I was saddened to hear of the passing of Walter Schloss on February 20th, 2012. Mr. Schloss, aged 95, was arguably the world’s greatest value investor. During the period 1955-2002 (his official retirement from the investment industry) the Schloss investment portfolios generated returns roughly 60% higher per annum, net of fees, than were produced by the S&P 500. Importantly, his investment philosophies were a clear departure from those expounded by modern day efficient market portfolio proponents.
A largely self-taught portfolio manager, Schloss entered the investment industry at roughly the same time as Warren Buffett. For a brief period, he actually worked in the same office as Mr. Buffett, but was deemed, by the investment industry, as being insufficiently talented to directly manage money. After several years of being assigned little more than the making of coffee for the stars of the Graham-Newman, Schloss struck out on his own. He quietly, steadily and without fuss, built an enduring reputation among fellow money managers as one of the very best in the world, ever.
The Walter Schloss style of investing involved minimal contact with company management. Schloss considered the querying of management to be of no practical value. Schloss postulated that management of any particular company would be as prone to confirmation bias as a retail owner of the underlying security. He also eschewed reading brokerage reports and analysis from third parties. His point, which I take to heart, is that if management is biased, and they confer with analysts, will not the analyst producing a report on said company merely further the bias?
Schloss only made security selections after rigorous scrutiny of financial statements; in particular, he would delve into footnotes. Schloss would compare footnotes from many prior quarters to glean insight into minutiae. For example, in SEC parlance, a simple one word change in a footnote (for example, from “might” to “may”) could mean the difference between whether or not a company would be likely to pay out hundreds of millions in potentially crippling legal settlements. As much of a financial statement is boilerplate wholly reprinted from prior reports, the change of a single word, in a footnote, must be deliberate, and accordingly, important.
Likely, few among the general investment public had ever heard of Schloss. The professional investment industry, to this day, considered Schloss to be either an enigma or a man that they begrudgingly envied. Efficient markets theorists could not explain the consistent outperformance of Schloss; they simply considered his work to be aberration. It is worth mentioning that investment envy is not confined to the “1% vs 99%”; paranoia, jealousy and resentment are recurring themes among managers who assess the work of peers. Hakan Castegren of Harbor Funds passed away in late 2010. Quite possibly the world’s best international value manager, Castegren was considered by most managers to be a “one off”. At various times pundits had also declared the returns and selections of the late Sir John Templeton to defy rational explanation.
It is my contention that these individuals ARE aberrations; all of their bodies of work had deviated from the norm sufficiently that neat descriptions came up short.
One point that continually trips up the efforts of efficient market theorists, when attempting to discredit the results of super investors, lies in the fact that at least a few of them crop up in every generation. Enough of these aberrant investment masters exist on the planet at any one time to make up a sub-category of money manager all their own. I call them the “Investment X-Men”.
I connote the term X-Men in a very literal sense; these are individuals that possess some abilities or characteristics defying convention descriptions and are therefore unquantifiable. Unquantifiable variables represent the X-factor. There are X-men in the world of chess, in the world of physics and math and in every profession on the planet today.
It would be more surprising to learn of readers’ awareness of Schloss than not. In an the industry that can neither neatly explain away returns nor ably reverse engineer a portfolio so as to offer up an expensive packaged product, the tried and true solution of industry competitors is to simply marginalize the manager in question. Even among fellow investment X-Men, there can exist a degree professional jealousy. On paper, Buffett called Schloss a long-time friend and proclaimed Schloss to be one of the “good guys”. That said, despite having a long term track record superior to that of Buffett himself, Buffett, in his 2006 letter to shareholders, inexplicably noted that Schloss “took no real risk and invested in about 1,000 securities, mostly of a lackluster type”.
It goes without saying that almost all of the truly world class and enduring managers of investment capital likely possess an X-Factor.
