Lessons from a momentum fund manager

Jun 15, 2018

In the 1980s, Gerald Tsai was out on a boating and fishing weekend with his son Christopher. In the midst of a conversation about Wall Street and investing, the elder Tsai told his son to throw a cup of water into the wind. The young lad dutifully heeded the command and tossed the water into a stiff headwind. Predictably, it came blowing back into his face.

The father laughed and went on to narrate the ‘moral of the story’: Never buck market winds, always go with the momentum.

Tsai was a famed practitioner of what later came to be named "momentum investing". He would buy stocks with positive price and earnings trends and sell when the momentum displayed signs of subsiding. In fact, he has often been credited with pioneering the use of momentum investing in money management.

But this is not a lesson on momentum investing. In the Learn from the Masters series, we focus on learnings from world-renown investors. This time I am approaching the subject with a reverse education approach. Do read on.

When the headwinds favour you

The “go-go” years was the period of the late 1960s when mutual funds captured the attention of investors by reporting performance that was too good to be true.

In The Making of a Market Guru, author Ken Fisher names Tsai as one of the flamboyant and famous top-performing “go-go” mutual fund gunslingers of the mid-1960s.

Tsai joined Fidelity as a junior stock analyst and after a few years was the manager of Fidelity Capital Fund, the company’s first speculative public growth fund.

In The Go-Go Years John Brooks writes on what a shrewd and decisive stock picker Tsai was when hunting for short-term appreciation. He concentrated on a few stocks that were then thought to be outrageously speculative and unseasoned for a mutual fund (eg: Polaroid, Xerox, Litton Industries).

His method was a stark novelty to the existing value investors. He ignored business fundamentals and intrinsic value of a stock, and focused on stock charts and technical indicators. Which meant, attention was given to glamour names and price momentum. He bragged about being in and out of stocks at the drop of a hat. His style is succinctly explained in the Washington Post: “The key is rising earnings per share. Then, if you're wrong in your timing, you can bail out a year later, two years later, because the stock price will eventually catch up and reflect the earnings.”

His annual portfolio turnover generally exceeded 100% (a share traded for every one held) – a rate unheard of in institutional circles then.

At the start of 1962, the market careened 25% and his portfolio toppled. In fact, Warren Buffett called him out on his performance in his 1962 newsletter.

Particularly hard hit in the first half were the so-called “growth” funds which, almost without exception, were down considerably more than the Dow. The three large "growth" (the quotation marks are more applicable now) funds with the best record in the preceding few years, Fidelity Capital Fund, Putnam Growth Fund, and Wellington Equity Fund averaged an overall minus 32.3% for the first half. It is only fair to point out that because of their excellent records in 1959-61, their overall performance to date is still better than average, as it may well be in the future

Tsai held tight and the market picked up and along with it the fund’s performance. Once again, Tsai was the star fund manager. The bull market was intact. His swift and nimble stock moves were timed to perfection.

According to Big Mistakes: The Best Investors and Their Worst Investments, there was only $1.3 billion invested in mutual funds in 1946.  By 1967, multiplied many times over to $35 billion. Interestingly, money flocked especially to one man, Tsai. In an era of anonymous money managers, he was the exception. The Fidelity fund he managed grew from $12.3 million in 1959 to $340 million in 1965 (source). He shrewdly knew it was time to monetize the fame and started his own fund.

In 1965, Tsai established the Manhattan Fund and when he opened it to investors it got 10x more than he anticipated - $247 million in capital, representing what was at the time the biggest offering in investment company history. The Manhattan Fund began trading in February 1966, the very same month the Dow Jones made its high of the decade. He had two middling years before performance vaporized. By July 1968, the Manhattan Fund was the sixth-worst-performing fund in the country. Being the perennial opportunist, he sold it for top dollar to an insurance company. C.N.A. Financial Corporation bought it for $30 million.

According to Forbes, the fund crashed spectacularly, losing 90% of its value in the years to follow (the market crashed in 1969). Neuberger Berman ended up acquiring it in 1979, enticed by the fund's $70 million tax-loss carryforward.

At the start of the article, I stated that I am adopting a reverse education approach. Here’s what we can learn from the above scenarios. 

  • Don’t blindly chase latest performance

Over history, in markets across the globe, investors have an infatuation with past performance. It is definitely a good indicator, but it must be judged over a long period of time that includes advancing and declining markets. Short-term returns of a few months can be extremely compelling. But do investors even bother to check what lies under the hood? Is the performance riding only on a few good stocks? Is it just a lucky streak?

  • Be wary of star fund managers

The press portrayed Tsai as an investing genius who “radiates cool” and is "the stock market's certified golden boy." It is said that he was the first fund manager to receive celebrity treatment in the press.

No one is taking that away from him, after all Tsai spurred the popularity of “momentum investing,” as he swiftly moved money from one hot growth stock to another. He is said to have pioneered the creation of performance funds in the 1950s.

But just as quickly as the sun rises on a star, it can set. And investors learn the inevitable in their search for the Holy Grail in investing; that there is no silver bullet that makes a fund manager a genius.

When looking at an asset management company (AMC) or portfolio management scheme (PMS), look for those that have a philosophy they articulate and processes they follow.

  • Check the philosophy

As an investor, are you comfortable with the fund’s investing philosophy? Also pay heed to the fund manager’s style. As is mentioned in The Go-Go Years, temperamentally, Tsai was a bull himself, and therefore he needed an up market to keep winning.

Would you be happy with the fund manager’s swashbuckling forays into momentum stocks? Are you comfortable with a strategy that relies on his ability to time the market’s every move? Maybe you are comfortable allocating a small portion of your portfolio to this fund. Or are you a more fundamentally-driven investor when it comes to equity? There is no right or wrong. The point is, just be aware of the fund’s mandate and the fund manager’s style. Then decide if it is in sync with your investing style.

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SV Prasad
Jun 26 2018 05:02 PM
Even locally we have a few odd funds exhibiting some of the traits of momentum investing from time to time, not just reflected in portfolio turnover but also in month on month portfolio changes. But wise AMC managers do very well differentiate between the kind of payoffs from an incremental portfolio valuation from strategies such as these and the one that can be attributed to an incremental AUM. Usually the latter would be more accretive to the AMC kitty, so such strategies are deployed by design by AMCs on a very limited scale to make that 'Splash' or 'Mark', which usually peters out later after garnering either name or AUM. I feel so somehow, I could be wrong here. Take SBI Small Cap as a case. Could be ABSL Pure Value if one examines their portfolio changes in the last couple of years and even Sundaram Rural a year before.
Manish Kumar Rai
Jun 21 2018 07:16 PM
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