Much of the asset management industry demonstrates their 'expertise' by flashing their CFAs, PHDs or MBAs as if to say, Listen, man, I know the rules of this game and I can play it well... Mean variance optimization? Love it. CAPM? Live by it. Efficient markets hypothesis? Strong form, bro."
But if the asset management industry is right to push their knowledge of, and mastery over, traditional models, why are the best investors so often those that sidestep the rules in creative ways?
I ask because Brett Arends of Smart Money had a very nice article last week about a guy named Allan Mecham from Utah. This guy, who youve likely never heard of, has been shooting the lights out for over a decade. In the Article, Mr. Mecham is referred to as the 400 percent man, for obvious reasons:
Allan Mecham had been posting mind-bogglingly high returns for a decade at a tiny private-investment fund called Arlington Value Management, and the Wall Streeters were considering jumping on board...Over a 12-year stretch, through the end of 2011, Mecham, now a mere 34 years old, has earned an astounding cumulative return of more than 400 percent.
Generally, in these types of articles (i.e., ones that describe a young investment phenom), you would now expect to be told about the secret algorithms that this individual or fund had developed (perhaps by unleashing physics PhDs into the world of finance). You would be told how these algos were uncovering market anomalies that, by the power of Gray Skull , the phenom in question can actually trade on. This black box is so powerful, we are often told, that it defies comprehension by mere mortals.
But thats not how the article on Mecham goes. As you might imagine, the way Mecham runs money is very different from how typical asset managers operate:
... Did he have an MBA? No. I dropped out of college. Did he have a clever computer model or algorithm? No, he replied. I don't use spreadsheets much... The story of his success, arguably, says a lot about the flaws of the fund-management industry. By his own account, and those of other investors who have vetted his fund, Mecham has no secret sauce or amazing algorithm; what's extraordinary about this young man is how ordinary he is... His investment approach will be familiar to anyone who has been even a casual follower of Buffett. Mecham looks for businesses with great long-term prospects, great management, strong cash flow and big defensive "moats," or barriers to entry for potential competitors. And he stresses the importance of sitting still and doing nothing. "Activity is the enemy of returns," says Mecham. "If I find two new ideas a year, that's phenomenal." Two ideas a year adds up to a pretty small portfolio -- Mecham typically owns between six and 12 stocks.
Actually, I'd argue that while there's no 'black box', there is a secret sauce here; its his long-term view:
Mecham says one of his big advantages over Wall Street managers is that he is free to ignore "noise" -- like the quarterly obsession over short-term earnings, which often drive stock prices sharply up and down as investors stampede in herd behavior. The first question he asks of any investment, he says, is where it will be in 10 years or more: "You have to have a high degree of confidence in the cash flows over the next decade." Mecham says that in contrast, the typical mutual fund manager is like someone who's hired to run a marathon -- only to have his clients announce that they're going to compare his time every 100 meters with that of an Olympic sprinter running a dash. "It's a myopic process," he says, with resignation.
In short: Go long, friends.
Anyway, here are my take-aways from Mechams success and what it might imply for a secret sauce for asset managers of the future:
- Concentrated portfolios over wide diversification;
- In-depth qualitative understanding over rigorous quantitative modeling;
- Investing for decades over investing for quarters;
- Doing nothing over doing something; and
- Business understanding over market understanding.
Now you too can make 400 percent over the next decade... but be prepared for some big losses (i.e. noise) along the way!