In 2000, I had an established network of supporters who had trusted me through the funding of three ventures.
Like me, these investors did not want the best of the worst (often referred to as “best of class”), but wanted to invest in companies that were making a positive difference in the world. Here are some lessons learned in the interim that apply to all investors.
First, I had to persuade clients to compromise their values a bit for the sake of diversification and invest in imperfect mutual funds while I developed my own list of positive stocks.
Second, to make sure my incentive was always aligned with my clients’ goals I opted for a set fee arrangement rather than charging commissions on transactions. I had been taught to avoid brokers who rely on your willingness to pay commission on each sale (especially annuities). There are, however, ethical brokers who trade only occasionally, and one may argue that this works out to be less expensive than a set advisory fee charged year after year with essentially little change in the portfolio. Now my firm offers impact strategies without advisory fees.
Third, I wanted to find ways to avoid simply rising and falling with the markets changing fortunes. Most brokers who trade individual stocks depend on analysts from big banks, and when I looked at prospects’ portfolios I saw a remarkable similarity in the mix of holdings. I wanted to find companies not followed by analysts but that had great stories. My courage and perhaps my confidence were boosted altogether too much with my first stock pick, which went up 2,000 percent in two years.
The best-performing stock in that ten-year period was Hanson Natural Soda, whose Blue Sky brand was carried by Whole Foods and Trader Joe’s. While Trader Joe’s was private, Whole Foods stock was overpriced, selling at more than twenty-five times what the company was currently earning. Meanwhile, Hanson was a deep “value stock,” priced at five times earnings. I guessed the company would surely benefit by the astounding growth of these two retailers, so I acquired it for all my clients.
An article about Hanson in the Wall Street Journal soon afterwards caused its price to double and double and split (a share is issued for each share owned because the price is too high to believe!). It continued on in this way, growing exponentially in two years. Eventually I learned that, in addition to “natural” soda, Hanson produced Monster, a caffeine drink targeting kids. I decided to get out, taking a handsome profit for my clients.
Realizing this experience was anecdotal and perhaps beginner’s luck, I was still encouraged to look outside the boxed-in universe that I saw in almost every prospective client’s portfolio. The same stocks were weighted heavily, with many different mutual funds owning the same stocks. Following the majority, and listening to the same commentators and analysts and wholesalers, seemed to me inherently risky. The phrase “a high tide lifts all boats” would apply equally to a low tide, so I wanted to find a deep cove away from the marina. The problem with this approach is liquidity. You can buy but it is sometimes hard to sell.
Every bank or brokerage firm has a limited list of managers allowed on its platform (the “stable”) and have agreements with only certain analysts, each of which has a small universe of stocks they tend to follow and know something about. Emerging managers with fresh ideas and unheard-of stocks are largely off-limits. Many public companies (more than 60,000 globally) are hard to trade.
Certainly the status quo feels safer but my question remains: “What is the value of advisors if they all follow the same course of action?” They may be better hand holders than I, but the work they are doing for clients is often neither original nor truly customized. This bothers me, especially since the common theme in all marketing is “performance.” The reality I have observed is that:
Investors being shown “performance” still want “in,” despite disclaimers that past performance may not be indicative of future performance. I was at Legg Mason in the heyday of Bill Miller, who broke all records by beating the S&P 500 fifteen years in a row. This was unheard of. And to his credit he warned new investors that this pattern might not continue. Despite his brilliance, much of his success could be attributed to his troop of advisors who flowed new cash to him every month. He could risk buying stocks at lower and lower valuations as they slid downward—then, like magic, when they popped back up, he had an unusual gain. As soon as all the advisors including me were shipped off to Citigroup Smith Barney in 2006, Miller’s cash cow reversed as the advisors took their profits and moved on. His performance went from best to worst in a relatively short time.
This article was first published on Stretch A Dime .