The Downside of Conviction

Absolute Certainty

Last week, FPA

that veteran portfolio manager Bob Rodriguez was retiring, effective Dec. 31. As FPA noted in its press release, Rodriguez ("Bob Rod" in Morningstar's fund-analyst slang) is the only fund manager to have collected Morningstar Manager of the Year accolades for both stock and bond funds. Indeed, he won three such honors for

(I wrote the commentary that accompanied 1994's award, but as that year predated the birth of morningstar.com, there is no link. For a suitable fee, however, I could recreate the era. I could find that binder in Morningstar's library, photocopy the relevant pages, and send them via fax. We could brand that experience: The Early Nineties Technology Ride.™)

The first two awards presaged seven years of good fortune, but the third was no charm. Positioned to protect against the next bond bear market, FPA New Income sharply trailed the Barclays Capital U.S. Bond Aggregate in 2009, and in 2010, and in 2011, and in 2012. It recovered to outperform in 2013, then went back to lagging. Cumulatively, it has dropped 16 percentage points to the index since its 2008 triumph.

Nobody can accuse Rodriguez of lacking conviction. Quite the contrary; he is the industry's most vocal, impassioned bond fund manager. DoubleLine's Jeff Gundlach attracts more headlines, but he leaves open the possibility of altering his tactics should the markets change. Rodriguez, in contrast, beats the same drum: The U.S. financial system is broken; bond investors live on "borrowed time"; Federal Reserve officials are "glorified snake-oil salesmen."

That's Entertainment Such passion is good for business. Table pounders are quotable. Journalists like them, fund analysts like them, financial advisors like them, and investors tend to like them. They also make for excellent speakers. Rodriguez drew a standing ovation with his thunderous condemnation of all finances American at the 2009 Morningstar Investment Conference. The audience loved it. If, however, they had acted on those comments, they would so far be poorer for their efforts.

This is not to disparage conviction. If this column did that, it would deconstruct itself, as it would be insisting about the error of insisting. We all know the story of The Big Short--insightful investors who foresee what looms, and who must have the courage of their beliefs to withstand steep market losses before enjoying even steeper market gains. That large tale is retold in small, year after year, throughout the financial markets. Often, being right means willing to endure long stretches of being wrong.

However, there is a difference between appreciating that some investments require patience, and praising the fault of intransigence. This is not to say that Rodriguez, specifically, has been stubborn. Perhaps he has not updated his views because he is correct. Rather, the point is that, as a general rule, refusing to change is no better than changing. One man's constancy is another's rigidity. One woman's inconstancy is another's adaptability.

Changing for the Better

And there are plenty of cases where abandoning conviction has served investors well. In their glory days of the '70s and '80s, when they routinely beat the S&P 500, Fidelity's diversified stock funds were famously (or notoriously, depending upon your view) flexible. Their managers would buy the securities that they liked, regardless of what the funds' names and prospectuses might imply. That spirit lives on today with giant

Another example would be the AQR organization, which expanded from running only hedge funds for institutions and qualified investors, to running registered funds for retail investors. The new funds were passively managed rather than actively so, diffuse rather than concentrated, and priced very differently. True, AQR had business reasons for making that decision, but there's no doubt that it tossed a few convictions out the window while doing so--and that investors have profited. (Heralded value investor Joel Greenblatt took a similar step with his firm, Gotham Capital.)

In academia, efficient-markets theorist Eugene Fama not only granted that stock performances were affected by companies' sizes and price/book ratios, but also that they were influenced by stock-price momentum. In the short term, stocks that had performed well tended to continue to perform well, and vice versa. The size and price findings could be explained away as caused by those securities' higher risks. But not momentum. In the words of Morningstar's Maciej Kowara, Fama decided that just because he didn't understand the effect, didn't mean that it didn't exist.

For an academic, that does indeed amount to singing a new tune.

The Oracle of Omaha

The most famous and successful of flexible investment managers, of course, is

In that role, he has continually changed. In the '90s, Berkshire Hathaway swapped out of its dowdy media businesses and bought such glamour blue chips as Gillette and

Nietzsche wrote that convictions are greater enemies of the truth than lies. That overstates the matter--as Nietzsche was wont to do. Let us say, more humbly, that conviction in and of itself is no virtue. What matters for investment managers is being correct.

Season's Greetings Bill Bonczek offers good tidings for all, except for negligent Internet columnists. About last Friday's column he writes:

Neither Digital Equipment Corporation or Compaq Computer went bankrupt and "stiffed their stockholders." Compaq bought Digital Equipment and Hewlett-Packard bought Compaq Computer. The stockholders got stock of the acquiring company. I think Compaq shareholders may have gotten stock and cash. You may want to do a little more "fact checking" next time.

Those final ironic quotes, ouch!

At any rate, if somewhat grouchy, Mr. Bonczek is also correct. Compaq bought DEC when it was heading south (in part for DEC's AltaVista search engine--add that to The Early Nineties Technology Ride™!), then Hewlett-Packard purchased Compaq a few years later when

that

firm struggled. Then

Those firms didn't go bankrupt, though. My New Year's resolution: Improve this column's "fact checking."

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.