Fund Managers Fess Up
Good ones tell shareholders what they've learned from mistakes.
Fund Spy
Fund managers make mistakes like the rest of us. Also like the rest of us, some managers admit mistakes and some don't. The best managers are able to learn from their mistakes so that they will do a better job the next time a similar situation presents itself. The bad ones simply have excuses. Yet, even with the good ones, it's amazing how few will take the time to walk shareholders through their mistakes.
I took a look at some of the third-quarter shareholder letters to see what managers were owning up to. I feel much more confident when a manager is being honest with shareholders. In addition, these lessons often provide valuable advice that the rest of us can apply. Here are a couple of the better ones.
Lesson: Don't Underestimate the Rate of Change in a Company
In Oakmark's (OAKMX) latest shareholder letter, Bill Nygren writes: "When we purchased Schering-Plough , we underestimated how rapidly their Claritin franchise would deteriorate and how severely earnings would be hit. Recently, we have enjoyed a good recovery in Schering's stock price (though not enough to eliminate our loss) and felt that management's decision to issue more stock suggested they felt their stock was now appropriately valued."
What I like here is that management is open to new information and willing to get out before making back its money. During the bear market, I talked with a number of investors who had made mistakes in funds and stocks, but were too paralyzed with worry to get out. They wanted to wait until the investment had fully recovered, but that doesn't make any sense if you can switch to something else that will earn a better return.
Lesson: If an Investment Is Still a Good Value, Don't Be Scared Off by a Rally
In Bill Miller's latest letter, the manager of Legg Mason Value Trust (LMVTX) writes: "Michael Goldstein of Empirical Research is one of the most thoughtful and careful market analysts in the business. He is rare in being someone who, when he has a testable thesis, actually tests it. Late last year he identified the energy sector as presenting unusually attractive value, based on then-existing oil and gas prices, and one that would provide exceptional returns should those prices increase, as they have.
"Michael spoke to our investment team about the values in energy, and he and I subsequently had a dinner devoted to the subject. By early December I was prepared to initiate a position in the group. The shares then started to advance and, hating to pay up for anything, I waited. That was a mistake. The group corrected in February and March, but by that time prices were well above the early-December levels, and the shares we planned on selling to fund the purchases had fallen below the levels they achieved in late '03, making the trade-off less compelling.
"My mistake was due to not reasoning as follows: energy is cheap and represents good value. The odds of its turning out badly over the next couple of years are low. Since energy is negatively correlated with the market (historically), if energy stocks do poorly, the rest of our portfolio should be fine, especially since we have a surfeit of volatility. If cheap energy stocks do badly, it will be because the price of energy collapsed, which is great for global growth and profits, as well as for insuring inflation stays low. The market and we would probably do very well if that happened."
Lesson: He Who Hesitates Is Lost
Selected American Shares (SLASX) comanagers Chris Davis and Ken Feinberg write this: "In the fall of 2002, the business software company SAP (SAP) was trading around $10 per share. Having followed the business for many years, we were convinced that this was an attractive price, but were slow to act. In a matter of days, the stock rose more than 50% as a result of an unexpectedly strong quarterly result and today trades around $40 per share. While this mistake does not show up in our gains and losses reports, it was a huge miss and one from which we learned the cost of unnecessarily hesitating in the face of opportunity."
Brandywine's (BRWIX) manager William F. D'Alonzo didn't actually say that, but that's my interpretation of his discussion of Sierra Wireless . It's not as deep as some of the above, but this was the best I could find from any growth-fund manager. Apparently they don't make mistakes. Brandywine is very focused on finding companies that will provide upside surprises to Wall Street. When they have bad news, Brandywine gets out. I suppose you could instead say the lesson here is don't fall in love with a stock and veer from your investment discipline. Something Brandywine takes to heart:
"Sierra Wireless: The provider of wireless data communications equipment grew June-quarter earnings to $0.22 per share from $0.04, beating estimates by 29 percent. Shares fell when the company announced its business with a large customer would decline. Your team sold Sierra Wireless to fund an idea with better near-term earnings visibility."