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You wouldn't be reading this if beating the market were easy. You'd probably be off somewhere basking in the sun, enjoying the riches you've amassed.
And as if we needed a reminder of just how hard this game is, Julie Segal has penned a lengthy missive for Institutional Investor titled "Beating the Market Has Become Nearly Impossible." Well, uh, yikes.
Are we really trying to do the (nearly) impossible by trying to outpace Mr. Market today? Though this is no easy task, I'm inclined to think that "impossible" overstates it. For the article, Segal spoke with legendary investor Peter Lynch about the search for alpha. She wrote:
Clearly, [Lynch] doesn't think, and never has thought, in terms of alpha or beta (market performance). Lynch's secret was to buy a lot of stocks based on fundamental research, knowing that most would be mediocre, some would do "OK," and a few would do really well.
Though Segal makes some reasonable points that the game has changed since early in Lynch's career, I think much of his approach is still applicable today. Notably, one way that the game has changed -- ultra-high turnover and high-speed trading -- potentially makes buy-and-hold investing and time arbitrage even more profitable approaches.
Forget the results
Of particular note to me was the fact that Segal spoke with investing idea man Michael Mauboussin. It was reading Mauboussin's prolific writings that seared into my head the importance of focusing on process versus outcome in investing. If there is still a route to beating the market today, a rock-solid investment process is an absolute must.
In a 2005 presentation at Yale, Mauboussin showed this matrix that delineated the explanations for various outcomes (I've recreated it, but the wording is his).
In the same presentation, he offered a quote from former U.S. Treasury Secretary Robert Rubin.
Any individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.
The obvious question, then, is how we build a process that's going to allow us to win at such a brutally competitive game.
Follow the yellow brick road
I had this question in mind while I was at the Value Investing Congress in New York earlier this week. If you can triangulate good process from anywhere, this group is a darn good bet.
Included in the attendee list at VIC was Chris Mittleman, whose Mittleman Brothers Investment Management has delivered a cool 716% return since its 2002 inception versus 126% for the S&P 500 (SNPINDEX: ^GSPC ) .
He was joined by, among others, value-investing legend Donald Yacktman, Fidelity's industrials specialist John Mirshekari, and Boyar Asset Management's Mark Boyar. If you're going to model your process after anyone, these investors are great choices.
If we assume that the presenters' investment process is at least somewhat mirrored by the way they present -- which may or may not be a good assumption -- I figured it possible to pull some investing-process insights from the presentations.
The presentation structure varied considerably from participant to participant, but if there was an element shared across most of the presentations is that they started, or included early on, a basic description of the company's business. This is basic, but still shouldn't be overlooked. It's going to be very tough to have a good investment process if you don't have a high-level understanding of what the company does. Sometimes this is simple, but often it can be more involved than it seems.
Mark Boyar, for example, presented a long case for Madison Square Garden (NYSE: MSG ) . With company holdings in sports franchises like the Knicks and Rangers; venues such as Radio City; entertainment properties like the Rockettes; and media properties including MSG, it's not a gimmie to understand the big-picture business.
So if we have a No.1, it would be to understand the business on a high level.
Once you have that down
Past that big-picture piece, the elements of investigation that the investors at the conference focused on differed. But as I watched the presentations and boiled them down to their component parts, here are the key elements that the group seemed to deem crucial to making an investment case:
- What is the market missing? If you're making a case that a stock is cheaper than it should be, you ought to have a good idea of what the rest of the market is missing.
- What is the theme behind the investment? In some of the presentations, the investors outlined a particular theme that they believe drove the investment case. Fidelity's Mirshekari, for example, leaned on the theme of better management incentives and improved capital allocation for his long case for URS (NYSE: URS ) .
- What are the most important points? You can easily drown in data. As Marty Whitman has said (though he wasn't at VIC), "Rarely do more than three or four variables really count. Everything else is noise." Know what's really important.
- What's the company worth? This was a value conference after all. Not all of the investors went about valuation the same way, but the presenters all had a view on what they believed the company's value was. And note the word "company" -- they all viewed their investments as investing in a company, not a stock.
- What is the macro environment? Many investors -- the likes of Warren Buffett among them -- believe that it's not worth spending much time worrying about the macro picture or trying to predict it. Others think that it's essential and possibly even increasing in its importance. Some of the presenters had a dissection of the macro environment and what it meant to their investment idea as a key part of their pitch.
- Who's running the show? Management at the company is pulling many of the key levers, so many of the investors took a close look at management.
- What is the catalyst? Not all of the presenters had a catalyst as part of their pitch, but many spent time walking through what they thought would need to take place to push the cheaply valued companies they highlighted closer to their full value.
What to do now
Not all of these items need to be part of your investing process. And perhaps there are points not listed here that you think are very important parts of a good investing approach. But the list above should provide some good fodder for you to create, bolster, or polish your investing process.
In a highly competitive stock market with investors around the world scrambling to capture outperformance, a well-honed approach isn't a nicety. It's a must.
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