Everybody loves a good hero story. Against all odds, an individual rises up and shows immense courage against the unknown. Disney has turned hero stories into a multi-billion dollar industry with their Marvel and Star Wars franchises. Even in the investing world, we have our fair share of legendary trades. Everyone loves to imagine how much easier life would be if we only made that one big trade. However, the recent failures of some of the world’s biggest money managers should give us pause in our pursuit to be an investing hero.
Investing is a game of patience and discipline. Everyone likes to talk about their big wins and it seems like everyone is always returning more than you are. The fear of being left behind starts to set in and you start looking around to see how you could increase your returns. Where most people turn is to make a big bet on an individual stock. While it may be true that this gives you a greater upside potential than diversifying, it also makes it far more likely that you fail. Here are a couple of great examples of legendary fund managers that have recently made such devastating trades that it has un-done a decade of hard work. Both are known for their intense research methods and concentrated positioning in their portfolios.
Bruce Berkowitz has headed up the Fairholme Fund since its inception dating back to 1999. His track record through the early 2000’s was incredible, earning him such accolades like the Morningstar Equity Manager of the decade. He successfully navigated through both the dot-com bubble and the housing/financial crisis. However, in 2011, he made big trades on Sears and St. Joe (a real estate company) which made up nearly 20% of his portfolio. Unfortunately, their performance has taken the best fund of the last decade and made it one of the worst of this one. In the last 5 years, Berkowitz has trailed the S&P 500 by 12% annually and has seen his assets fall from nearly $20 billion to less than $3 billion.
Another legendary fund headed by Robert Goldfarb has fallen on such hard times that it has cost him his job after serving as co-manager since 1980 on the Sequoia Fund. The Sequoia Fund is the gold standard when it comes to active management. If you were to invest $10,000 when it first opened in 1970, your investment would have grown to $3,275,201 today versus the S&P 500 at $966,997. However, in 2014, they took a position in Valeant Pharmaceutical at over 20% of their total assets. You might recognize the name of Valeant in connection with their CEO being charged with fraud. This year alone Valeant has fallen over 72% and has placed the Sequoia fund at the very bottom in their investment category and nearly cut their total assets managed in half from just a few years ago.
Both Berkowitz and Goldfarb are some of the most impressive investors in the modern era. However, even with their armies of analysts and Ph.D.’s on staff, they were unable to foresee the amount of risk they were taking in their concentrated positions. Hopefully, over the coming decade, they will be able to bounce back with hard work and strict discipline.
However, for many, especially the retiree, a decade is too long to recover from such a large return shock. If you build a plan ahead of time that works with reasonable return assumptions, there is no need to shoot for such outsized returns and gamble on a few high flying stocks. When it comes to investing, it is better to look for consistent returns and leave the heroes to save the galaxy instead.