Stock Market Wizards: Interviews with America's Top Stock Traders Hedge fund market wizards: how winning traders win / Jack D. Schwager. p. cm. Includes. Jack Schwager is a renowned industry expert in investing, hedge funds, and futures. Hedge Fund Market Wizards provides a microscopic view of the world of. Exploring what makes a great trader a great trader, Hedge Fund Market Wizards breaks new ground, giving readers rare insight into the trading philosophy and.
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Marty Schwartz and Linda Raschke were two former Market Wizards ("former" [The multibillion-dollar hedge fund was overleveraged in the bond market and. Hedge Fund Market Wizards: How Winning Traders Win [Jack D. Schwager, Clinton Wade] on spicesinlaris.cf *FREE* shipping on qualifying offers. Editorial Reviews. spicesinlaris.cf Review. Guest review of Hedge Fund Market Wizards, by Stanley Druckenmiller Jack Schwager's newest book, Hedge Fund.
The salesmen could make any story sound great. So apparently you had failed to learn your lesson about not listening to tips and rumors. You made the same mistake all over again.
I couldn't bring myself to tell my wife that I had lost almost all the money. I had trouble sleeping the entire month. I made up all these excuses why I was looking so sickly. I told my wife that I had the flu. She was worried, but she had no idea what the truth was. One day a buddy who worked beside me gave me a tip to download Commodore Computer. That was the low point in my life. The thought that because of some gambling 1 could lose everything that I had built up in ten years of saving really scared me.
It was the black abyss. After I liquidated, the stock reached as high as the low twenties, but it eventually went back down to zero when the company went bankrupt.
That single trade was enough to almost make me whole again. You actually were salvaged by pure luck, by a tip that could have been a disaster because the stock eventually ended up going to zero.
You just happened to catch it during the right time window.
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It was just luck. To this day, I look back at pivotal points in my life, and I don't know whether they were due to luck or intelligence, but I never care about the difference.
It's funny how things work out. I always tell people that luck is a very important factor in this business. Maybe you have to put yourself in the position to be lucky, but I think we all get our fair share of luck—both good and bad. We just have to take it as it comes. That Commodore trade saved me. You might think my attitude would have been: "That tip worked, so I'm going to listen to other tips.
I realized that I was being bailed out by the stock market gods. I did learn my lesson. From that point on, 1 traded so much better. Did you say, "Thank God, I won't sin again"? Even though everything worked out, the stress was incredible. Therefore, when I made it back, it was a godsend. Then I just started to chip away at it. Of course, I still had a lot to learn, but at least I had that experience behind me.
I think it's important to get that low and see the abyss. How did that help you? The shock of the experience gave me clarity. I understood that stocks don't go up and stay up because of stories, tips, or people's opinions; they go up for specific reasons. I was determined to find those reasons, shut out the world, and then act on my own knowledge.
I started to do that, and over time, my record got better and better. This was really the first time in your life that you were trading stocks with any success. What types of things were working? The theme I noticed back then that has persisted through bull and bear markets is: Good companies, on balance, continue to go up.
Grandmothers in Kansas City know that. And how do you find these good companies? I look for companies that have been blessed by the market. They may be blessed because of a long string of quarters they've made [quarters in which the company's reported earnings reached or exceeded expectations], or for some other reason. You can identify these stocks by how they act. For some reason, the market goes to some stocks, and it doesn't go to others, no matter how many brokers tell their clients to download these other stocks because they are cheap.
In effect, you actually reversed what you had been doing before: Instead of downloading bargains and selling stocks that had gone up a lot, you were downloading the expensive stocks. That theme has continued to this day. The hardest thing to do is to download a high-flying stock or to sell a stock that has gone down a lot, but I always find that the hardest thing to do is the right thing to do.
It's a difficult lesson to learn; I'm still learning it now. What tells you—to use your word—that a stock is "blessed"? It's a combination of things. The fundamentals of the stock are only about 25 percent of it. What is the remaining 75 percent? Another 25 percent is technical. What are you looking at on the technical side? I like stocks that show relative linearity in their trend.
I don't want stocks that are swinging all over the place. That's 50 percent, and you have already gone through fundamental and technical. What's left? Another 25 percent is watching how a stock responds to different information: macroeconomic events, its own news flow.
