In Late 2016, Jeff Ptak of Morningstar was recently interviewed by Patrick O’Shaugnessy to talk about Active investment management. I enjoyed the conversation and thought Patrick had a number of good questions. If you are interested in learning more about Jeff you can find some of his additional work which is published on the Morningstar website here. These are my notes from the podcast hopefully these are of some help to you. If you have any feedback please send my way.
- When evaluating investment products never overlook the associated fees. Choose low cost over high cost in most cases. Passive ETF’s and mutual funds have been winning market share over the past few years owing to increasing investor allocation to lower cost products. As a result you have seen mutual fund fees drop from large investment managers such as RBC Asset Management, and Investors Group.
- Look for investment managers who have low portfolio turnover. High portfolio turnover implies more of your own capital will be paid in fees all else equal. In my view, managers who don’t trade often have higher conviction when they do trade and are potentially doing more in depth research when allocating capital. Perhaps they are looking for the right opportunity each time they allocate rather than just today’s opportunity.
- Look for investment managers who are meaningfully invested in the products themselves. Alignment in incentives between any Principal and Agent is required for an agreement to work. If anyone is aware on how to find out easily how much a manager owns of a particular mutual fund I would be interested in seeing the data.
A few investment managers Jeff highlighted as strong included Sequioa, Capital Research Group and Dodge & Cox. While investment managers who he thinks have more structural problems includes Third Avenue which has faced some issues with generational transfer to the new group of managers and a blow up on its Focused Credit Fund.
The most interesting investment manager he’s worked with was PrimeCap Management, who is led by Theo Kolokotrones and Joel Fried. Jeff mentioned he really enjoyed the conversation between these two and noticed a stark difference in the amount of time they were willing to spend explaining their business and how they think about it. Theo/Joel discussed culture, generational transfer, capacity to invest, how they teach new analysts and optimizing incentives for employees. One unique aspect at PrimeCap appeared to be how analysts get to run a small component of the actual portfolio which was utilized to better incentivize analysts. A short excerpt on the company’s investment philosophy is pasted below.
“Four key principles guide PRIMECAP Management Company’s approach to investment selection: commitment to fundamental research, long-term investment horizon, emphasis on individual decision-making, and focus on value.
First, PRIMECAP Management Company is committed to fundamental research. The primary objective of its research is to develop opinions independent of Wall Street and to understand the companies it follows as well as any industry analyst. The firm looks for stocks where it believes the underlying company’s long-term fundamentals will evolve significantly better than the current Wall Street consensus or valuation suggests. This can be a function of greater expectations it has for new products, new markets, new management, restructuring, a structural shift in demand or supply, or other changes in industry dynamics. The firm’s research involves interacting directly with the companies it is reviewing as well as their competitors, suppliers, and customers.
Second, PRIMECAP Management Company takes a long-term perspective. The firm looks for stocks that it believes will outperform the market over a three- to five-year time horizon. Portfolio managers strive to recognize values early and patiently wait for the market to reach a similar conclusion. Often, the search begins with companies and industries that are currently out of favor among investors. Consequently, PRIMECAP Management Company’s investment ideas are frequently early. However, if the firm believes that the long-term thesis is intact, conviction derived through its research efforts gives portfolio managers the fortitude to stay the course when the near-term fundamentals are challenging.
Third, PRIMECAP Management Company emphasizes individual decision-making. The firm shuns “group think” and committees whenever possible and relies on individual decision-making in its investment process. The firm believes that individuals, not committees, generate the best investment ideas.
Fourth, PRIMECAP Management Company believes the key to successful investment decisions rests in correctly appraising the relationship between the fundamental value of a company and the market price of its stock. In its judgment, a stock has the potential to be a good investment only if it is purchased at the right price.”
The conversation of hedge funds and their associated fees also came up. If you already make 2% on AUM why would you really care about the 20%. Well I think if you are an emerging hedge fund the 20% on relatively small AUM can keep you focused on delivering returns. In a best case scenario, this would engage an investment manager to think about the market opportunity they have to access and would hopefully drive them towards limiting AUM growth.
That’s all folks. If you’ve read something good lately send me a note or drop a link in the comments. Thanks for the time.