It’s March, and that means March Madness. It’s the time of year when thousands of people vie to fill out a perfect winning bracket that correctly predicts the victors of each Division I college basketball tournament game. Each team is “seeded,” or ranked, within its region. Lower-ranked teams are placed in a bracket against higher-ranked teams. A lot of thought can go into predicting which team will emerge victorious from each game. Hint: The higher-ranked team does not always win.
Similar to those who put a lot of thought into completing their brackets, Beacon Pointe believes that to obtain successful long-term investment results, it makes sense to invest with successful investment managers over the long-term. There are periods of time when top-quartile investment managers, measured by ten-year results, may often underperform dramatically for periods of two to three years. By dramatically, we mean these managers may rank in the absolute bottom of their peer group and lag the index by 10-15%! To tie it back to March Madness, there are “top-quartile” basketball schools (schools that earn #1 seeds year after year in the NCAA Tournament) that occasionally have a rough regular season and earn a lower seed. When predicting March Madness brackets, there are many factors that determine whether a bracketologist will select the higher-ranked team or the lower-ranked team. Will this team’s struggles during the regular season be an accurate predictor of their tournament performance? Or is this a team that is about to go on a hot streak and become a bracket buster?
Our primary objective at Beacon Pointe is to achieve strong returns for our clients over a full market cycle (five to seven years) and, at the same time, manage risk and protect capital. We believe successful long-term investment results are achieved by embracing the power of compounding without interruption. We all are familiar with the mathematical concept—losing 30% requires much more than 30% to reach break-even. Beacon Pointe would rather experience a transitory period of underperformance rather than chase the latest performance fad, knowing that in the long-term this philosophy will serve our clients well.
Beacon Pointe believes that there are two business models in the investment manager domain. The first emphasizes and is driven by the investment managers’ profits; the second is focused on the clients’ profits. It is no surprise that Beacon Pointe prefers the latter. We search for asset managers that are client centric and have certain common traits.
- They are benchmark agnostic; in order to outperform over a complete market cycle, they will not look like the benchmark which, by definition, leads to periods of underperformance, sometimes as much as three years.
- They are principled; they invest their money alongside their clients’ money.
- They are not often found in the large brokerage or bank platforms (“wrap programs”) and choose not to affiliate with these programs, as large platforms could possibly overwhelm managers with assets at certain size levels.
- They embrace the margin of safety, Graham & Dodd principles of investing, and they employ intrinsic value strategies.
- They have concentrated portfolios (18-25 positions).
- They may not have dedicated marketing professionals.
- They may not necessarily adhere to the regimen of style boxes.
- They have experienced multiple market cycles. Experience begets consistency.
- They don’t try to predict the future, but rather adhere to a rigid discipline.
This leads us to a stable of investment managers especially in the more efficient large-cap category that will occasionally underperform its indices or peer groups for periods of time. We expect this! Beacon Pointe’s managers will not necessarily look like the index and may have lower correlation to it. As Sir John Templeton so well stated:
“If you buy the same securities as other people, you will have the same results as other people. It is impossible to produce superior performance unless you do something different from the majority. To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.”
Often, these managers will be purchasing mispriced securities which will be at odds with conventional wisdom. We also recognize that patience is required by long-term investors as they wait for a connection between business performance and stock price to occur. This investment strategy will require extreme patience from our clients as well but we know our clients will be rewarded in the long-term.
As Yale’s former CIO David Swenson stated:
“Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.”
Beacon Pointe maintains that unconventionality is required for successful investment results. We do not believe one can “follow the herd” and expect to outperform. No one has ever achieved a perfect bracket by only selecting higher-ranking teams. There are always a few upsets. Conversely, some investors do not want to “rock the boat,” hence the flood into indexes and ETFs (exchange traded funds) in the last few years. Howard Marks, founder of Oaktree Capital Management, states:
“Large investment management firms, pension funds, endowments, and investment committees; they’re all institutions. As such, they tend to engage in what is described as “institutional behavior”— an oft-heard phrase that’s rarely intended as a compliment. We all know what’s implied: shared decision making, diffused responsibility, personal risk minimization, and go along-to-get-along interaction. All of these things work to discourage unconventionality and thus to render superior investment results elusive.”
David Swenson in his book “Unconventional Success” hits institutional behavior head on:
“Active management strategies demand uninstitutional behavior from institutions, creating a paradox that few can unravel. By operating in the institutional mainstream of short-horizon, uncontroversial opportunities, committee members and staff ensure unspectacular results, while missing potentially rewarding longer-term contrarian plays.”
There are many asset managers who do not outperform their passive (index) benchmark, so many advisors and fund sponsors sometimes will opt to indexing simply because of the work and the expense involved in the effort required to find and monitor successful managers. This research and the understanding of the qualitative and quantitative components that drive our list of select active managers is Beacon Pointe’s core competency.
Just like predicting the perfect bracket, Beacon Pointe believes the right approach to portfolio construction requires a dedicated and focused research effort, patience, and discipline. Quoting Barton Biggs’ book Hedgehogging: “It Ain’t Easy.”
Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.
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