I try to get a feel whether a company has that special shine to it. I want to see a stock move higher on good news, such as a favorable earnings report or the announcement of a new product, and not give much ground on negative news. If the stock responds poorly to negative news then it hasn't been blessed. That's 75 percent. The last 25 percent is my gut feeling for the direction of the market as a whole, which is based on my sense of how the market is responding to macroeconomic news and other events.
It's almost like looking at the entire market as if it were an individual stock. How long do you typically hold a stock once you download it?
I don't day trade, but I only hold a stock for an average of about a few weeks. Also, when I download a stock, even if it's a core position of a few hundred thousand shares, I might be in and out of it twice in the same day and six times in the same week, trying to get a feel about whether I'm doing the right thing.
If I'm not comfortable with the way the stock is trading, I get out. That's one thing I love about running a hedge fund.
I don't have to worry about my customers seeing the schizophrenia in my trading. I used to work for a company where the customers received a confirmation statement for every trade that I did. They would go nuts. They would call up and say, "Are you crazy? What are you doing? I thought you were supposed to be doing real research. I get out either because the stock looks as though it's rolling over, and I am in danger of losing what I have made, or because the stock has made too much money in too short a period of time.
Would you then look to download back the stock on a correction? Does that work, or do you often end up missing the rest of the move?
I often end up missing the rest of the move because the stocks I am downloading are good companies, and they usually continue to go up. Have you considered changing your trading approach so that you hold stocks longer? I have changed gradually over the years, but to this day, I still fall prey to the mistake of getting out too early. Sure, all the time. So you are at least able to bite the bullet and admit that you made a mistake by getting out, and then get back in at a higher price.
To me, the successful stock is not one that I bought at 10 and held to a , but one where I picked up 7 points here, 5 here, another 8 here, and caught a major part of the move. But it sounds as if it would be easier to just download one of these blessed stocks and hold it. Sometimes, but it really depends on market conditions.
For example, right now valuations are so high that I don't have any core positions that I intend to hold on to. That brings me to a question I was going to ask: In this type of market, where the leading stocks have already seen such extraordinary price run-ups, do you still use the same approach?
If not, how do you adjust your methodology? To be honest, I'm having a hard time adjusting. My philosophy is to float like a jellyfish and let the market push me where it wants to go.
I don't draw a line in the sand and say this is my strategy and I'm going to wait for the market to come to me. I try to figure out what strategies are working in the market. One year it might be momentum, another year it might be value. So you adopt your strategy to match your perception of the market environment.
Exactly, I try to anticipate what the market is going to pay for. How do you know when there is a sea change? I'll look at everything and listen to as many people as I can, from cabdrivers to stock analysts.
Then I sit back and try to see what idea rises to the top. Sometimes the opportunities are so obvious that you almost can't lose when they come around; the only problem is that they don't corne around that often.
The key is not to lose money in the times in between. Last year  it was very clear to me—I don't like saying stuff like this because it makes it sound as though I have a crystal ball—that the market had a very good chance of rolling over in a serious way during August.
What made you so sure? I constantly evaluate market sentiment—Is the market hopeful? Is it fearful? Throughout last winter and spring, the situation was very confounding.
There were lots of reports about potential problems in Asia, but the market ignored everything. Therefore, the only way to make money was to be long, even in the face of this potential trouble. So I decided to get really long in July. The leaders were performing great, and the market was roaring.
At one point, I was up 15 percent for the month. Then all of a sudden, in a matter of days, I lost everything and actually found myself down 3 percent for the month. The market took the money away so quickly that just by looking at my own portfolio, which was filled with market leaders, not stocks with poor fundamentals, I knew something had to be wrong.
What did you do at the time? You said you had started out the month heavily long. Did you cover your entire position? Did you go net short? I was percent long. What I typically do when I believe there's a major bearish event occurring in the market is to sell everything and then just watch.
That's what I did then. Did you go short?
Yes, about two weeks later. I thought that the Asian crisis that precipitated the break would have a second leg to it. Usually you don't just hear about a problem and then have it end. We also started seeing headlines about potential problems in Russia. Although we had seen these types of news reports before, the difference this time around was that prices were responding.