Over great periods of time, X-Men generate investment returns that pull away from the also-rans. In certain managers the ability appears to be infinite patience. Others possess a largely unerring power to identify and capitalize on those trends that are permanent vs those that are transitory. Still other investors achieve great success by making relatively fewer mistakes than competitors. Many have a “nose” which keeps them out of trouble; at some point, in historic conversations with most truly legendary managers, most will remark that a specific investment just “didn’t smell right” to them. Some of the more introverted superinvestors feature a keen focus that enables them to winnow through extraneous, superfluous fluff put forth by pundits. Some investors can allocate capital among investments with great skill; their ability to bypass overvalued sectors helps them to deftly sidestep the periodic sector tsunami. Others simply achieve exemplary long term results by “sticking to their knitting”; they do not attempt to invest beyond their core competency.
One thing is for certain; X-men have an innate ability to identify, not one, but a whole series of businesses, often in very different industries, that all possess a highly positive X-factor.
The investment industry is, unfortunately, littered with fake X-Men and Mystery Men.
Many times, the investment industry becomes enamored of the “one hit wonder”. This, for lack of a better term, is a manager who scores big once, is feted by the media as the next big thing, only to meander through the investment markets for years fruitlessly attempting to recreate a lightning strike and recounting past glories. Occasionally, the one hit wonder benefitted from a persistent trend, such as a multiyear decline in interest rates. Other times, said wonder could have owned a number of complimentary stocks within a sector, such as housing, that profited from a bubbly rising tide. Such trends were exacerbated by those who adopted strategies designed to piggyback on the returns of the one hit wonder. Eventually, when the tide turns, the purported X-man is revealed to be just a poor investor propelled to stardom by sheer dumb luck, a certain telegenic quality or an ability to read a PowerPoint presentation with authority.
Market action from 2007 through today has clearly separated the wheat from the chaff.
Many media darlings have had their portfolios revealed to be less than durable. The true X-Man will maintain conviction throughout periods of adverse sentiment; accurate analysis should prove out over the course of time. Regretfully, an astounding number of mutual fund managers, since 2008, had made wholesale fundamental shifts with their portfolios and their investment style. It would appear that there are more one hit wonders in the professional investment world than previously believed.
You can generally identify a one hit wonder by confronting them with unassailable logic. Absent a teleprompter, many investing “superstars” revert to the real life equivalent of “Mr. Furious”. (Movie buffs will recall a character in the Ben Stiller superhero movie spoof “Mystery Men”. The ability of Mr. Furious was that he became really, really, angry and very red in the face; Mr. Furious could then talk over other characters in a conversation).
True Investment X-Men also embody certain ideals that suggest a higher purpose.
I’ve had the incredible fortune to have briefly met a couple of the original Investment X-Men in my lifetime. More recently, I’ve rubbed elbows with several individuals that I believe will come to the fore in this generation. One point that rings true of both the old guard and the new crop; none of the X-men that I have met consider the researching of investments, the allocation of capital and the management of money to be a profession for the purpose of earning a living. It’s something that they do, because it needs to be done. In a world increasingly polarized between the supposed 1% and the 99%, or what South Park writers prefer to call “gods and clods”, I sensed a refreshing purity of spirit and purpose in each of them.
When an Investing X-Man dies, or leaves the professional investment industry, the capital managed by that individual should normally wind down as a result.
Logic would indicate that sensible investors would simply select, of their own volition, a replacement manager to an X-man that best serves their needs. However, the income streams earned on investment funds are far too lucrative for a company to give up without a fight. The investment industry, when faced with the problem of succession, has embraced a solution employed in the music and entertainment industries. The solution? An investment cover band.
Investment cover bands are the investment equivalent of the musical cover band or the Broadway understudy. The job of these replacements is to invest in the mold of their X-men and, most importantly, preserve existing assets under administration. Investment cover bands cannot deviate from the norm, nor can they rely on their own investment selection methodology. As with musical cover bands, the key qualifications of the investment cover band are to wear the uniforms provided to them and to play the investment tunes assigned to them, exactly as they were originally performed by the X-man (woman). Each team performer is replaceable at a moment’s notice. Under no circumstances can a band ever, ever, perform personal material.
Sometimes these cover bands are highly touted by the sponsoring firm. This is generally due to the fact that the members have understudied for years at the firm of the X-man. Some might even be able to boast that they were mentored by the X-man himself (herself). Sadly for the investing public, technical knowledge and tenure simply cannot replicate the X-factor.
