October
2006
Competitive Advantage: What’s Your Edge?
What is your firm’s competitive edge? That’s my favorite question to ask when I meet with investment leaders. What are your beliefs about market opportunities? How is it that in this incredibly competitive game, you think you can win? By the way, “We have really bright people” is not a compelling answer to the question. Why? Simple: All investment firms have smart people. That’s a given. What is it that allows yours to win?
Good Answers
Here are some answers that I like.
A Clear-Cut Strategy
Acadia Management Company has a super-duper quant model that
includes 25,000 stock names from all over the world. The firm has a
clear-cut strategy: It develops sophisticated quant models that take all
the human error out of stock selection. It then uses a black box to
screen all the names it can. The results have been excellent, and assets
have grown from $5 billion to more than $40 billion in the past five
years.
Tight Teamwork
Disciplined Growth Investors has assembled a team of three
portfolio managers who work closely together to discover investment ideas
that fit the “growth at a reasonable price” description. The three
portfolio managers have identified their roles on the team — one is the
glue, another the fire, and the third the analyst — and how they work
together as a decision-making team. CIO Fred Martin is very savvy about
human nature and conscious not to manage by fear. He points out that
“fear will cause investors to pick safer stocks rather than the best
risk–return opportunities.” The tight teamwork, clear process,
psychological savvy, and long-term perspective account for Disciplined
Growth’s success.
A Star Player
Another perfectly good answer to the competitive advantage
question is, “We have a star.” Of course, for this answer to be valid,
you actually have to have one — not someone pushing his or her ego around
in a wheelbarrow but a real star with a bona fide track record. Bill
Miller, Warren Buffett, and a few others qualify.
An Unusual Answer for Success
But the most unusual success formula I have seen recently belongs
to a Canadian firm’s equity team. A casual observer would not notice
anything unusual about its process. It is a fundamental shop, with real
estate, fixed-income, and equity portfolios. The Canadian equity team
includes a leader and five analysts, all of whom have sector coverage.
They use a quantitative model to screen candidates for purchase and sale.
Stocks that look attractive based on the model are then assigned to
analysts who do the fundamental research – so far, nothing out of the
ordinary.
It is personality types that make this team unique. We often use the Myers-Briggs Type Indicator (MBTI) as a team-building tool for investment professionals. The MBTI measures how our brains are hardwired to take in information, process it, make decisions, and communicate them. Each aspect of the MBTI has a distinct impact on how a person views the investment process. The Canadian equity team’s personality types seem to influence its success.
Extroverts
First, the team is nearly all extroverts (five of the six), which
is highly unusual for the investment world. (In the population at large,
about 75 percent of people are extroverted, but in the investment world,
only about 25 percent are.) Most investment types are on the quieter
side; they like to focus internally on their ideas. Extroverts, on the
other hand, tend to process their thinking out loud. Consequently, the
Canadian equity team has fairly lively discussions and debates about
stock ideas. The discussion allows the team members to process their
thinking and come to conclusions. The level of candor in their meetings
is high. Ideas and energy flow.
Balance
The team is also balanced between detail - and big-picture
-oriented members. (MBTI refers to these types as “sensors” and
“intuitors.”) The sensors are classic fundamental investors, learning all
the details of the firm, reading through annual reports, and watching for
inconsistencies at the operating level. The intuitors, in contrast, are
the top-down investors who start with big ideas and themes and then work
down to individual investment names. The Canadian equity team’s balance
between these two approaches is unusual for equity teams, which are
generally made up of intuitors, the big-picture types. But the balance
serves the Canadian equity team well, because both approaches are
valuable. Integrating the forest with the trees is critical to top-flight
analysis.
Feeling
The third psychological factor for the Canadian equity team is
the strangest of them all. As you might guess, most investment
professionals consider their decision making to be rational (thinking)
versus emotional (feeling). The former means that the individual tends to
be detached and objective, taking the human element out of the decision.
By contrast, people who make decisions in a feeling way tend to be more
involved and subjective as they solve problems. Good leaders tend to
balance both of these approaches.
The Canadian equity team consists of five feelers and one thinker. Why might a team of feelers, which is completely contrary to the typical firm, be exceptionally good? As I watched them work, I concluded the following.
1. They work well as a team. Feelers, unlike thinkers, like harmony and win/win situations. Extroverted feelers especially like team situations. So, the team is hardwired to enjoy working together on decisions.
2. The level of candor is good. Team members are willing and eager to get their ideas on the table. The level of discussion is highly engaged.
3. The team’s preference for feeling allows them more comfort with instinctive answers rather than formal, logical conclusions. They have all read Malcolm Gladwell’s Blink. If one of them is working on a buy idea, that person will have the entire team (10 in all, including the traders and junior analysts) give an intuitive response. This “blinking” process, which includes a preliminary vetting of the idea, bolsters the analyst’s confidence.
4. The decision making is by consensus. The Canadian equity team uses “the wisdom of crowds,” to use James Surowiecki’s theory, which states that collectives (groups of intelligent and independent thinkers) will make better decisions than single experts. The Canadian equity team believes that 10 heads are better than 1. The quantitative model is the first step in the process, and it allows the Canadian equity team to benefit from both the “left” and “right” brain approach to investing: rational, purely mathematical plus intuitive and instinctual. After the computer model selects the appropriate pond to fish in, the 10 “feelers” go about their business of vetting the names using the collective to beat a complex problem.
5. Senior management at the Canadian equity firm is smart enough to align monetary incentives with the team process so there is a clear motivation to perform as a team, not as individual stars.
Summary
There are many fascinating answers to the question, “What is your
firm’s competitive advantage?” If the secret to winning in the markets is
to find a unique approach and not get lost in the middle of the herd,
then the Canadian firm’s equity team seems to have found an answer.