I felt convinced that the situation would continue. Russia was not going to get fixed the next day, neither would Thailand or Korea, and prices were reflecting these fears.
During the second week of August, I went percent net short, and the scenario played out. To me it was very obvious. I covered my shorts during the second week of October. I have a number of rules taped to my quote machine. One of these is: download on extreme weakness and sell on extreme strength. The only way to identify extremes is to get a feel for the sentiment, whether it is euphoria or pessimism. Then you have to act on it quickly, because there are often abrupt peaks and bottoms.
By the second week of October, I felt that I had to take advantage of the opportunity of the market's extreme weakness to cover all my shorts. I covered the entire position in one day and actually went net long 25 percent.
Was there anything significant about that day in particular that prompted you to reverse your position? That day, stocks like Dell went down from 50 to 40, and before the end of the day they were going up 2 or 3 points at a clip. So you were downloading these stocks at much higher prices than they were trading at earlier the same morning.
Actually one of the things I like to see when I'm trying to download stocks is that they become very difficult to download. I put an order in to download Dell at 42, and I got a fill back at I love that. Do you just put your download orders in at the market, or do you try to get filled at a particular price?
I always download and sell at the market. I never mess around trying to get the best fill. I'm a broker's dream. You said you went long about 25 percent.
When did you increase that long position? Whenever I start to go back in on the long side, I like to wait and see that the market rebound continues the next day and that there is no further bearish news. If there is additional bearish news and the market doesn't go down, then 1 really go nuts. Did that happen then? It didn't happen the next day, but it happened later in the week.
There was more news about the collapse of Long Term Capital. See David Shaw interview. That gave me greater confidence to just plow in on the long side. I had a chance to download all these market leaders while they were down sharply from their peaks, which I love to do. Did the all-or-nothing trade that recouped most of the money you had lost from your home-equity loan mark the beginning of your successful trading career? Did you stay true to your vow to give up your trading transgressions?
For the most part. I immediately started trafficking in quality growth names. I bought the stocks that went up more than the market when the market was going up. I figured those were the horses to bet on. I forced myself to download these stocks on down days. I found these stocks would often go up five points in a week, whereas I would have been lucky to get five points in a year in the low-quality stocks I had previously been downloading.
The only time I really got into trouble was when I fell prey to a great sales pitch. The most dangerous thing on the Street is the ability to communicate. I worked with some great salesmen. They would say, "Stuart, you have to look at this.
Maybe this trade would work, and if it didn't, I'd get out quickly. Before I knew it, I would be down 20 or 30 percent on the trade. It's a lesson that I continually have to learn.
Do you still find yourself vulnerable to listening to tips even now? At some level, I have a gambling urge, which I decided a long time ago I needed to satisfy, but in a small way.
Therefore, I set aside a small amount of money in the fund for doing these speculative trades. On balance, do you end up winning or losing on these trades? About breakeven. How did you go from being a stockbroker to a fund manager?
For that matter, did you ever make a sale? Eventually I started to do okay as a stockbroker because I learned how to sell. How do you sell? You need to find out what the customer wants and package your sales pitch—not the product—accordingly. What did the customer want? Instant gratification, excitement, sizzle, the comfort of knowing that lots of other people were downloading the same stock, and a million reasons why the stock would go up.
So you tried to make the stock sound as good as possible without any qualifications? That's what all stockbrokers do. Weren't you troubled by making something uncertain sound certain? Sure, but it wasn't exactly lying, because I had no idea whether the stock would go up or not. It was, however, a huge embellishment. After a while, I just couldn't hack it anymore. How did you get out of it? After I started doing well in my own account, 1 began recommending some of my own ideas, not just the stocks that were part of the company line.
I was bailed out by one of my accounts who liked my style and offered me a job to manage money for them. That was really what I wanted to do. If I hadn't landed that job, I would have had to quit because I was once again at the point of waking up in the morning and feeling I can't do this anymore.
What kind of firm was it? Were you allowed to make your own trading decisions, or did you have to follow their guidelines? I could download any stock I wanted, but it had to meet their investment criteria. What were those restrictions? Earnings had to be growing by at least 20 percent per year. There were also some balance sheet and liquidity conditions that had to be met. Was that a help or a hindrance?
