Patient Capital Outperforms – are you fishing in the right pond?

While investment manager returns can be observed on an ex poste basis, the more important question is whether managers with a high probability of success can be observed on an ex ante basis. Our response is that they can. There are key characteristics that we see repeatedly across excellent investors. The first characteristic is one that surprises many casual observers of the investment problem. When investing in companies or buildings or lending money “active” should not imply activity. The ability to trade successfully and the ability to invest rarely reside in the same person or team. Excellent investors are patient, methodical people who think about the development of a business in terms of years rather than the development of a share price over minutes. Contrast this with the quick minded trader, taking advantage of market psychology on the demand and supply of paper assets. While the popular image of an investment floor involves Bloomberg terminals, flashing lights, phones tucked into bent necks and much shouting, the Cerno investment team sits in an environment not dissimilar to a library. Some of the great investment teams we speak to boast of the absence of Bloomberg terminals on their investment floors.

The result of in depth, patient, fundamental analysis is that excellent investors tend to own companies for many years and often decades. Portfolios can be easily examined to confirm this.

There is academic evidence to support the idea that the pool of patient investors who build idiosyncratic portfolios is an attractive pool for the manager researcher to fish. In their December 2015 paper; Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, Cremers and Pareek[1] show that a group of US equity managers selected purely on the basis of long duration of holdings and high active share outperformed the S&P by a little over two percent per annum over the twenty year measurement period.

Turnover can be used as a proxy for the patience of an investor although it is not the same thing as duration of holdings and the Cremers and Pareek study does not support its use in place of holding period. High turnover is not necessarily a bad thing, but we tend to be suspicious when we see it.

While portfolio construction (active share) and duration of holdings are quantitative metrics that help define a universe of managers with performance potential, a qualitative approach which focuses on understanding an investment approach and determining soft factors will improve the chances of selecting an investment manager with a high probability of delivering strong performance.

[1] Cremers & Pareek, “Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently”, December 2015

By | 2017-10-17T10:33:39+00:00 June 6th, 2017|Cerno Capital Posts|

About the Author:

Fergus surveys the full range of the firm’s investments on a bottom up basis and is principally engaged in manager and security selection. He began his investment career at Valu-Trac Investment Management in 1995, where he worked in their global equity and asset allocation products. He worked for Russell Investments as a Portfolio Manager of UK equities (2001-2006) and Asian equities (2006-2009). Fergus graduated from Edinburgh University with a BCom (Hons), holds the CFA charter and is a member of the CFA Society of the UK. Fergus is a Director of the Salters’ Management Company.