What Makes A Great Investor?

There are many ideas to what makes a “great” investor. Different qualities exemplify themselves in different market climates as we’re always being tested from different angles. Whether it’s our Commander and Chief firing up his Twitter app one morning, a break of a major support level on a chart, a surprise corporate announcement, or simply the madness of crowds moving a stock or the market as a whole in a new direction.

Mark Sellers, a former hedge fund manager, made (what became) a well-known speech at Harvard about what it takes to become a great investor. His no b.s. take is refreshing, thought-provoking, and challenging to anyone who hopes to eclipse the massive heard of our industry. While I don’t believe Mark’s take on what makes a great investor to be the end-all-be-all to what it takes to success in finance, I do find his points of interest as one view from one corner of the finance community. With that, whole speech is worth a read but I’ve pulled out some of his main points….

Very few will reach the rarefied air of the group which history associates as “great.”

One thing I will tell you right off the bat: I’m not here to teach you how to be a great investor. On the contrary, I’m here to tell you why very few of you can ever hope to achieve this status. If you spend enough time studying investors like Charlie Munger, Warren Buffett, Bruce Berkowitz, Bill Miller, Eddie Lampert, Bill Ackman, and people who have been similarly successful in the investment world, you will understand what I mean. I know that everyone in this room is exceedingly intelligent and you’ve all worked hard to get where you are. You are the brightest of the bright. And yet, there’s one thing you should remember if you remember nothing else from my talk: You have almost no chance of being a great investor.

You have a really, really low probability, like 2% or less. And I’m adjusting for the fact that you all have high IQs and are hard workers and will have an MBA from one of the top business schools in the country soon. 

Mark goes on to describe how some of the greatest investors of our time have produced annualized 20+% returns during their careers, a feat few have come close to accomplishing. He notes that it’s still possible to have success in investing, but just realize it takes more than a high IQ.

On the bright side, although most of you will not be able to compound money at 20% for your entire career, a lot of you will turn out to be good, above average investors because you are a skewed sample, the Harvard MBAs. A person can learn to be an above-average investor. You can learn to do well enough, if you’re smart and hardworking and educated, to keep a good, high-paying job in the investment business for your entire career.

Mark then describes the things that won’t provide enough of the necessary edge needed to become “great.”

Everyone reads.

There are 8,000 hedge funds and 10,000 mutual funds and millions of individuals trying to play the stock market every day. How can you get an advantage over all these people? What are the sources of the moat?

Well, one thing that is not a source is reading a lot of books and magazines and newspapers. Anyone can read a book. Reading is incredibly important, but it won’t give you a big advantage over others. It will just allow you to keep up. Everyone reads a lot in this business. Some read more than others, but I don’t necessarily think there’s a correlation between investment performance and number of books read.

Everyone can get an education or earn an investment credential.

Another thing that won’t make you a great investor is an MBA from a top school or a CFA or PhD or CPA or MS or any of the other dozens of possible degrees and designations you can obtain. Harvard can’t teach you to be a great investor. Neither can my alma mater, Northwestern University, or Chicago, or Wharton, or Stanford. I like to say that an MBA is the best way to learn how to exactly, precisely, equal the market return. You can reduce your tracking error dramatically by getting an MBA.

Everyone can get experience.

Experience is another over-rated thing. I mean, it’s incredibly important, but it’s not a source of competitive advantage. It’s another thing that is just required for admission. At some point the value of experience reaches the point of diminishing returns. If that wasn’t true, all the great money managers would have their best years in their 60s and 70s and 80s, and we know that’s not true. So some level of experience is necessary to play the game, but at some point, it doesn’t help any more and in any event, it’s not a source of an economic moat for an investor.

So what are the keys to developing a competitive advantage in investing, at least according to Mark? You’ll notice that what’s not included is a Twitter follower count threshold, The number of presentations made at the SALT or Delivering Alpha conferences, owning homes in multiple zip codes or secretly knowing Bobby Axelrod’s character is based on you. Instead, Mark notes a great deal has to do with the psychology beyond investing, breaking it down into seven traits that previous great investors have shared.

