In one of my all-time favorite columns, Traits of Successful Money Managers, I argued that "long-term investment success is a function of two things -- the right approach and the right person" -- and highlighted eight characteristics related to each. Today, I'd like to go one step further and name some names (sort of, anyway), in the spirit of Warren Buffett's famous 1984 speech, The Superinvestors of Graham-and-Doddsville. In it, Buffett argued:
Is the Graham and Dodd "look for values with a significant margin of safety relative to prices" approach to security analysis out of date? Many of the professors who write textbooks today say, yes. They argue that the stock market is efficient.... Investors who seem to beat the market year after year are just lucky....Well, maybe. But I want to present to you a group of investors who have, year in and year out, beaten the Standard & Poor's 500 stock index....
In this group of successful investors that I want to consider, there has been a common intellectual patriarch, Ben Graham.... The common intellectual theme of the investors from Graham-and-Doddsville is this: They search for discrepancies between the value of a business and the price of small pieces of that business in the market....
I'm convinced that there is much inefficiency in the market. These Graham-and-Doddsville investors have successfully exploited gaps between price and value. When the price of a stock can be influenced by a "herd" on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical.
In other words, not everybody is looking for the next Microsoft (NASDAQ:MSFT). A disproportionate number of long-term successful investors seek to do only one thing -- buy dollar bills for a lot less than a dollar. (Buffett noted in his speech that "it is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately to people or it doesn't take at all. It's like an inoculation. If it doesn't grab a person right away, I find that you can talk to him for years and show him records, and it doesn't make any difference. They just don't seem able to grasp the concept, simple as it is.")
Buffett highlighted the spectacular investment records of nine Graham-and-Doddsville funds/investors, noting that "I selected these men years ago based upon their framework for investment decision-making. I knew what they had been taught and additionally I had some personal knowledge of their intellect, character, and temperament."
Today's superinvestors
Over the years, I've gotten to know some incredibly talented, mostly young, up-and-coming investors whom I believe are likely to be the next generation of Graham-and-Doddville superinvestors. So, in this column, I'm going to do Buffett one better: Rather than identifying investors who already have long, successful track records, I'm going to stick my neck out and describe 12 investors whom I believe will prove to be superinvestors based on their track records in the future. All of them share the following characteristics:
- They are friends of mine, and I know how they think about investing and many of the investments they have made.
- They are extremely well-educated and analytical.
- They have been successful investors so far, but in some cases for only a limited time.
- Their portfolios have little in common, yet they all have the same Graham-and-Doddsville approach (see Traits of Successful Money Managers).
- While they may have some support staff, they all manage money alone (with two exceptions). To quote Buffett, their "idea of a group decision is looking in a mirror."
- None suffer from the ridiculous, artificial constraints that hamstring most money managers such as being able to invest only in certain industries, stocks with particular market capitalizations, etc. They can scour the entire investment universe for the best opportunities.
- All manage private investment partnerships (a.k.a., hedge funds), but do not behave like stereotypical hedge funds, which often trade furiously, use large amounts of leverage, etc.
- Like most private partnerships, almost all charge a 1% annual management fee plus 20% of net profits. Note that all returns cited below are net to investors.
- None have worked for a mutual fund, and most have never worked for anyone in the money management business. They are largely self-taught.
- Each has the bulk of his personal net worth in his fund.
So, without further ado, here's my list, in no particular order. (Note that most of these managers prefer to remain anonymous, in part because SEC regulations do not allow hedge funds to market to the general public, even indirectly such as through this column. I have, however, sent my editors at the Motley Fool a list of the managers such that when I report on their performance over time, one can be sure that I'm not switching horses mid-race.)
Investor 1
He taught himself investing and started managing his family's money as a teenager, buying Berkshire Hathaway (NYSE:BRK.A) nearly 20 years ago. For a number of years, he went back and forth between medicine and working for a hedge fund before deciding to pursue a career in money management and launching his own fund. Since inception in Nov. 2000, his fund has appreciated 126% versus -18% for the S&P 500 (all figures in this column are net of all fees, through 12/31/03).
He invests in a highly concentrated fashion, with many 10-15% positions. He does not typically short stocks, but makes bearish bets on occasion via puts and credit-default swaps.
Investor 2
Like Investor 1, he was also a doctor, taught himself investing in his spare time (do doctors have spare time?), and launched his fund in Nov. 2000. Since then, it has risen 146% vs. -18% for the S&P 500.
Like Investor 1, he too invests in a highly concentrated fashion, but does a bit more short selling (largely replaced today with a very large position in credit-default swaps).
Investor 3
He has an MBA and worked in investment banking and private equity prior to launching his fund a year ago on Jan. 1, 2003. Since then, through this week, it is up 49% versus 33% for the S&P 500.
At the end of 2003, his fund held 26 positions, of which 10 accounted for 86% of the portfolio. Common stocks were nearly 90% of its value. There were no short positions and turnover was only 27% (for comparison, the average mutual fund churns its portfolio 130% annually).
Despite the shortest track record of the group, he makes my list because I really like the way he thinks and invests.
Investor 4
Born in South Africa and raised in Iran, Israel, and England, he earned his MBA and had short stints as a management consultant and banker before launching his fund in September 1997. Since then, it's appreciated 90% versus 29% for the S&P 500.
