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Posted on November 28, 2016

Conviction: A Portfolio Manager’s Secret Weapon

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Published by Rob Furlong, Co-Portfolio Manager, and the Carson Group Partners Investment Committee

Each year I serve as a coach to a local college team competing in the CFA Society’s Annual Investment Challenge. Over the next several weeks, I’ll meet with this year’s team to offer advice on how to prepare and present an equity analysis on this year’s company. Every year I’m impressed and encouraged by the curiosity of the students. Often our sessions will digress into broader conversations about the industry, career choices and what makes a good investor or portfolio manager. It’s during these digressions that I’m usually peppered with questions about discounted cash flow models, Sharpe ratios and the efficient frontier, all quantitative academic tools the students learn about in their portfolio management classes.

What I end up telling the students I think often disappoints them. I tell them there are no shortcuts, that not even Nobel-Prize winning formulas offer a silver bullet for investing success – if they did, everyone with a calculator would be a great investor. I tell them that good portfolio managers understand that there is way more to investing than price-to-earnings ratios, beta calculations and GDP growth rates.

And then I tell them that great investors and portfolio managers understand that their most important function is to do the necessary work to build conviction in their investments. Without conviction, emotion hijacks decision making and often becomes the biggest detractor to long-term performance by coercing investors to sell fear while buying stability and popularity. Most of the time, investors should do the exact opposite, and conviction is the only thing that makes swimming upstream palatable.

Building conviction comes from knowing what you own and why you own it. There are no shortcuts for this. It requires careful study of a company’s and industry’s history as well as conversations with management or industry participants. It also requires a deep understanding of how to make better decisions, including how to overcome behavioral biases and improve forecasting. The skills required to extract, map and analyze information from this old-fashioned detective work are far more important to building conviction than most skills taught in traditional portfolio management classes. The students are often surprised by this. Yet, I’m always encouraged that every year at least one heeds my advice and spends a little more time with psychology in philosophy textbooks in an attempt to become a better investor.

Building conviction is especially important for all investors in today’s environment. The popularity of low-volatility stocks and many sovereign bonds has pushed many of them to become repulsively expensive. Uncovering true value now requires seeking out investments with higher volatility. However, the potential long-term gains from these investments can only be harvested if the short-term price swings can be stomached. Navigating these waters will require discipline and above all else, conviction.

 

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