It was a huge impediment because it dramatically narrowed the universe of companies that I could invest in. Not necessarily. I would never adopt that type of strategy myself, but I feel that any sound strategy will work as long as you stick to it. Were there any restrictions on the stocks you bought for your own account? I was allowed to download any stocks I wanted to, as long as they were not the same names I was downloading for the company's clients.
What was the difference in performance between your own account and the accounts you were managing for the company? For the company accounts, I would only be up an average of 1 5 to 20 percent per year, while on my own account, I was averaging well over percent per year.
Did you try going to management and saying, "Look, here's what I've been doing for my own account without any restrictions. Let me trade the company accounts the same way. The last thing an investor wants to see is a change in strategy. My idea, however, was to try to adapt to any new strategies that seemed to be working. Eventually I built up enough capital in my own account so that I could go my own way.
How did you get investors? Strictly word of mouth. I didn't do any marketing. Don't you have any help? I have a secretary who comes in every other day. That's it? Don't you need any additional assistance? I hired someone last year—a great guy who is now off on his own— but I knew immediately that it wasn't for me. Why is that? I found that having another opinion in the office was very destabilizing. My problem is that I am very impressionable. If I have someone working for me every day, he may as well be running the money because I'm no longer making my own decisions.
I like quiet. I talk all day on the phone, and that's enough for me. I don't need committees, group meetings, and hand-holding to rationalize why a stock is going down. I even like the fact that my assistant only comes in every other day, so that every alternate day I am completely on my own and can sit here and germinate. I understand that completely, because I work in a home office.
I find that when you work on your own, you can get completely engrossed in what you are doing.
That's the main reason I like to be on my own. People come in here and ask me, "How could you manage this much money on your own? Don't you want to become a bigger firm? Well it's worked for me so far. The only thing that matters is how well I do, not the amount of zeros I'm managing. With your track record, you could easily raise a lot more money. That would just kill everything. The only way I can possibly maintain my track record is to make sure I don't overwhelm myself with assets.
Right now, if I have a good quarter, it ramps up the amount of money I am managing. By growing through capital appreciation, I can evolve my trading style to accommodate the increase in assets managed. A lot of people who do well and decide to dramatically increase their assets find that their first year is their best year. After that, it's downhill.
Of course, they still make huge sums of money. But I want to feel good about coming in every day. I want to have happy customers and see my assets steadily growing. I don't want to be cranking out a great living on a business that is deteriorating.
I have almost no overhead, so I still make a great income.
There is no need to get greedy. Do you think the experience of coming close to the edge of bankruptcy helped you become successful? In what way? The odd thing about this industry is that no matter how successful you become, if you let your ego get involved, then one bad phone call can put you out of business.
My having seen the abyss might spare me from malting that phone call. I know how quickly things can go bad. Any stock can go to zero, and you need to realize that. When I talk to potential new investors I focus on my mistakes. Because if you are going to invest with someone, you want that person to have made mistakes on his own tab and not to make them on yours.
Someone who has never made a mistake is dangerous, because mistakes will happen. If you've made mistakes, you realize they can recur, and it makes you more careful. We've talked about the mistakes you've made early in your career. What mistakes have you made during your more recent successful years? This year I got very bearish without waiting for prices to confirm my opinion.
What made you so blindly bearish? I became very concerned about the rise in interest rates. In the past, higher interest rates had always led to lower stock prices, and I assumed the same pattern would repeat this year. The market, however, chose to look at other factors.
I was down 7 percent in March, which is a pretty big one-month drop for me. Any other mistakes come to mind? In January invested in a bunch of small-cap initial public offerings IPOs , which all performed incredibly poorly in the first quarter they went public. What was your mistake there? My mistake was getting involved in illiquid securities without doing sufficient research.
What prompted you to download these stocks? Market sentiment. The market was getting very excited about conceptual IPOs—stocks with a dream and a story but no earnings.
When stocks like these go sour, they can go down 70 percent or more very quicldy. It was as if a tornado had swept through my portfolio. I was down 12 percent for the month and decided to liquidate everything.
One stock that I bought at 18, I sold at 2. If these stocks were down that much, wouldn't you have been better off holding them in case they bounced back?
