Ken Kam, Marketocracy: A lot of people are looking for the next Warren Buffett — including Warren Buffett. My search started with the simple truth that you can tell a lot more about a managers’ investment skill by analyzing their track records than by interviewing them and reviewing their resumes. That’s why for more than 10 years, I’ve asked potential managers from all over the world to manage a model portfolio in real-time at Marketocracy.com so I can track their investment decisions day by day, stock by stock, trade by trade. I believe I’ve gathered more data in greater detail on more managers than anyone else who has ever searched for truly outstanding investors. In this and the next several articles, I would like to share with you some of the data I find striking and tell you how its changed my thinking about how to find and manage the next generation of Warren Buffetts.
When I started Marketocracy, I told everyone who wanted to manage other people’s money that they first had to prove themselves by managing a model portfolio that complies with the SEC rules for mutual funds and that I would contact them if I thought their track record after 5 years was compelling. Because of the press I received when I left as the co-manager of Firsthand’s Technology Value Fund, which at the time was the top performing mutual fund in the country for the previous 5 years, we signed up 30,000 prospective managers in our first 8 weeks. Since then, over 127,000 model mutual funds have been started. Here is the data showing how many are currently active and for how long.
Marketocracy Model Funds Started: 127,599
Active Funds: 11,105> 5 years: 5,799 3 – 5 years: 1,539 1 – 3 years: 1,632
Before we analyze the active funds, lets take a look at the 116,000 or so funds that were started but are no longer active. About 65% of these funds were abandoned during their first year, with another 25% before the end of the 3rd year.
I think the simplest explanation for the high rate of abandonment in the first year is that investing skill, like most other skills, needs to be nurtured and for most people this takes work. Just as it takes a lot of work for people with athletic ability to develop into professional athletes we should expect that those with a gift for investing will need to work to develop their skill.
The problem with investment skill is that it is hard to discern over short time periods. In many sports, after the season ends, a good coach can see who should be nurtured and who should be encouraged to move on.
With investing, however, a one-year track record does not tell you much about the manager’s ability. How many athletes would train for five years without any positive feedback or encouragement? Yet, five years is the minimum length of track record before we can say anything about a manager’s skill.
While high schools and colleges the world over celebrate their best athletes, I don’t know of any similar awards for investment ability, not even among the top business schools. The lesson I draw from this data is that few people who have raw investment talent ever receive the positive feedback and encouragement necessary to develop their skill. No wonder there are so few great investors in the world.
What does it take to work on a track record for 5 years before getting any positive feedback? In a word, passion. The 5,799 funds that are now at least 5 years old, have managers who are passionate about investing. These are people who read annual reports for the joy of it, ask the best questions in earnings conference calls, and make investment decisions based on their own research. Like professional athletes, they are willing to be judged on their performance. I think clients expect this kind of passion from the people who are managing their money.
The next article will look deeper into the funds that are at least 5 years old.
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Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.