Most people would say it�s intuitive to give more money to a top performing manager. But, it wasn�t long after Morningstar crowned Bruce Berkowitz, the manager of the Fairholm Fund (FAIRX), as the equity manager of the decade that his performance started to deteriorate. FAIRX is down 29.45% year to date in 2011 while the S&P 500 is up 1.08%.
Justin Uyehara, a Marketocracy Master who is profiled in the book �The Warren Buffetts NextDoor�, is up a cumulative 166% over the past 5 years, and up 23% so far this year. Should I give him more money, or take money away?
The conventional wisdom is that past performance does not guarantee future performance. That may be true, but it does not mean that exceptional past performance has no bearing on the future. An exceptional track record is evidence that the manager made investments in stocks when no one else saw their potential. This is the very definition of a skilled investor.
The reason that the past returns don�t predict future returns is that the stocks that generated those impressive past returns have already come to fruition so they simply are not as good an investment now as when the manager first bought them.
Future performance depends on 2 factors; the opportunities that are available today, and the investment skill of the manager to find them.
We need to find the managers who have exceptional track records in the sectors and styles that are today�s best opportunities. These are the managers for whom the market is throwing fat pitches and who have the skill to hit them out of the park for investors.
Justin Uyehara is a swing trader. He does well when the market is volatile because that�s when the swings between the highs and the lows are at their biggest. Volatile markets are Justin�s fat pitch, and if there is one thing I think we will see more of in the coming year, it�s volatility. Because Justin Uyehara is up 23% year to date, it appears that the market continues to throw him his fat pitches, so I�ve decided to put more money into Justin�s model portfolio.
As for Mr. Berkowitz, I think he is an exceptionally skilled investor for whom the market is not throwing many fat pitches. I would sell the Fairholm Fund and monitor its performance, because when the market starts throwing Mr. Berkowitz some fat pitches again, you�ll want to get back in.
Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
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