What happened to these stocks after you liquidated them? They bounced, but not by much. As I liquidated these stocks, I used the money to download the types of stocks that I should've been downloading— good companies at much higher prices. So you had deviated from your philosophy. Yes, once again. It's like a junkie who is off drugs for three years and then runs into some crack dealer who is able to convince him to start again. I don't mean to blame other people for convincing me.
It was my own fault for allowing myself to be susceptible to these stories. I think I've learned not to trade on those types of stories anymore. The good news is that I quickly switched back to downloading the types of companies that I like. By the end of the quarter, I had recovered all my losses. I guess the implication is that holding on to a losing stock can be a mistake, even if it bounces back, if the money could have been utilized more effectively elsewhere.
By cleaning out my portfolio and reinvesting in solid stocks, I made back much more money than I would have if I had kept the other stocks and waited for a dead cat bounce.
Do you talk to companies at all? I used to visit companies all the time when I was working for the investment advisory firm.
Stock Market Wizards
Did it help at all? Hardly at all. I found that either they told me what they had previously told everyone else, and it was already factored into the price, or else they lied to me. Once in a blue moon you would learn something valuable, but there was a huge opportunity cost traveling from company to company to get that one piece of useful information. Can you give me an example of a situation where management lied to you. The examples are almost too numerous to remember.
Pick out one that stands out as being particularly egregious. I had never heard such a great story. They produced software that was used in computer backup systems all around the world. The management team was very believable and articulate.
The stock was high, but I felt it was a big momentum horse. I bought half a million shares, and the stock started to crumble almost immediately. I called management and asked them what was happening. The stock, which had closed at 30 that day, opened at 7 the next morning. It was funny because every time I had talked to the company, "business had never been better. Is this an example of a situation in which you ignored your own rule of paying careful attention to how a stock responds to news, or if it goes down for no apparent reason?
Unfortunately for my former employer, I was still learning that lesson at the time. Did that experience sour you completely on talking to management? Not completely. I might call a company's management when its stock is very low and no one is talking to them, because that is when they are usually desperate enough to talk to anyone. My hope is that I might learn about some catalyst that could cause the stock to turn around.
What are the traits of a successful trader? Ironically, I find myself lacking on each of those counts. I would attribute my own success to having both conviction about my gut feelings and the ability to act on them quickly. That is so critical. So in your own case, you've been able to offset some other drawbacks simply by having the ability to pull the trigger? Exactly, that's a very good point. What is the biggest misconception people have about the stock market? Currently, the biggest misconception is the widespread belief that it is easy to make a living trading in the stock market.
People feel they can give up their jobs and trade for a living; most of them are bound to be disappointed.
What are the trading rules you have posted on your computer? There are five key elements: I know you have no desire to be working with anyone, but let's say five years from now you decided to pursue a new career making films. Could you train someone to take over for you and invest in accordance with your guidelines?
I could teach someone the basic rules, but I couldn't teach another person how to replicate what I do, because so much of that is based on experience and gut feeling, which is different for each person. After you reach a certain level of financial success, what is the motivation to keep on going? The challenge of performance and the tremendous satisfaction I get from knowing that 1 contributed to people's financial security. It's fantastic.
I have a lot of clients, some of whom are my own age, who I have been able to lead to total financial independence. How do you handle a losing streak? I trade smaller. By doing that, I know I'm not going to make a lot, but I also know I'm not going to lose a lot. It's like a pit stop. I need to refresh myself. Then when the next big opportunity comes around — and it always does — if I catch it right, it won't make any difference if I've missed some trades in the interim.
What advice do you have for novices? Either go at it full force or don't go at it at all. Don't dabble. Is there anything pertinent that we haven't talked about? It is very important to me to treat people with fairness and civility. Maybe it's a reaction to all the abuse I took in the New York trading rooms.
But, whatever the reason, the everyday effort to treat others with decency has come back to me in many positive ways. Stuart Walton had no burning desire to be a trader, no special analytical or mathematical skills, and was prone to emotional trading decisions that caused him to lose all or nearly all his money on Persistence. He did not let multiple failures stop him. He realized his weakness, which was listening to other people's opinions, and took steps to counteract this personal flaw.
To this end, he decided to work entirely alone and to set aside a small amount of capital—too small to do any damage—to vent his tip-following, gambling urges.