Not surprisingly, given the manager's background, the fund owns a number of foreign stocks. Most holdings are large, high-quality, market-leading companies, and 10 positions comprise more than 75% of the fund. He almost never shorts or makes bearish investments of any sort. Turnover is exceptionally low.
Investor 5
Another MBA, he just started his own fund this year, after many years as a principal of another money management firm. He grew up in the real estate business, so some of his best investments are in this area. Unlike the other managers, who prefer to keep a low profile, in a few cases he has been an activist investor on both the long and short side.
Investor 6
He installed risk management systems for European banks for five years before becoming an investment writer. He launched his fund in Aug. 2002 and continues to write part time to this day. His fund is up 43% since inception versus 22% for the S&P 500 (a predecessor "friends and family" fund, created in Nov. 1999 has risen 45% versus -21% for the S&P).
He runs a slightly less concentrated fund than the other investors on my list, with approximately 40 long positions and 10 shorts. Unlike the other solo managers, he's recently been joined by a co-portfolio manager.
Investor 7
He initially specialized in arbitrage and started managing other people's money in 1978 via private accounts at a Big Board firm. These accounts became his limited partners when he formed his own fund in 1983. In the 24 years from Dec. 31, 1979 to Dec. 31, 2003, he made investors more than 29 times their money versus 21 times for the S&P 500 -- that's 15.1% versus 13.6% compounded annually.
Someday, I hope to be like him. He reads all day, does no marketing, spends plenty of time with his family and supporting charities, and makes perhaps one significant investment decision per year. Fortunately, one of those decisions was buying Berkshire Hathaway at roughly $2,000 per share many years ago -- and he's had the good sense never to sell any (it closed yesterday at $88,500).
Investor 8
During his senior year at Oregon State University in 1970, he took a class on investing that was taught using Graham and Dodd's classic, Security Analysis (he laughingly notes that "The next year they switched to teaching the Efficient Market Hypothesis. Lucky me!"). He was even acquainted with Graham in the early 1970s.
In 1975, he started managing a small pool of friends and family money that has since grown quite a bit and now has outside investors as well. Over the past 29 years, his fund has increased 61 times versus 42 times for the S&P 500 -- that's 15.2% versus 13.8% compounded annually. (For Investors 7 and 8, note how small differences in annual returns translates into substantially more money over time.)
He has never used leverage, shorts, or options -- just 20-25 long equity positions, the largest of which is Berkshire Hathaway, which he bought 14 years ago at $5,500 and has never sold. Unlike every other manager profiled here, he does not earn a percentage of his fund's profits -- just a 1.5% annual management fee.
Investor 9
He has a law degree, worked for AT&T Wireless (NYSE:AWE), started, built and sold an online retailer, and worked as an Entrepreneur-in-Residence at a venture capital fund before starting his fund in Aug. 2001. Since then, it's appreciated 29% versus -4% for the S&P 500.
His fund is similar to the average of the other investors cited here -- concentrated opportunistic value, with a long bias though moderate bearish positions in certain stocks.
Investor 10
His father started the fund approximately 20 years ago, and he joined in 1991, gradually taking over day-to-day management. In the 13 years since he joined, the fund has appreciated 427% versus 340% for the S&P 500.
He focuses on buying high-quality companies with outstanding management, which means that sometimes he has to wait for years until the stocks of certain companies he admires become undervalued enough to buy.
Investor 11
When he launched his fund in October 1995, his primary focus was shorting stocks and was quite successful until the last gasp of the greatest bubble in U.S. market history clobbered him in early 2000. He realized that a short-focused fund is "a lousy business model" and now runs a low net exposure fund, meaning that short and long positions roughly balance each other.
Overall, his fund has risen 229% since inception versus 116% for the S&P 500. Since switching investment strategies when the market peaked 45 months ago in March 2000, his fund has risen 122% versus -22% of the S&P 500, and has had only had seven down months, the worst of which was a 1.3% decline.
Investor 12
He has both a law degree and an MBA and was a corporate lawyer and investment banker before joining a very successful value hedge fund. He is currently one of two portfolio managers for a long-short fund that strives to be beta neutral. Since 1994, his fund has generated annual returns in excess of 16% versus 12.2% for the S&P 500.
In addition to his core long-short value equity focus, his legal and banking background enable him to invest in often complicated and specialized situations such as distressed debt and merger arbitrage and other event-driven opportunities.
Conclusion
I wish I had more space in this column to go into detail about the investment strategies of these investors, but at least one can see that they manage money in very different ways. Yet, they all have the same fundamental Graham-and-Doddsville approach to investing which, combined with the right personal characteristics, make long-term investment success highly likely in my opinion. It will be interesting indeed to see whether my assessment is correct and what their long-term returns will be, so I will keep my readers updated every year or two.
One final note: Without exception, these investors all say that they are having an extraordinarily difficult time finding any cheap stocks to buy. This further reinforces my negative outlook for stocks, discussed in my last column.
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Whitney Tilson is a longtime guest columnist for The Motley Fool. He owned shares of Berkshire Hathaway at press time, though positions may change at any time. Under no circumstances does this information represent a recommendation to buy, sell, or hold any security. Mr. Tilson appreciates your feedback at [email protected]. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/. The Motley Fool is investors writing for investors.
