undoubtedly make a similar mistake later in your career. And in fact, even if you do analyze them it’s tough to avoid repeating the same mistakes.
A fourth trait is an inherent sense of risk based on common sense. Most people know the story of Long Term Capital Management, where a team of 60 or 70 Ph.D.s with sophisticated risk models failed to realize what, in retrospect, seemed obvious: they were dramatically overleveraged. They never stepped back and said to themselves, “Hey, even though the computer says this is OK, does it really make sense in real life?” The ability to do this is not as prevalent among human beings as you might think. I believe the greatest risk control is common sense, but people fall into the habit of sleeping well at night because the computer says they should. They ignore common sense, a mistake I see repeated over and over in the investment world.
Trait No. 5: Great investors have confidence in their own convictions and stick with them, even when facing criticism. Buffett never got into the dot-com mania thought he was being criticized publicly for ignoring technology stocks. He stuck to his guns when everyone else was abandoning the value investing ship and Barron’s was publishing a picture of him on the cover with the headline “What’s Wrong, Warren?” Of course, it worked out brilliantly for him and made Barron’s look like a perfect contrary indicator. Personally, I’m amazed at how little conviction most investors have in the stocks they buy. Instead of putting 20% of their portfolio into a stock, as the Kelly Formula might say to do, they’ll put 2% into it. Mathematically, using the Kelly Formula, it can be shown that a 2% position is the equivalent of betting on a stock has only a 51% chance of going up, and a 49% chance of going down. Why would you waste your time even making that bet? These guys are getting paid $1 million a year to identify stocks with a 51% chance of going up? It’s insane.
Sixth, it’s important to have both sides of your brain working, not just the left side (the side that’s good at math and organization.) In business school, I met a lot of people who were incredibly smart. But those who were majoring in finance couldn’t write worth a damn and had a hard time coming up with inventive ways to look at a problem. I was a little shocked at this. I later learned that some really smart people have only one side of their brains working, and that is enough to do very well in the world but not enough to be an entrepreneurial investor who thinks differently from the masses. On the other hand, if the right side of your brain is dominant, you probably loath math and therefore you don’t often find these people in the world of finance to begin with. So finance people tend to be very left-brain oriented, and I think that’s a problem. I believe a great investor needs to have both sides turned on. As an investor, you need to perform calculations and have a logical investment thesis. This is your left brain working. But you also need to be able to do things such as judging a management team from subtle cues they give off. You need to be able to step back and take a big picture view of certain situations rather than analyzing them to death. You need to have a sense of humor and humility and common sense. And most important, I believe you need to be a good writer. Look at Buffett; he’s one of the best writers ever in the business world. It’s not a coincidence that he’s also one of the best investors of all time. If you can’t write clearly, it is my opinion that you don’t think very clearly. And if you don’t think clearly, you’re in trouble. There are a lot of people who have genius IQs who can’t think clearly, though they can figure out bond or option pricing in their heads.
And finally the most important, and rarest, trait of all: The ability to live through volatility without changing your investment thought process. This is almost impossible for most people to do; when the chips are down they have a terrible time not selling their stocks at a loss. They have a really hard time getting themselves to average down or to put any money into stocks at all when the market is going down. People don’t like short-term pain even if it would result in better long-term results. Very few investors can handle the volatility required for high portfolio returns. They equate short-term volatility with risk. This is irrational; risk means that if you are wrong about a bet you make, you lose money. A swing up or down over a relatively short time period is not a loss and therefore not risk, unless you are prone to panicking at the bottom and locking in the loss. But most people just can’t see it that way; their brains won’t let them. Their panic instinct steps in and shuts down the normal brain function.
From this list, I’d add a few others that I personally observed:
Trait No. 8: The ability to process data and information effectively – said differently, the analytical edge. Everyone can spend the time reading a book or an annual report but how you process the information you read is enormously important.
Trait No. 9: Willingness and capacity to adapt to changing environment. Charlie Munger (Trades, Portfolio) said that the skills and knowledge him and Buffett acquired during one decade would not be sufficient for them to succeed in the next decade. For instance, the Graham approach worked spectacularly when financial information was not easily accessible but with information made easily accessible by internet and the proliferation of institutional investors, it is less likely to work well. This also applies to the analysis of individual companies. Great investors can sense the impending threats from changing competitive dynamics from technology, new entrants, which may make the current business model obsolete.
Trait No.10: Being able to balance arrogance and humility. Humility means knowing you circle and competency and arrogance means within your circle of competency, you need to say “I know more than the guy who’s selling it.” Humility can also mean that even within your circle of competency, you need to feel comfortable that you still might be wrong and when the disconfirming evidence presents itself, you need face the reality.
These the 10 traits that I think every extraordinary investor possesses. The good news is we don’t need to be great to be above-average. Hard work, intelligence and consistency can bring good enough returns. The bad news is, being the next Bruce Berkowitz (Trades, Portfolio) might be much harder than you think.