Should You Invest With Butch Cassidy & The Sundance Kid?

What can investors learn from this classic movie?

This is the third of three annual silly-season notes I wrote looking at how characters from great movies would fare as mutual fund managers (third of four if you include the controversial and unpublished Marvel Avengers ‘ESG’ special from 2019).

They’re tongue-in-cheek, but only partly. I’d get carried away in the writing of them, and end up making serious points about the pitfalls of investing. Well, I think so, anyway. You’ll be the judge of that…

Should You Invest With Butch Cassidy & The Sundance Kid?

Originally published on Trustnet in December 2018:

I’m always looking for ways to make advisers’ lives easier. That’s why I’m writing this series on ‘Should you invest with…?’, which may or may not allow you to claim CPD points by watching classic movies on the telly over Christmas.

Probably ‘may not’, actually. In fact, now I think about it, which is to say now my compliance colleagues think about it, definitely not. Forget I mentioned it.

Anyway, having ticked off Star Wars and Indiana Jones, I’m now examining the thorny issue of whether you should invest with Butch Cassidy and the Sundance Kid. And given how popular these managers are, you’re not going to like the answer: It’s a ‘no’ from me I’m afraid.

Why not? Cassidy and Kid have generated incredible numbers over their careers, but these take no account of the risks they and — by extension — their investors took to get them. Let’s unpack a few of those now.

They built their early, impressive track record specialising in the US banking sector. But that niche was never scalable.

I suspect this, and the fact that their success drew the attention of competitors and regulators alike, drove them to expand their mandate to include rail companies. These lie outside their circle of competence.

This is a warning sign: just because a manager is good at one thing, let’s say small-cap stockpicking, it doesn’t mean they’re good at everything, such as large-caps or market timing.

But investors should have been wary before that. Strip away the managers’ persuasive charm and slick marketing, and was clear they were taking too many risks.

Unfortunately, when performance is that good, fund buyers often ignore their inner sceptic, and end up buying the story anyway: Usually at the worst possible time.

There were other flashing lights too.

A manager hooning around in a flashy, must-have sports car is worrying. Granted, in Cassidy’s case it wasn’t a Lamborghini, or even a car for that matter; it was a pushbike. But the principle stands: it’s classic top-of-the-cycle stuff (pun intended).

And top of the market it proved: The managers were wrong-footed when earlier risks came back to bite them.

This should have been curtains, but what happened next is a lesson for fund pickers everywhere. With their track record looking terminally compromised, they took one final punt: The famous cliff jump into the rocky river below.

As fund analysts, we need to be wary of managers who have got themselves into a situation where taking a large kill-or-cure bet becomes their only option (As Cassidy reasoned at the time; “would you make a jump like that if you didn’t have to?”).

All good managers underperform from time to time, but what makes them good is that they expect it to happen (even if they don’t know when it will happen). It’s the ones who thought their process would work, uninterrupted, forever you need to watch: They’ll be shell-shocked when it doesn’t. That’s when panic sets in. And you don’t want your money anywhere near a panicking fund manager. It’s invariably better to sell out, even if that means realising a loss.

I remember one US equity manager, who’d had a tough financial crisis, going ‘all in’ on banks a month before the market troughed in 2009. It was such a brutal month for those shares that he ended up panic selling them just days before the decisive rebound, thereby locking in heavy losses.

He’s not a fund manager anymore.

He might, however, still be one if he’d taken the same gamble a month later. But that would have made him lucky, not good. In fact, given the perils of ego, he might even have become worse than he was before.

That’s why the Cassidy and Kid case is interesting: they’re the rare example of managers who took a Hail-Mary gamble and got lucky. As such, their track record now looks great again, and investors are streaming in.

But the warnings signs are still there. Yes, they’ve returned to their favoured banking sector, but this time not in the US, but in emerging markets. This is even riskier and requires different knowledge. Furthermore, they’ve recently drifted into non-financials again. The parallels with their previous rough patch are worrying. I fear it won’t be such a happy ending for them this time round.

So, if they’re uninvestable, who should you choose?

I think their nemesis, the railroad tycoon Mr E H Harriman, was on the right track (yep, intended that one too).

He carefully selected a posse of experts, each of whom was the best in their own field. He also made sure they were well diversified, so he not only included tough lawmen like Joe Lefors, he also added the native American Lord Baltimore — the West’s finest tracker (I’m not a fan of trackers myself, but I accept that the reasons for using one in this case).

The ensuing results demonstrated resilience, repeatability and, ultimately, great success in achieving the desired outcome. Hats off to Mr Harriman’s approach, I say.