Portfolio Management: Which Risks To Take

At Smead Capital Management, we make it a practice of constantly reviewing our discipline of stock selection and portfolio management. Like a sports agent compares athletes, one of the ways we do this is to follow competitors with proven track records of success. Many portfolio managers of U.S. large-cap equity funds have had a very difficult time during the last several years in the U.S. stock market. The market has been especially harsh on many high-conviction, long-duration portfolio disciplines lately. What do history and current circumstances teach us about our stock picking discipline?

To answer these questions, we draw on Mark Twain, who said, “History doesn’t repeat itself, but it rhymes!” The worst thing I have ever sat through as a portfolio manager was the last two years of the tech bubble of 1994-2000. From April of 1998 to March of 2000, the technology and telecom sectors grew to be close to 40% of the S&P 500 Index and caused huge gains, while the other eight sectors went virtually nowhere. Unwillingness to own tech at ridiculous prices was tortuous. Under-performance among value managers was rampant, as PE multiples for non-tech companies continued to shrink. How would an investor know that the tech bubble was about to break?

Many events contributed to the tech bust starting in March of 2000. In our opinion, three events happened in a three-month stretch in early 2000 which convinced us that things were about to change and signified the end of that phase in the market.

On January 12, 2000, one of Fidelity’s most successful managers, George Vanderheiden, “retired.” Vanderheiden was only 54 years old and ran three of Fidelity’s most impressive funds, Fidelity Destiny I and II, and the Fidelity Advisor Growth Opportunities Fund. Here is how theStreet.com reported his circumstances:

“Fidelity Wednesday announced the retirement of George Vanderheiden, who manages three funds and $36 billion for the $589.1 billion Boston fund heavyweight. […]

More recently, however, the fund’s performance has sagged. Vanderheiden couldn’t justify buying technology shares at thin-air valuations and the fund posted a paltry 5% return last year.

In 1998 and 1999, Vanderheiden came under fire for poor performance. Last year the fund’s shareholders approved the removal of performance-based fees on the fund. Still, he says his retirement from portfolio management is voluntary.”1