#1: Not panicking

Everyone thinks they can do this, but then when October 19, 1987 comes around and the market is crashing all around you, almost no one has the stomach to buy. When the year 1999 comes around and the market is going up almost every day, you can’t bring yourself to sell because if you do, you may fall behind your peers.

The vast majority of the people who manage money have MBAs and high IQs and have read a lot of books. By late 1999, all these people knew with great certainty that stocks were overvalued, and yet they couldn’t bring themselves to take money off the table because of the institutional imperative, as Buffett calls it.

#2: Being obsessive

These people don’t just enjoy investing; they live it. They wake up in the morning and the first thing they think about, while they’re still half asleep, is a stock they have been researching, or one of the stocks they are thinking about selling, or what the greatest risk to their portfolio is and how they’re going to neutralize that risk.

They often have a hard time with personal relationships because, though they may truly enjoy other people, they don’t always give them much time. Their head is always in the clouds, dreaming about stocks.

#3: Willingness to learn from past mistakes

The thing that is so hard for people and what sets some investors apart is an intense desire to learn from their own mistakes so they can avoid repeating them.

Most people would much rather just move on and ignore the dumb things they’ve done in the past. I believe the term for this is repression.

#4. Having an inherent sense of risk based on common sense

Most people know the story of Long Term Capital Management, where a team of 60 or 70 PhDs with sophisticated risk models failed to realize what, in retrospect, seemed obvious: they were dramatically over leveraged. They never stepped back and said to themselves, “Hey, even though the computer says this is ok, does it really make sense in real life?”

The ability to do this is not as prevalent among human beings as you might think. I believe the greatest risk control is common sense, but people fall into the habit of sleeping well at night because the computer says they should. They ignore common sense, a mistake I see repeated over and over in the investment world.

#5: Having confidence in their convictions

Great investors have confidence in their own convictions and stick with them, even when facing criticism. Buffett never get into the dot-com mania though he was being criticized publicly for ignoring technology stocks. He stuck to his guns when everyone else was abandoning the value investing ship and Barron’s was publishing a picture of him on the cover with the headline “What’s Wrong, Warren?”

#6: Using both sides of your brain

I later learned that some really smart people have only one side of their brains working, and that is enough to do very well in the world but not enough to be an entrepreneurial investor who thinks differently from the masses.

On the other hand, if the right side of your brain is dominant, you probably loathe math and therefore you don’t often find these people in the world of finance to begin with. So finance people tend to be very left-brain oriented and I think that’s a problem. I believe a great investor needs to have both sides turned on. As an investor, you need to perform calculations and have a logical investment thesis. This is your left brain working.

But you also need to be able to do things such as judging a management team from subtle cues they give off. You need to be able to step back and take a big picture view of certain situations rather than analyzing them to death. You need to have a sense of humor and humility and common sense. And most important, I believe you need to be a good writer.

#7: the ability to live through volatility without it impacting your process

This is almost impossible for most people to do; when the chips are down they have a terrible time not selling their stocks at a loss. They have a really hard time getting themselves to average down or to put any money into stocks at all when the market is going down. People don’t like short-term pain even if it would result in better long-term results. Very few investors can handle the volatility required for high portfolio returns.

They equate short-term volatility with risk. This is irrational; risk means that if you are wrong about a bet you make, you lose money. A swing up or down over a relatively short time period is not a loss and therefore not risk, unless you are prone to panicking at the bottom and locking in the loss.

Mark concludes with a point that I’m not entirely sure I agree with, which is that these seven traits are all learned before reaching adulthood or not at all. While I agree that many of our foundation attributes are molded and formed during childhood, the idea that we become mentally and psychologically immutable is inaccurate. Must an investor or trader have all seven of above mentioned attributes if they are to have a fighting chance of having success in this business? Many would argue no, but I would challenge that I do think there’s a glimmer of truth to each of the seven – but also that being successful in anything can not be boiled down to an equation or list of traits.

Taking on the uphill climb of investing, an arena that thousands have failed at is no easy task. Personally I take the idea of being included on the list of the most successful investors as a challenge rather than a deterrent. So I say to Mark – Game On!

Source: Hedge Fund Manager Mark Sellers on Becoming A Great Investor (Nasdaq)

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.