Minority AM Liam Zhou: Do Portfolio Managers roll the dice?

Liam Zhou   2022-07-05 本文章218阅读

A single year performance of any portfolio manager could be a walk of randomness, with great element of luck, much like rolling dices.


The market was quite turbulent in the first half of this year. There were both bull and bear switching, as well as style switching. The market fell sharply in the first four months and rebounded sharply in the following two months, while the value stocks strengthened from a yearlong weakness. Fund performance rankings had also changed dramatically. Some portfolio managers who were praised as Gods before now scolded as dogs. In fact, this kind of market turbulent is not rare, it happens every two to three years. Although few portfolio managers made money in the first half of the year, it was a good stress test anyway.


When there is a loss, you can see how much risk the fund taken. In reality, the most attractive funds in the market are usually the most profitable ones in the recent year or two. But when funds making profits, it is not easy to see the underline risks, as investors more focused on gains. It makes portfolio managers easier yielding to the pressure of short-term profitability and choose high-risk investment strategies because profit is immediately visible to clients, while potential risks do not necessarily appear every year. However, the reckoning day might come late, but never absent. When market become very volatile, potential risks are exposed. Just as Mr. Buffett said: “After all, you only find out who is swimming naked when the tide goes out.”


Portfolio managers developed various ways to handle the market turbulence. Some long-only managers tracked the market trend, and significantly adjust stock positions, or even hold full cash. This kind of market timing could produce desirable results when done right, but also could inflict double whammy when done wrong. Some choose to stick to their long-term investment philosophy and hold through market swings. This way, the NAV of the fund might move in tandem with the market over the short run, and put the investors ‘patience to test. As a fund manager, “what kind of investment method should we choose?” a question we have been pondering and exploring over the past few years. We would like to share some thoughts here.


Investment methodologies have been evolving from long-term correctness towards short-term effectiveness. The short-term mentioned here is not days or months, but 2 to 3 years, in contrast to the long-term of 10 or 20 years. The right investment method in the long-term may not be effective in the short-term. For example, value-investing, certainly right if measured in 10 or 20-year time span, it has been proven by many investment masters, who made huge excessive returns. But in the short-term, it often underperforms the market over a few months, even a few years. Mr. Buffett underperformed the index for a decade since 2010, although recently he surpassed Cathy Wood. We understood that very few investors will hold a fund for 10 or even 20 years. According to the Asset Management Association of China (AMAC), less than 20% of investors have held a fund for more than three years. How long could I hold an underperforming fund, three years? The vast majority of investors will say “no”. It is essential to enhance investment strategy from long-term correctness to short-term effectiveness, so that investors can have better experience and viable returns.


So, we can't rely on a long-term correct investment strategy, once and for all, but constantly explore short-term methodologies that can bring alpha in a period of 2 to 3 year. We infuse peer behavior, shareholding crowdedness and market sentiment etc. on top of value-investing foundation to improving short-term effectiveness. In the past two years of research, we found way to identify quality companies in the prosperous sectors which can improve short-term effectiveness. In the first half of this year, we applied it to our portfolio and achieved remarkable results.


Investment methods have been evolving from logical rigor towards empirical proof. Active investment pays great attention to the rigor of investment logics. What's so good about the industry? What's so good about the company? Those investment logics that many portfolio managers have polished again and again. But behavioral finance theory tells us that due to the interference of human instinct and emotion, the investment logic sounds flawless is often specious. For instance, one often refers to the past profit growth of a company to deduce its future growth. But can past higher-than-industry-average growth be translated into alpha over the next two to three years? We need empirical proof to cross check. Empirical proof has helped us to excluding some plausible investment logics, particularly those might work over the long run but is ineffective in the short run.

In the first half of this year, taking opportunities of market volatility and style shift, we applied our new ideas from last two years’ research by increasing exposures in some of the quality companies in the growth sectors. Benefiting from the low drawdown of the existing holdings of value stocks and the good performance of the newly added growth stocks, all our products/funds are profitable this year so far, and about 5% away to reach new NAV high.

In any single year, the portfolio managers ‘performances might resemble a random dice rolling game - someone gets a 6 this round, while the other gets a 6 next round. But over the long run, fund performance will exhibit a clearer pattern and tendency - some portfolio manager will get 6 much more often than the rest as their investment method is constantly evolving from long-term correctness to short-term effectiveness and from logical rigor to empirical proof. As a result, investors ‘experience will continue to improve.