Monday, April 21, 2008

Death by Style

WP Stewart was the poster-child for buying and holding "good" "solid" large cap growth on behalf of wealthy families and a select number of policy investors. Fees were high, relatively speaking, but loyalty was (for a while) requited by performance. Mr Stewart became a very wealthy man (on paper) in the process, and was revered in both buy-and-hold circles and by trustees of his investors. Unarguably, he (and by this I mean both him and his investment style) had a good mighty run in the mid-to late 90s and further wonderful acceleration out into post-bubble ashes, a result of expanding globalization and unprecedented good times for large-cap growth - both at home and abroad. And though economic historians might look back and in hindsight see this period as having been artifically driven (in large part) by never-theretofore-seen-growth in credit, to the owner of the equity of companies whose earnings grew rapidly and more importantly, whose market valuations grew even more rapidly as a result of expanded "ratings" (i.e. diminished equity risk premia on this style of equity), the result was the same. Mr Stewart was in the catbird seat, as he and affiliated trusts with majority ownership, sat atop a company with a billion-dollar-plus market-cap ($1.4 billion at peak valuation), making him a very wealthy man indeed.

One thing you couldn't call WP Stewart was a style whore. As a firm they were monogamous to finding, buying, and subsequently holding (emphasis on the latter) large cap growth with a zeal bordering on the fanatical. This worked wondrously through the heady days of the 90s when companies like Coke, P&G, Disney, Walgreen, Cisco, Intel, AIG , and big pharma were the rage, as new markets opened, inflation was contained, and fmr President Clinton was sharing cigars with his favorite intern in the oval office. But underneath this veneer of apparent success lies the chilling objective reality: there comes a point where the very success of an investment style sows the seeds of its own future failure, and perhaps none is more emblematic of this than when over-valuation is supremely evident in a style following persistent and unprecedented diminishment in equity risk premia that has alreadyaccrued via price appreciation in excess of associated changes in sustainable growth rates.

Under such circumstance, what is such a one-trick pony to do? In WP Stewarts case, the answer was resoundingly: "nothing, much like the proverbial "deer in the headlights". This response may have been result of their blinding zeal, or their hubris. No one is talking for the moment. Either way, as a result, they (or their customers to be more precise) gaveth back, what the bountiful lord had giveneth prior, in terms of excess return to their "benchmark". So much did they evidently give back that their US Growth strategies were (as evidenced by their listed MF's performance - see adjacent inset) in the bottom decile over five year horizons to their peer group. And while investors will give successful managers and strategies a little rope after a good run there are limits to investors' patience. Even the trustees of "Dead Pet Trusts" will eventually redeem and allocate to, errrrr ummmm Citadel?!?

But worse was still to come in WP Stewart's case of fanatical style devotion, for not only did the market decide that large cap growth (of the particular flavour they favored) was overvalued, (thereby compressing the ratings from their dizzying and inflated heights), but in many instances, growth in member portfolio companies faltered, causing liquidation by purists, and further multiple contraction, all which hurt performance. In such instances, the buy-and-hold investor looks like the mug, for with abysmal performance comes redemption, and associated with redemption are forced sales of stock on portfolio companies further hampering share-price recovery and relative performance, causing further redemption and reallocation to, yes, Citadel (or Capital Research).

Of course, such transpiring events cannot but cause the value of one's own enterprise to rapidly descend along with AUM, since fee income drops like a stone, without associated cuts in staffing, an evenuality seen pictured in the weekly graph of WP Stewart's share performance (adjacent). And along with this, so went the paper net net worth of Mr Stewart's WPL Holdings, falling from more USD$700million at peak valuation, to little more than $35 million - a crucial point at which (so I am told) one is barely comfortable "flying private". Tragic.

Perhaps even more fascinating and telling when one is attempting to forensically evaluate whether their prior success was "skill-based" or "luck-based" (i.e. riding the outperformance of their parochial but immutable style) is their (Mr Stewart, the Board of Directors, the zealots etc.) eventual response, which more than five years AFTER THE FACT, and AFTER their share price is more than 95 percent complete in its route to Zero, is to hire a new chief investment officer in order to (as detailed in their official press release), yes, you guessed it, evaluate and modify their investment process. How long before the religious, smitten too much and too often stop believing?

Much return - both alpha and beta - has resulted from the bull market in commodity and related stocks. The story was and, has been , a good one, encompassing value with momentum and powerful cyclical forces combined with slow-burning secular trends. It too may likely continue in the long term given the strength of the forces at work. But it IS at present extended, rife with speculative representation, despite there being a variety of forces potentially conspiring against it, (in the shorter term). As such allocating investors would be well-served to evaluate their managers' concentrations here, for like "large cap growth" before it, there is at present almost universal agreement amongst investors about BOTH the compelling nature of the story and its increasing representation in their portfolios. This is not a prediction of this ultimate trade's demise. But rather it is a word of caution to those investors in awe of returns generated by those trading upon their singular devotion to the style.


Anonymous said...

Sad, but it ALMOST sounds like it's time to buy large cap growth.

Etz3l said...

"economic historians might look back and in hindsight see this period as having been artifically driven (in large part) by never-theretofore-seen-growth in credit"

That's quite an understatement for the biggest Ponzi scheme ever created.

You wrote Stewart but my eyes read Miller.