Walton became successful exactly when he developed a specific market philosophy and methodology. Although Walton started out by selling powerhouse stocks and downloading bargains, he was flexible enough to completely reverse his initial strategy based on his empirical observations of what actually worked in the market. If he believes a stock he previously owned is going higher, he is able to download it back at a higher price without hesitation.
If he realizes he has made a mistake, he has no reservation about liquidating a stock, even if it has already fallen far below his download price. Finally, he adjusts his strategy to fit his perception of the prevailing market environment. In Walton's words, "One year it might be momentum, another year it might be value. Most great traders have some special skill or ability. Walton's talent lies in not only observing the same news and information as everyone else, but also in having a clearer insight into the broad market's probable direction—sometimes to the point where the market's future trend appears obvious to him.
This market diagnostic capability is probably innate rather than learned. As an analogy, two equally intelligent people can go to the same medical school, work equally hard, and intern in the same hospital, yet one will have much greater diagnostic skill because ability also depends on intrinsic talent. Walton's case history demonstrates that early failure does not preclude later success.
It also exemplifies the critical importance of developing your own methodology and shutting out all other opinions. Nothing personal, you understand. In fact, he admits being a fan of the earlier Market Wizard books. It's just that he doesn't think he qualifies as a "market wizard"—at least not yet.
Well, Lauer hasn't been managing a fund for ten years, but in the seven plus years that he has, very few can match his combination of stellar returns and low risk. You might think that with such lofty returns, Lauer must be taking some huge risks. Amazingly, Lauer has achieved his stratospheric returns while keeping losses both small and short-lived.
The maximum peak-tovalley equity decline in Lauer's flagship fund was a moderate 8. This number represents the author's estimate, based on reported net returns and stated fees. During those same losing months, Lauer's fund earned a cumulative positive return of 66 percent.
Although Lauer emphasized what he considers the relative brevity of his track record, his trading experience a personal account predates his fund manager career by over a decade. He acknowledged that the average return for his personal account was even higher than for his funds, but he downplayed this track record as irrelevant, because it was achieved using leverage and involved a much lower asset base.
The capital under management could be significantly greater, but he is closed to new investors and even returns assets when profits cause the funds he manages to grow beyond what he considers an optimal size. Since Lauer deliberately restricts himself to a small number of major stock investments at any given time for reasons detailed in the interview , he could increase the amount of money he manages by simply expanding the small number of his holdings.
Lauer, however, explains that he is very happy with the status quo. His operation currently consists of only two traders, two analysts, and several support staff—and he likes this cozy arrangement.
He has no desire to increase the size of the firm. As a college student, Lauer supported himself by driving a cab during the night shift, an experience he considers far more relevant to his later success than his formal education.
He graduated in with a B. Being fluent in several arcane languages, Lauer briefly went to work for one of the government intelligence services, an experience he declined to discuss for confidentiality reasons. Lauer landed a job in the stock research department, where he eventually became a multi-industry and technology analyst.
During his career as a stock analyst, which spanned three brokerage firms his subsequent affiliations included Cyrus J. Lawrence and Kidder, Peabody , Lauer was selected to be a member of the Institutional Investor All-Star analyst team for seven consecutive years—a streak that ended when he decided to become a portfolio manager in The interview was conducted in a conservatively decorated, windowless conference room at Lauer's firm.
Lauer's passion for investing and confidence in the superiority of his own approach came across very strongly. Our conversation began with the reason why Lauer does not include as part of his track record the documented recommendations he made as an analyst, which date back to eleven years prior to the initiation of his fund.
Note: Although the performance statistics in this introduction were updated through March , the interview itself the first one I did for this book , which contains a number of prognostications regarding specific stocks and funds, was conducted on May 4, I guess your recommendations as an analyst cannot really be turned into a meaningful track record unless you assume that you would have traded the same percent of equity on each recommendation. But, of course, in real life, it doesn't work that way.
I'm sure you take much larger positions in some trades than in others. In fact, many analysts blow out when they become fund managers because they do not have the conviction level that is essential to put on a big position. I tell my guys that if we come up with a good idea, and as a firm we only download 50, or , shares instead of a million plus, then that trade is a mistake.
