Defining Financial Strength
"A strong financial position is something that is measured not so much by the presence of assets as by the absence of significant encumbrances."
Source: http://www.sanjaybakshi.net/Sanjay_Bakshi/Articles_files/Learning_To_Look_Down_Before_Looking_Up.HTM
Peter Lynch, another outstanding mutual fund manager who has made billions for dollars for his clients by buying stocks no other institution was interested in has also criticised the typical behaviour of institutional investors.
"Between the chance of making an unusually large profits on an unknown company," says Lynch, "and the assurance of losing only a small amount on an established company, the normal mutual fund manager would jump at the latter. Success is one thing, but it's more important not to look bad if you fail. There's an unwritten rule on Wall Street: You'll never lose your job losing your client's money in IBM.
If IBM goes bad and you bought it, the clients and the bosses will ask: "What's wrong with that damn IBM lately?" But if La Quinta Motor Inns goes bad, they'll ask: "What's wrong with you?" That's why security-conscious portfolio managers don't but La Quinta Motor Inns when two analysts cover the stock and it sells for $3 a share. They don't buy Wal-Mart when the stock sells for $4, and it's a dinky store in a dinky little town in Arkansas, but soon to expand. They buy Wal-Mart when there's an outlet in every large population centre in America, fifty analysts follow the company and the stock sells for $40."
Ralph Wanger's Zebras
Ralph Wanger is an outstanding mutual fund manager in the U.S. He manages two mutual funds - The Acorn Fund and The Acorn International Fund. In both funds Wanger has outperformed the market by a large margin. In case of Acorn Fund, $10,000 invested in June 1970 had grown to $575,000 till June 1996. If that money, had been invested in the Standard and Poor's 500 index, it would have grown to only $249,970. In case of Acorn International fund, $10,000 investment made in 1992, had grown to $19,500 till June 1996. If that money had been invested in EAFE index, it would have grown to only $15,965.
Wanger has made money for his clients by shunning popular stocks and by looking for hidden value in small and unknown companies that other institutional investors don't even look at.
Wanger's letters to his investors in the annual reports of both the funds managed by him are collectors items, much like the Warren Buffett's letters contained in the annual reports of Berkshire Hathaway - Buffett's investment vehicle. Over the years, Wanger has made some hilarious comments on professional investors who like to move in herds. In one annual report, he compared institutional investors to zebras. Here is his description of typical institutional investors, a description that applies equally well to many Indian mutual fund managers:
"Zebras have the same problems as institutional portfolio managers. First, both seek profits. For portfolio managers, above-average performance; for zebras, fresh grass.
Secondly, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions.
Third, both move in herds. They look alike, think alike and stick close together.
If you are a zebra, and live in a herd, the key decision you have to make is where you stand in relation to the rest of the herd. When you think that the conditions are safe, the outside of the herd is the best, for there the grass is fresh, while those in the middle see only grass which is half-eaten or trampled down. The aggressive zebras, on the outside of the herd, eat much better.
On the other hand - or other hoof - there comes a time when lions approach. The outside zebras end up as lion lunch, and the skinny zebras in the middle of the pack may eat less well but they are still alive.
A portfolio manager for an institution such as a bank trust department cannot afford to be an Outside Zebra. For him, the optimal strategy is simple: stay in the centre of the herd at all times. As long as he continues to buy the popular stocks he cannot be faulted. To quote one portfolio manager, "It really doesn't matter a lot to me what happens to Johnson & Johnson as long as everyone has it and we all go down together." But on the other hand, he cannot afford to try for large gains on unfamiliar stocks which would leave him open to criticism if the idea fails."
Needless to say, this Inside Zebra philosophy doesn't appeal to us as long-term investors.
We have tried to be Outside Zebras most of the time, and there are plenty of claw marks on us."