How to find an investment manager who has the “X” factor

The world offers no shortage of competent investment managers. Many handle funds prudently, make pretty good decisions and deliver reasonable returns. But then there are a few who often outperform their industry peers or a particular market benchmark, or both year after year. They seem to have a special quality – an “X” factor, but how might one find such an investment manager?

Keeping with our previous factor post, let’s translate this financial ability into musical terms. The ‘60s produced no shortage of memorable music, but if we are forced to rank those artists for overall enduring performance, many baby boomers would argue that The Beatles outperformed Led Zeppelin, the Dave Clark Five, The Who, and the rest of the acts at Woodstock or The Fillmore. The Beatles had an undefinable, inventive, yet instantly recognizable “X” factor that stands out permanently in an enormously talented crowd.  Groups that only use formulas can have short term success (One Direction) but without the serious X factor they will never be the Beatles.

We all would love to find the Beatles equivalent of an investment manager. But how? We can start with a specific set of attributes most top performers share. Occasionally these characteristics become the basis for outright genius; great investment managers have clearly defined views, unique insight and the ability to implement these opportunities. Let’s call these “X” factor attributes the three Ps.

  • Philosophy. Great investment managers don’t roll dice. Instead, they develop and adhere to a view of how the investment universe works particularly given human behavioral biases. This informs what they buy, avoid, and hold or sell. For example, Warren Buffett has a personal belief in how the world works, and that is his filter for identifying potential value in situations others may have overlooked. “Buy when others are fearful sell when others are greedy”. A well thought-out philosophy allows managers to stay competitive in what is a ridiculously hard game.
  • Perspective Great investment managers have a radar that looks beyond normal horizons. Building on their philosophy, they see stocks are cheap and actually understand why this is so. This hones their market insights. It often takes some degree of hubris to believe you’re smarter than the crowd and can make decisions in ways that evade most others. But hubris is risky business -- while this brazen attitude often accompanies keen perception, it needs to be paired with a genuine sense of humility with regard to the difficulty of the task.
  • Process. Great investment managers do their homework. Philosophy and perspective fail without disciplined implementation. They have research underpinning a solid process of discovery and analysis. They build a coherent investment framework where buy/sell/hold decisions are not based on any single factor (i.e. price). Often if an asset is falling, but they still feel it’s undervalued, they’ll hang onto it. (Note hubris above.)  The best managers often also have authoritative decision-makers rather than individuals trying to steer a fund collectively.

Investment managers who apply these three principles often improve their odds of achieving a fourth P: Performance. But performance is not a defining characteristic unto itself; rather it is typically the result of summing these other characteristics. It is an end, not a means, and evidence that philosophy, perspective, and process are working together.   As such, by itself is not a very good predictor of future success at all.

Every once in a while this brazen orchestration of vision, insight, and discipline becomes the “X” factor – a standard by which we measure others for decades to come.