Traits of the best money managers

Date: September 23, 2015

Having worked in a fund of hedge funds, I have met with and analysed some of the best
long/short equity managers globally. I have compiled a list of what I see as some of the
key traits of great money managers as well as, often hard learned, personal lessons.
Things to watch out for. While the focus is on equities, they relate to all strategies.

While most active managers under-perform and some get lucky, there are a few truly
talented managers that consistently outperform. While luck certainly plays some part and
initial success may breed later success, in my opinion the great managers demonstrate
certain traits some of which I highlight below:

Disciplined Process: The best managers have a very clearly defined process which they
stick to thick or thin. They may be value investors or momentum, it doesn’t really matter,
they stick to their craft. Value investors do not morph into growth because of market
performance – they continue to buy when they consider an asset to be cheap and sell
when they consider it expensive. They are not biased by market forces or some vision of
what the future may hold.

Patience: They have the patience to wait for their process to work. A value investor will not
buy expensive stocks simply because there is nothing else available. Rather they will hold
cash and wait for better opportunities or will enter a sold down area of the market that
offers value, even if it may take years for performance to emerge.

Manage Risk: They look for trades that are asymmetrical, where the potential for profit is
significant while that of loss small. The good managers I have met, tend to spend their
time focused on the risks of a trade not on the potential upside. They also try to diversify
the risk to mitigate the impact of a single event.

Let winners run and cut the losers: Related to risk, good managers close out of their
losing trades early. Soros, one of the greats and not a manager I have met, is reported to
have made the following comment ‘My approach works not by making valid predictions but
by allowing me to correct false ones’. He sells the losers and holds the winners.

For most of us, it’s human nature to hold onto a position when a position runs against you,
perhaps even add to it, in the hope that fortunes will reverse. More often than not though,
the position will inevitably continue to work its way down, eventually forcing the trade to be
closed at a massive loss. Often just as the market turns. The better managers don’t let the
loss develop. If it’s not working to plan and they are not sure why, they close out and add
to something that is.

Control Emotions: The good managers don’t get emotional – when a trade is loosing and
they see the market moving away from their thesis, they cut the position without any
hesitation. They don’t let Ego, Greed and Fear hurt returns – they stick to the process.

Limited trading: A fall out from having a clear strategy and not allowing for emotional bias
is that time is spent researching for core trades rather than trading aggressively because
of market moves. This relates particularly to value investors but it’s a rule that applies to
most strategies. Limiting trading is important as its costly in terms of fees and also on
research effort.

Non-consensus: The only way to get ahead of the market is to have non-consensus
views at critical reflection points. Value investors will, for example, tend to be sellers just
before market tops when consensus is most positive.

If you follow the herd it’s likely you will perform in line with them. Better to make your own
mind up on what to own and why and not be afraid to step away from the crowd.

Focussed on generating steady returns: money managers are assessed on their
Sharpe ratio – a measure of the return they generate relative to their risk, as measured by
standard deviation. A high Sharpe is preferred as it reflects that the manager is able to
generate stable returns. They do this by holding diversified portfolios, often with a number
of catalysts that are not correlated to each other.

Thus, while one trade may fail, another may do very well and, by maintaining the discipline
to cut losing trades, will ensure a positive and steady result. Managers who focus on
hitting the ball out of the park, may do well for a time until they don’t…

Diversification of alpha: related to the above, good managers don’t bet their portfolio on
one trade. The worst is to bet on one trade which is directional – such as commodities.
One well known manager blew up a few years ago as the bulk of what he was doing was
focussed on only one trade and the commodity moved in the wrong direction.

Focussed on the long term: The industry is very focussed on quarterly or monthly
numbers. Weaker managers and many in the mutual fund industry thus miss the big plays.
Better managers are able to manage through periods of weak performance, focussing
rather on getting the fat pitch right which may mean sitting on a flat position, waiting for a
key catalyst to play out.

For investors in managers, focussing on recent performance is not value add. Better rather
to be focussed on understanding what edge if any they have and the drivers of
performance. When you can identify what manager’s thesis and rationale is, only then can
one make a call as to whether or not it’s worth investing.

Valuable lessons, many of which I have learned the hard way:

Don’t bet on the market’s direction or try and time the market: As in the case of
managers sticking to their disciplines, few of us know exactly how the economy will play
out or which asset classes will outperform another. Most good managers don’t try and
guess it right, rather they stick to their process. Macro and multi-strat managers will take a
view of the economy and the market’s direction, but will usually be quick to reverse the call
if proven wrong.

Be an investor not a speculator…

Watch your leverage: Be a seller when you want to not when you have to. Leverage
can help generate outsized returns but when it works against you it can wipe you out.
While many professional investors will use leverage, they are very conscious of its risks.

When uncertain move to cash: We all suffer set backs and tough markets. The trick is to
keep your capital so that you can reset when the market offers you opportunities.

Use technicals: Assets move in waves, some larger than others and getting the entry
price right is critical.

Position sizing: A big mistake is to find a great opportunity with low risk and then not
take a large enough position in it.

The market is always right – don’t fight it. Enough said.

Don’t get bogged down: every day is a new start. If unhappy with a position and
nothing works CUT and take a break. Don’t add in the hope that things will reverse. This
is a tough lesson to learn.

Watch your shorts: A short that pops higher can destroy a portfolio. Witness VW in
2009 when short sellers had no liquidity to close their positions. Many hedge funds
suffered significant loss on the back of this but, if you held on throughout, the shorts
eventually made money.

Psychology: Track one’s mental state of mind and watch for periods of over negativism
or over positiveness.This is related to greed/fear and understanding how to deal with
these emotions.

Cut when away from the desk on holiday: there’s nothing worse than trying to fix a
trade when sitting on a beach with no internet.

Don’t fall in love: Always question your positions and the exposures and when the
market works against you, enforce strict drawdown controls.

Always be liquid: Ensure you have enough liquidity regardless of what the market does.

Admit and declare your mistakes and move on: The worst thing a trader/investor can
do is hide a loss in the hope it will correct itself. Usually this will just lead to an even
larger loss. Anybody who has worried about and then cuts a loosing trade, knows how
good it feels…

Invest to Live: While you have to enjoy investing you have to see it for what it is. Have
fun doing it and don’t sweat it. At the end it’s just numbers.

Only ‘play’ with what you can afford to lose: Only invest once the mortgage/house is
paid off, or provisioned for, and you have spare cash in the bank to take care of daily
requirements, for at least a few months.

….and lastly, sometimes it’s better to find a good manager than try to be one
managing money can be enormously stressful. Alternatively, find a partner to
do it with so that you can discuss and debate views. Not only will that be a lot more fun
but you’ll have a good drinking partner when things don’t work out as planned….

Good Luck!

Contributed by Rob Aspin

Rob is an investment professional and CFA Charterholder with extensive experience in discretionary portfolio management, portfolio construction, hedge funds, global stock selection and investment advisory. His views can be followed on