To reach the peak of the investment world, you must balance several contradictory impulses. This is hard, but the best make it look easy.
There are plenty of competent fund managers. Sadly, merely being competent won’t justify their fees, let alone mine on top. So, as a professional fund buyer, I need to find exceptional managers, and they’re a rare breed.
They’re rare because they have an unusual collection of characteristics, some of which are contradictory. These characteristics allow them to behave one way, while simultaneously doing the opposite.
They are, in other words, a paradox. And I’ve noticed three paradoxes that are shared by all the best managers I’ve bought over the years. Understanding them is useful for finding other great investors, or becoming better yourself.
1 Pessimistically optimistic
Managing a fund is an inherently optimistic exercise. You must believe you’re good enough not just to beat the market — a hard enough task — but to beat it beyond your fund’s charges.
More than that, if you’re an equity fund manager, you must contend with the fact that, generally speaking, your market goes up.
I’d back-of-a-cigarette-pack estimate that markets spend 70% of the time rising and only 30% of the time falling. So, statistically speaking, if you’re given to thinking that markets are about to fall, the odds are against you. I’ve seen too many intelligent managers knocked out of the game trying to time a selloff that never came. It’s no job for an out-and-out pessimist.
But it’s no job for an out-and-out optimist either.
Those who blithely assume everything’s going to be brilliant might last longer and get the juices flowing while they do, but they’re just as likely to get terminally burned. Because when a blind optimist’s fund hits tough conditions, it doesn’t just go south, it goes penguins-and-snow south.
In contrast, the best managers are a balancing act. They’re often optimistic people, hence the day job, but they’re borderline paranoid about what can go wrong. When they find a great idea, they don’t pile straight in — they tear it apart looking for flaws. Too expensive? Too much leverage? Wobbly management? No thank you.
It’s this pessimistic optimism that keeps them in the long game but stops them blowing up in bear markets.
2 Flexibly dogmatic
If you don’t stand for something, you’ll fall for anything. And process is the best way of ensuring you keep standing for something. This is why, when assessing a fund, I focus 50% on the manager’s character and 50% on their process. Everything else is detail.
There are few guarantees in investing, but the fact that markets will batter you emotionally is one of them. No matter how sensible your process is, there will be uncomfortably long periods when it looks broken.
At these times, the temptation to abandon the process is strong. But that’s why it’s there. Process is what forces one manager to keep buying unbroken companies when everyone else thinks they’re bust, and another to keep faith with a top-quality company when the mob says it’s too expensive.
The best managers dogmatically stick to their process when it’s out of favour. Then, when it returns to favour, the elastic pings back: they recapture lost ground surprisingly fast.
However, every rule has an exception. And spotting the exceptions to their process is something the true greats have a knack for.
Back in 2007, US value manager Bill Miller had the makings of an investment legend, but the financial crisis wrecked all that (see chart above). His process told him to double down into falling share prices, which had worked well for years. But it doesn’t work if the companies go bust, which many of his financial stocks did in 2008. Disaster.
This points to the fact that, no matter how good it is, a process operated without human judgement is just an algorithm. The best managers know this. They stick dogmatically to their process but somehow remain flexible enough to spot the occasions when it’s about to drive them into a brick wall.
3 Agreeably disagreeable
Becoming a fund manager is hard. You have to take lots of exams, most of which are only passingly relevant to becoming the best at your job. But an official somebody from somewhere else has told you to do them, so you must spend years of your life doing them.
Being willing to do what you’re told is a character trait. Let’s call it agreeability. And not everyone has it: some bridle when told what to do, particularly if they think it’s a waste of time.
Becoming a fund manager, therefore, requires an agreeable temperament. Not just in jumping through the right hoops to get the job, but then to work well with the analysts, senior management and all your other colleagues who are integral to doing it well.
However, becoming an outstanding fund manager means doing something very different to the market (how else can you be outstanding?). And as the market is basically the aggregated views of everyone on the planet, that means being willing to disagree with everyone on the planet.
That can be tough. Holding beaten-up, unknown small caps, for example, when the market only loves fast-growing mega caps feels like arguing with everyone, everywhere, all at once.
If you’re strongly agreeable, that’s too much to bear. If this is you, it’s likely you’ll end up doing what the benchmark tells you to do. And that, by definition, won’t be outstanding.
So, as much as agreeability is necessary to get — and keep — the job, you must also be disagreeable to then excel at it (or, to be more precise; ‘bellitious’, as explained here’).
It’s no wonder that so few do.
This article originally appeared in Citywire in March 2023.