Eric’s Wonder Years

Timing is everything in investing, so they say.

I could argue timing doesn’t have to be perfect, but that’s a topic for another day. Today I wanted to discuss timing as it relates to careers in investing. The inception date of a professional investor’s career can be a headwind or tailwind, depending on where one lands in the market cycle.

My career started in 1993 after graduating from Stetson University. I started in the tax trust department at First Union National Bank. I knew immediately I did not want to spend my life in a cubical factory filling out trust tax forms. After a few months I fortunately landed in the investment department and worked as an assistant for a very knowledgeable institutional portfolio manager. Some of my early duties included a lot of busy work, including putting together presentation booklets and updating spreadsheets. I was a grunt, but was thrilled to have a job and to be working in the industry. My boss knew I wanted to be an analyst, so he allocated time for me to write research reports and make stock recommendations. Life was good!

After gaining experience and passing a couple CFA exams, I was eventually promoted to portfolio manager. I worked with a very talented counterpart who remains in the industry today. The accounts we managed were called Tier III accounts. The Tier III accounts were smaller on average and needed a lot of work. And it was a lot of work. Looking back, I now realize how I got the promotion – no one else wanted the job! All kidding aside, it was a great experience and allowed me to finish up my CFA and apply for an analyst position with the Evergreen Funds in New York (First Union acquired the Evergreen funds in 1994).

In 1996, I landed my dream job as an analyst for a small cap value fund with Evergreen Asset Management. When I started my new job I quickly learned there wasn’t going to be a lot of structure. My boss, and manager of the small cap fund I was working on, managed a lot of other money. Her main job was managing a very large income strategy and running the firm. The small cap fund was more of a pet project and only had $6 million under management.

My new boss showed me my office and expected me to provide her with buy ideas immediately. And I did. I eagerly got to work and began to form my possible buy list, which remains with me today. These were exciting times. My recommendations were making it into the fund and they were working. The fund had very good performance and we eventually made it on the Barron’s top 100 funds in America list for two consecutive years. Assets grew quickly from $6 million to over $300 million. Life was good!

Up to this point in my career, everything seemed to work out perfectly. Almost all of my stock recommendations generated attractive returns. Of course I had a few that didn’t work out as planned, but overall this investing stuff seemed too easy! This finally gets me to the point of this post (sorry it took so long). During my first five years in the investment management industry, I thought I knew it all and believed I could do little wrong – my confidence was sky-high. However, what I didn’t carefully consider at the time, was my stock selection and my career were being aided by rising corporate profits and rising stock prices.

Although that particular profit cycle ended in 1997, stocks continued their upward march until late 1998 (there’s that profit market cycle lag again). Since the inception date of my career in September 1993 and through June 1998, the S&P 500 increased 173%, or 24% annualized. No wonder most of my stock recommendations were working out and I was so confident. This all changed abruptly in 1999, when the stocks of traditional businesses I owned sank, while tech stocks I refused to own exploded higher.

The tech bubble turned the investment world upside down. I often say I’m most proud of my 1999 performance when I lost -8% (the largest annual loss in my career). As an absolute return investor, why am I so proud of a loss and my worst year? Because it was the first time in my career I was confronted with and overcame considerable adversity. Up to that point, rising profits and asset prices made investing easy. What I learned the hard way in 1999 is investing and maintaining discipline throughout an entire cycle isn’t easy at all, it’s extremely difficult. When making money in stocks feels effortless, watch out – the risk of losing a lot of money is quickly approaching!

By refusing to buy tech stocks in 1999 and remaining true to my absolute return discipline, I was able to generate attractive returns during 2000-2002. It was my first full cycle and I was happy with the outcome.

I started thinking about my first market cycle earlier this week when I pulled up a chart of the S&P 500. Since the beginning of the current market cycle, the S&P 500 has increased 270%. It’s been an amazing run. Making money during this period has been very easy and reminds me of my first market cycle. How many portfolio managers and analysts are currently experiencing their first cycles? After almost eight years of making considerable returns with limited mistakes, confidence must be high.

Out of curiosity I looked into the average experience of a portfolio manager. I found a study by NYU stating it was approximately 9-10 years on average. It’s reasonable to assume the average analyst has less experience. Given the length of this cycle, it’s also reasonable to assume there are a lot of portfolio managers and analysts who have not managed money through an entire market cycle. It will be interesting to see how they respond when confronted with their own 1999.

Until the bids disappear, volatility spikes, and “buy the dip” fails, it’s difficult to simulate how the end of market cycle will influence investor behavior. Hopefully when the end inevitably arrives, young managers and young analysts will be ready. I thought I was ready, but the challenge to my discipline and confidence was much greater than I expected.

However, in hindsight it was one of the best things that could have happened to me as a young investor. It was a healthy and valuable experience that tested my ability to manage through adversity.

Investors are due for another round of adversity. It’s been too easy for too long.

Considering how far we’ve veered from normalized valuations and yields, I believe the end of the current cycle will be a good lesson for all of us, not just for young managers and analysts. I would have thought after 2000 and 2008 those lessons would have been learned; however, the seductiveness of conformity and a seemingly endless bull market can break the discipline of even the most experienced investors.

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