I used to run beauty contests for investment managers.
They weren't really beauty pageants, but that was our pet name for what is known in the institutional investing world as a finals presentation.
In a finals presentation, we'd invite three or four investment managers to present for thirty minutes to a client of ours, such as a college foundation investment committee.
The client had never previously met these firms in person, although we provided them plenty of information about the investment managers beforehand.
After the firms finished their presentations, the committee members would discuss the candidates and select one of the firms to manage a $10 million or more chunk of the client's investment portfolio.
I found these contests fascinating. Each firm was equally qualified as our research team had already spent many hours conducting due diligence on their respective investment processes, philosophy and performance.
That meant the winner of the contest was often decided by something other than investment factors.
It usually came down to story telling, poise, confidence and at times looks. Hence, a beauty contest.
This was a perfect laboratory to observe the dynamics of group decision making.
Of course, no one would actually recommend a firm be hired because the presenter was a better storyteller, but having sat through dozens of these meetings over the years, I know for a fact that is why firms often got hired.
Except in one case, when a committee couldn't reach a decision so they chose the winner based on the outcome of a coin toss.
The best presenters usually told stories about the securities in their portfolio.
They would tell how they sold a portfolio holding after they had walked the factory floor of a company and learned from one of the workers about the unsold inventory piling up on the back dock.
Or how they got some of their best stock ideas by asking companies who their fiercest competitors were or their most efficient suppliers.
Sometimes stories backfired as one manager kept talking about their investment in pawn shops, but with his heavy Brooklyn accent the client thought they had invested in porn shops.
Now if a college will invest $10 million in a good storyteller, is it any wonder people make poor investment decisions with much smaller sums because they get hooked by a good story.
Or that the overall stock market shoots to stratospheric valuations based on a good story as it did during the Internet bubble.
Investors are human and humans crave stories. They then use those stories to justify their investment decisions.
One reason I recommend investing in baskets of undervalued securities, such as through Exchange Traded Funds (ETFs), is those baskets are full of securities that have been beaten down because investors didn't like the company stories.
Undervalued securities are more likely to have stories with surprise happy endings. Usually because investors overreacted.
And that leads to the happiest ending of all. You meeting your long-term investment goals.
-J. David Stein | May 7, 2013
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