In my post of 9/13/13, “The Trouble with Bull Markets,” I talked about some of the behavioral problems investors encounter as they navigate Bull Markets. That post got a lot of comment, but there is another issue I failed to mention, so I’m inserting this blog here.
That issue is this: bad investors, and even some bad managers, tend to outperform in Bull Markets. Of course, they then underperform mightily in Bear Markets, but while the Bull is running weird things are happening.
Consider the late 1990s, when investors who didn’t have a clue what they were doing simply plunged into growth and tech stocks and, for a very considerable period of time, dramatically outperformed more sensible, better diversified investors. In those bad old days Greycourt was fired by several clients who concluded that we just didn’t get it. (One of them hired Alliance Capital Management and one devoted himself to day trading. I’m not sure which was worse.)
During that same period, some of the best managers in the world were viewed as “your father’s Oldsmobile:” passé, over-the-hill, out-of-touch. One of these was Warren Buffett. Buffett’s concluding presentation at the famous Allen & Co. Sun Valley conference in 1999 (Buffett was arguing that there was no “new paradigm”) caused nothing but a lot of eye-rolling by the soon-to-be-broke tech hotshots.
Speaking of Alliance Capital, they were one of the hottest managers on the planet in the late Nineties simply because their style happened to favor growth stocks. Sanford Bernstein, on the other hand, appeared to be one of the worst managers on the planet, simply because their style favored value stocks. Investors piled billions into Alliance and pulled billions out of Bernstein, so much so that in 2000 – talk about bad timing – Bernstein was acquired by Alliance, forming AllianceBernstein.(1)
As it happened, Bernstein actually was a good firm, while Alliance was just a lucky firm. Over the next few years, Alliance’s performance collapsed (and they got into legal trouble over late trading/market timing) and the Bernstein side of the company had to take over and right the ship.
The reason for outperformance by mediocre (and worse) investors is simple: the only kind of “Bull Market” that US investors care about is a Bull Market in US stocks. And being overweight in US stocks is a hallmark of naïve investors, who favor “home country bias.” The reason for frequent outperformance by mediocre managers is that they just happened to be in the right place at the right time.
This is important because we’re going through this exact process now. Fueled by the Federal Reserve’s addiction to Quantitative Easing, there has been a terrific appreciation in risk assets, especially US equities. Bad investors are looking great and mediocre-but-lucky managers are looking great, too.
This worm will turn, but sometimes it takes a good long time for a worm to turn. In the meantime, sound investors will have to watch patiently while lousy investors brag around the water cooler. And good managers will have to grin and bear it while brain-dead managers shoot the lights out.
In the meantime, a lot of foolish decisions will be made, as investment assets pass from sound-but-temporarily-underperforming hands to hot-but-unsound hands. Sensible investors shouldn’t be part of this migration.
(1) I realize that Zalman Bernstein was in poor health and wished to focus his attention on Israel, but if there had been a 1990s Bull Market in value stocks, Mr. Bernstein would never have sold the firm to Alliance.
Next up: How Not to Invest a Fortune, Part 1
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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.