In What Category of Investor do you Belong?
Individual investors possess the same mental acuities as do professionals. The retail investor is also armed with the same fundamental information databases, in this modern era, as are professionals. From a negative standpoint, the personal investor is subject to the same anchoring and confirmation bias that can impact professionals. It stands to reason, accordingly, that if the professional investment world is largely carved up among many cover bands, a gaggle of “Mr. Furious” one hit wonders or Mystery Men, and a very select handful of X-men (some despised, some little known and some actively envied); we as individuals likely also fall into one of the aforementioned categories, insofar as personal investing goes.
Perhaps you voraciously read the work of public managers and cherry pick a couple of their favorite stocks. Your rationale for owning these stocks is that a fund manager you admire owns them and that’s good enough for you. Since they have done the research, why on earth would you need to do your own digging? For diversification, you mix in some ETFs and index funds because that is what everyone else is recommending. If this is your investment policy, you share more attributes with investment cover bands than you realize. In of itself, that is not a bad thing; the difficulties that you might find with your portfolio returns is a lack of consistency.
Perhaps you despise professionally managed money, having scored a multibagger at one point in your life, and are now devoted to replicating that initial success. At various times in your investment life, you either get a rush from investing, a hollow pit in your stomach when things go wrong, or are bored stiff during the periods of sideways action.
Or, perhaps, you don’t think of investing in anything close to conventional terms; you consider the equity market as a series of pieces, in a number of puzzles that require sorting and assembly in order come up with a finished product. You don’t worry about short term market movements because that simply represents another variable to take into account. Maybe you even play chess, but don’t think of it as a game, but rather a problem to be solved. You’ve made a number of successful investments in various industries, but cannot necessarily determine what it was that made you select the right one vs a dud.
Are Investment X-Men managing your money?
The most notable X-men of the 20th century are fast reaching retirement or have already passed on. Warren Buffett spends a great deal of time talking up succession.
Charlie Munger is 88. Hakan Castegren, Sir John Templeton and Walter Schloss have all left the building. Cover bands and/or understudies have been assigned the near impossible task of trying to wear the uniforms of these former investment legends. Mario Gabelli's firm,GAMCO, tirelessly seeks to promote the work of son, Marc.
Some old guard X-Men still remain. Many, like those at Sequoia Fund, no longer accept new investments from the public. George Soros had returned all external funds managed and now only works with family capital. Carl Icahn has recently suspended work with the public; he now invests only for his own account.
Where ARE the new X-men?
Maybe YOU are one. In the investment world, what separates the Investment X-man from the cover band, the Mystery Man or the one hit wonder is return + consistency + time. If you want to hone your investment portfolio management skills, there is a site designed to meet those objectives. Marketocracy Inc. has developed and improved upon their site for more than a decade. It is a special incubator that allows you to build hypothetical portfolios for comparison and analysis. Some of the best investors on the planet use Marketocracy exclusively to develop, improve upon and to monitor their investment strategies.
Marketocracy Inc. was expressly designed to identify those who might have some latent talents, and allow those talents to be monitored and honed over time. Featuring far more stringent investment compliance than is mandated by the SEC, a theoretical account at Marketocracy can be a powerful tool to augment your long term investment management and decision making. The site is run by a real life version of the X-Men’s “Professor Xavier”, Ken Kam. Over the past decade, I’ve considered Marketocracy to be a most useful benchmark for gauging individual acumen. Bear in mind, it can also prove to be a sobering experience for those who represent the investment equivalent of the bathroom karaoke singer. If you ARE a one hit wonder, or a "Mystery Man", you’ll figure it out pretty quickly at Marketocracy. There is no cost to set up a Marketocracy Inc. account.
On a final note, I intend to be available at the Marketocracy panels and will likely attend some private events to be held in conjunction with the Moneyshow Las Vegas. I'll be discussing global investment trends and will report on several industries benefitting from evident secular drivers. The Moneyshow will be held from May 14th-17th at Caesars Palace. I should be presenting on the 15th or 16th and will have a more firm date to report in the month ahead. This will represent my first truly public presentation in well over a decade.