Decentralising Portfolio Management

One of the major factors for investment success is people. People produce growth, whether they are managing the portfolio or managing the companies that form a part of it. But people are human and change is a part of every equity investment. At some point, people will leave, and a portfolio must be robust to those changes in order to continue to profit.

If an investment portfolio is professionally managed, the return depends in some part on the ability of the portfolio manager to choose appropriate investments. Ideally, the same portfolio manager would continue to manage the investments throughout the accumulation and spending phases. However, this would be an unrealistic expectation. Like others, professional portfolio managers will change companies, start their own companies or retire. It is important that these movements not put an investment strategy at risk. Some organisations address this risk by having a small group of portfolio managers working together. In that way, if one leaves, there will be others to continue investing using the same approach that investors have come to rely on.

Another way to address the possibility of an investment manager leaving is to manage the investments yourself. This is one area in which passive investments are appropriate most of the time. Because no one is choosing or trading investments, there is no dependence on an individual person. At the same time, there is no one at all making choices, which avoids mistakes, but doesn’t avoid follies, an example being when Nortel made up around 30% of the Canadian index. To be fair, many professional investment managers participated in the run up of Nortel. It seems that it would make sense to become personally involved in the management of your investments. Without developing in depth expertise, knowing what you own and why you own it can provide continuity in the case of the departure of an investment manager. You can also provide a double check for developments that don’t seem congruent with your strategy, in the case of a large overweighting.

The people who make investment choices are important to success, but the people who actually run the companies an investor owns are just as essential. Directors and management of companies have a great influence on the success of the company. When choosing to invest in a company, the price and profitability will contribute much to the outcome of the investment. But long term, it’s the people who work in the company that will determine the profitability of the operations. It is important to understand the team that is guiding and managing the company and to understand why people leave and who is replacing them. One major red flag, as an example, is the resignation of a CEO or CFO. That is often an excellent time to reevaluate an investment decision. I look at the reason a manager gives for leaving. “Pursuing other opportunities” sometimes indicates that the executive no longer felt comfortable taking responsibility for future results at the company, and could indicate problems that they foresee. Retiring or training their replacement for a period of months or years to provide a transition concerns me much less.

Warren Buffet is a great example of the idea of decentralising portfolio management. He owns a large number of businesses which operate in a variety of industries. Mr. Buffet has written about the importance of understanding the companies that an investor owns. I am certain that he understands the companies he owns, either wholly or a large holding of shares. Mr. Buffet then has profits directed to his head office in Omaha. He makes decisions about the allocation of capital; if a manager wants to deploy capital for expansion or to support operations, that decision passes through Mr. Buffet. However, all other business-related decisions are made by the managers of the individual companies. Mr. Buffet chooses managers that he feels are competent, hard-working and honest. He stays out of their way and allows them to do great work, and he gives high praise to his managers when they are successful. If Mr. Buffet were to become incapable of managing Berkshire Hathaway, each individual business should continue to succeed on its own.

Decentralising portfolio management can have similar benefits for the individual investor. It is important to understand what’s in your portfolio and why, so that if a professional manager were to leave, you would be able to describe your strategy and your holding to a new manager, who would be able to step into the role. It is preferable to own closely-held or family-owned businesses, knowing that people whose lives are very involved in running the business will tend to stick with it through good times and bad, and who will train their successor before leaving. Continue to watch out for key management or directors departing and learn the reasons given for their departure, evaluating whether or not you, as an investor, are well-served. Finally, it is difficult to overstate the importance of surrounding yourself with competent, honest, hard-working people. In these ways, an investment portfolio will be as robust as possible to the risks present from depending on people working on your behalf.

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