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By Ken Kam, Marketocracy
The first cut narrowed our search for the next Warren Buffett down to 459 managers — 398 Marketocracy managers and 61 mutual fund managers. Each of these managers has an individual track record that is at least 5 years and each has outperformed the S&P 500 by at least 600 basis points, or 6%, per year for the last 5 years. They have clearly been doing something right during a volatile time in the market. These are the managers it is worth the time to interview. So, what should we ask them?
We can learn a lot about managers’ investment skills by analyzing their track records. Doing so will help us formulate better questions for each manager.
A Word About Past Performance
First, a word about past performance. Many people’s first instinct is to choose the manager with the highest return. While the returns are evidence that the manager made good investment decisions in the past, the stocks that the manager bought have already come to fruition. To generate those returns, those stocks went from being undervalued to fully valued, and now they may be overvalued. For that reason, the manager’s future returns are unlikely to be similar to his past returns, especially if he sticks with the same stocks.
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We can say with almost complete certainty that the future will bring different opportunities and so we should expect the returns to be different. However, we should also expect the manager to continue to apply the same decision making skill that resulted in those past returns to whatever opportunities the future brings. Here are some examples.
Stock Picking And Trading
To be a great investor you have to do two things well, pick the right stocks and trade them well. If you are a good stock picker, then a high percentage of the stocks you put in your portfolio will be profitable. I call this the winning percentage.
If you are a good trader, then the stocks you buy should outperform the stocks you sell. If you calculate your average gain on your winners and divide it by your average loss on your losers, you’ll come up with a ratio that measures whether that is the case. I call this the gain/loss ratio.
My experience at Firsthand Funds taught me that the people who understand any industry best are those with firsthand experience in the industry. Someone who has built a business understands the opportunities, the customers and the competition far better than someone who analyzes the industry. The problem is that this kind of expertise is usually limited to just one industry. Few people have firsthand experience building successful businesses in more than one industry. That’s why a manager whose resume shows a successful career in the tech industry and whose track record shows the lion’s share of gains came from the technology sector should not be presumed to be equally skilled in any other sector.
Is investing a job or a passion for the manager. Is he in for the long haul? If we have found the next Warren Buffett its important that the manager be committed to managing our money through at least the next full market cycle. I say this because I have yet to find any manager who can perform well no matter what the market is doing. All managers have good and bad periods, including Warren Buffett. If you want to benefit from the good periods, you need to be sure you have enough confidence in the manager to ride out the bad periods. If we are going to have to commit to stick with a manager for an entire market cycle, it is only fair to ask the manager to make the same commitment.
In the next article we’ll interview one of the managers to make a judgement about whether there is enough evidence to stick with him for an entire market cycle.
The post Finding the next Warren Buffett: The winning percentage appeared first on Smarter Investing
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