This is also the reason why we limit ourselves to a maximum of fifteen major positions on the long side. I take it then that you disagree with the premise that more diversification is better.
For a number of reasons. Concentration is critical to superior performance. The greater the number of stocks you hold, the more marketlike your performance becomes, and the less value you add as a money manager.
Those who preach diversification as a risk control measure are essentially hedging their fundamental ignorance of their own holdings. Also, one of my objectives is to be able to make money in any market climate, which means that I have to decouple my performance from the market indexes.
Limiting myself to a relatively small number of positions is essential to achieving this goal. Finally, from a purely practical perspective, it is much easier to find and stay on top of fifteen positions.
I believe that few, if any, fund managers are as well informed about our fifteen stocks as we are. Why fifteen as opposed to five or fifty? There has been some convincing academic research showing that with fifteen different stocks one can achieve approximately 80 percent of the benefits of much broader diversification. Keep in mind, though, that to achieve our twin goals of exceptional performance and low correlation with the broader market, we don't want to diversify too much.
Is this a fixed number? At any given time, our holdings will exceed fifteen stocks because of the frequent rotation of our portfolio—the divesting of some of our positions and the addition of others. But fifteen positions will usually account for more than 75 percent of the portfolio's value. What is your correlation with the major indexes? It's been inconsequential. The closest correlation to an index would be with the Russell , and only because most of my long positions happen to be the Russell type names.
What is happening now [May ] in the fund industry is not only dangerous but it's also downright insidious. Many of the largest public funds that individual investors believe are being actively managed, with stocks presumably being selected based on fundamental merits, are actually closet index funds. What do you mean? Take Fidelity Magellan as an example. When Peter Lynch managed the fund, he typically held one thousand to two thousand stocks.
He picked stocks based on value and earnings expectations, and his performance was exemplary. The same can be said of many of Magellan's peers.
You could call this now prevalent investment style "turbo-indexing. The problem is that their approach depends on the "greater fool" premise. The theoretical case for indexing is actually quite persuasive. It allows the investor to own a representative piece of the market, with presumably lower risk due to the index's diversification.
In addition, because of their low turnover of stock holdings, index funds also offer the benefits of lower management fees and more favorable tax treatment.
Frankly, there is nothing wrong with this argument. Indexation, as it was intended, is a reasonable investment strategy. As index funds outperformed the majority of other funds at lower costs, however, they attracted a steadily expanding portion of investment flows. This shift, in turn, created more downloading for the stocks in the index at the expense of much of the rest of the market, which helped the index funds outperform the vast majority of individual stocks, and so on.
As a result, what started out as a strategy for investors to link their fortunes to the market via an index has been turned on its head, with the index responding to the ever-increasing share of index-linked investment capital. How do funds such as Fidelity Magellan fit into this picture? Thus, their goal has become to beat the benchmark and is not necessarily linked to their clients' paramount objective: making money.
Stock Market Wizards
To the extent that they slightly modify the portfolio, there has been a strong bias toward a greater concentration in the highest capitalization stocks. The bottom line is that in the present perverse incentive structure of benchmark-guided portfolios, there is more risk for fund managers in not owning certain grossly overvalued mega-capitalization stocks than in abstaining from them. Who are they going to sell to? This is an amazingly small community. Only about 25 mutual fund institutions control almost one-third of total equity assets in this country, and every one of those guys knows what the others are doing.
It may become quite uncivil if they all run for the exits at the same time. An annual anal Embed Size px. Start on. Show related SlideShares at end. WordPress Shortcode. Published in: Full Name Comment goes here.
Are you sure you want to Yes No. Be the first to like this. No Downloads. Views Total views. Actions Shares. Embeds 0 No embeds. No notes for slide. Book Details Author: Jack D. Schwager Pages: Hardcover Brand: Description Hardcover 4. If you want to download this book, click link in the next page 5.When I looked across the room to the bond trading desk, I noticed that everyone was very quiet.
I had zero trades. Initially we weren't worried because we thought we would get jobs in a month or two. She was pretty positive.
Do we trust the management? If you had called, we would have held the plane. I did tell her that I was going to invest it, but I told her that I was going to invest it in a conservative dividend play that would give us a greater return than the rate we had to pay on the home-equity loan. Schwager Pages: