Every investor makes mistakes, including the pros. In this long read, Cherry Reynard asks a range of fund managers about missed opportunities and stocks that went wrong, highlighting lessons learned.
“If any fund manager says they’re never wrong, they’re a robot or a liar. A good fund manager simply makes fewer mistakes than their peers,” says Bryn Jones, manager of the Rathbone Ethical Bond fund, a member of interactive investor’s Super 60 and ACE 40 investment ideas. Given that most investors would rather that neither a liar nor a robot were managing their portfolio, it is worth targeting those managers who are willing to admit their errors and learn from them.
From the airline industry to the NHS, there has been an increasing recognition of the importance of understanding and learning from mistakes. In his book, Black Box Thinking, author Matthew Syed argues that the key to success can be a positive attitude to failure: “It is about creating systems and cultures that enable organisations to learn from errors, rather than being threatened by them.” The fund management industry is no exception.
However, admitting mistakes and learning from them doesn’t always come easily to the ‘Type A’ personalities who become fund managers. After all, fund managers need conviction in their decision-making, and the most successful will often take a very different stance to the wider market to deliver compelling returns. Nevertheless, some evidence of humility can be important, as are checks and balances in the wider organisation.
Discipline is key
A disciplined approach to decision-making is vital. That way, if mistakes are made, a fund manager can understand why they made them. For Jones, this proved important in 2021, when interest rates started to rise and the pain was felt in the bond market: “We could have put in a hedge against further rate rises, but it would have cost us around 2.5% - that was the entirety of the fund’s yield at that point. It was a really tough call and we didn’t do it.” With hindsight, he says, it would have been really helpful, but at least he understands why he didn’t do it at the time. “It’s not an exact science,” he admits.
If there is bad news about one of Jones’ holdings, he will sit with the analyst team and look at whether they have made a mistake, or whether the market is over-interpreting a particular problem and has got it wrong. If this is the case, it might be a buying opportunity. He says where investors don’t have this discipline, there is always the potential to be whipsawed by the market, panicking in and out of positions, and losing money in the process.
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Kirsty Desson, co-manager on the abrdn Global Smaller Companies fund, another Super 60 investment idea, says foresight would be a superpower for any fund manager: “The ability to see into the future and buy and sell stocks with perfect timing would be a dream. Instead, we rely on multiple indicators to judge whether a stock is attractive and when it is time to sell. Of course, fund managers don’t get every decision right, but every decision is made with the best judgement according to the information available at the time.”
Desson believes any missed opportunity should serve as a lesson for the next time, adding: “One lesson which has served me well is that it is never too late to sell an investment when the investment case has turned negative. I was reminded of this recently when looking at Chegg Inc (NYSE:CHGG), the US listed online education platform. We bought into the stock in 2018, however, [we] became concerned when management issued new equity in February 2021, and therefore, significantly reduced our holding.
“Despite decent results, the stock continued to slide, leading us to cut our position further in August 2021. We finally sold the residual holding in November 2021 on poor results. Although the stock had lost more than half its value from the peak in February 2021, Chegg’s shares have subsequently dropped to less than one tenth of what the stock was once trading at. Despite share prices falling substantially, stocks can always get cheaper.”
Fund managers also need to be wary of the ‘bogey stock’, says Dale Robertson, fund manager on the MI Chelverton European Select fund: “Followers of sport will be familiar with the concept of having a ‘bogey team’. This concept holds in portfolio management. The bogey stock in our portfolio is the former Dutch state-owned deliverer of your daily junk mail and occasional bill, PostNL NV (EURONEXT:PNL).
“Despite an apparently sound initial investment case each time, not only did I lose money on PostNL in my previous job – not once, but twice – money has also been lost on it at Chelverton. God loves a trier, but in this case, we should adapt the British Olympian Steve Redgrave’s famous quote after exhausting himself on the way to his fifth Olympic gold – ‘anybody sees me go anywhere near a boat, they have my permission to shoot me.’”
This, he says is the famous ‘value trap’ – a stock that looks superficially cheap, but only gets cheaper. Sometimes investors need to believe what the market is telling them. Robertson adds: “It’s certainly hard to be overconfident when coming in to work you know that if you ‘only’ get 45% of your decisions wrong then, ceteris paribus, you are likely to have done a pretty good job for investors. So it is that learning from mistakes is a critical part of the job.”
Watch out for value traps
Edmund Harriss, fund manager on the Guinness Asian Equity Income Fund, also in our Super 60, says investors need to cautious about the cliches that surround individual stocks and sectors. In particular, they shouldn’t mistake high yields for safety.
He says: “An emphasis on the dividend itself is misplaced and focus should instead be on the quality of the operating assets that generate the cash and are the ultimate source of the income stream.
“Cyclical businesses, like commodity stocks, can go through periods of offering high dividends when product prices are high as they have been in 2021 and 2022; but when product prices drop it is inevitable that the cash flows, the dividends and the share prices will follow.
“High dividends may also be the product of high payouts, where companies distribute all their earnings each year. Such businesses are not re-investing and therefore are less likely to be growing.
“Today, anaemic economic growth is less likely to lift revenues, profits and cash flows and when higher interest rates and inflation combine to erode the value of money in real terms, a higher dividend is also unlikely to afford protection.”
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This was a lesson he learned in 2010-11, when heavier exposure to energy and materials hurt fund performance. He added: “It illustrated the problems posed by cyclical, as opposed to consistent, growth.” This is an important point to note as the economic cycle turns.
On-the-ground research a key lesson
Dan Carter, manager on Jupiter Japan Income, a Super 60 pick, says his key lesson has been the importance of 3D, on-the-ground research: “We made a real stinker of a buy in 2019 - industrial knitting machinery maker Shima Seiki. The business had a plausible investment case - a niche Japanese leader in a field that was craving investment and technology. Apparel-making was being mechanised and increasingly automated and Shima Seiki's knitting machines were going to provide ‘3D printing for clothes’.
“However, the share price - and operational performance - was way below our expectations. Something had gone wrong: the shares were slipping, and product pricing was coming down - not what we expect for a leader in a secular growth industry. We finally got to the bottom of it when my co-manager Mitesh attended ITMA, a specialist convention for apparel industry kit in Barcelona. The Shima Seiki exhibit stand was empty, and those of its Chinese rivals were packed.
“The competitors had managed to increase quality, and crucially maintain a big price discount - something that buyers on the ground confirmed, and something that would have taken us a long time to work out had we not gone to Spain to speak to them.”
Then there’s the plain old mathematical error. Alex Wright, portfolio manager on Fidelity Special Values (LSE:FSV), says: “Graham Clapp, a former Fidelity fund manager, gave me good advice – the number one rule is not to make mistakes; the number two rule is to admit them when you do. As a fund manager you will make mistakes.
“I had made a big mistake with a Turkish bank, where I was the analyst: Yapi Kredi. It had carried out a complex transaction and I had incorrectly calculated the new share count, so that the number of shares in issue was 40% too low! This was a very large mistake. We still made money on the stock, just nowhere near the amount I thought we might.”
Markets shift, companies change and the good fund manager will constantly reappraise their initial judgement. They need to keep a balance between conviction and bull-headed optimism. This should ensure they get better over time – a little humility can go a long way.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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