Several years ago I sat down with the team here at Iron Capital and together we defined our guiding principles. We have used these as entirely internal guidelines for our behavior at work and how we approach serving our clients. One of our principles is that everyone here at Iron Capital will strive for wisdom. I can still remember the conversation around this one: The initial reaction was that wisdom is hokey and old-fashioned. I persisted because I felt then, and still feel, that wisdom is what our clients expect from us. After all, information is now at your fingertips. Knowledge isn’t all that rare or even helpful in many cases. What clients are looking for is wisdom – the combination of knowledge and experience that produces insight for the actual actions that need to take place for clients to reach their goals.
True wisdom can only be gained in one way: experience. Some dictionaries define wisdom as good judgment, which reminds me of my honeymoon. My wife and I honeymooned in Scotland, and in the town of Edinburgh we found a great, old hole-in-the-wall Scottish pub where we could relax. On the wall hung a sign that read, “Good judgment comes from experience. Experience comes from poor judgment.” It is true that experience is based on mileage and not years, but there is no denying that it takes time to accumulate experience, and therefore wisdom.
Why has wisdom been on my mind? While it has been quiet in the capital markets and there has frankly been little to write about, the political world has been what has captivated us. First the government was shut down by a young senator and his followers who wished to defund the Affordable Care Act, aka “Obamacare.” Then after that battle and the other side’s refusal to avoid shutdown by postponing the Obamacare launch, the new national healthcare system opened on schedule, and I think we can all agree that at best it was not quite ready for prime time. I am not here to discuss politics except to say that I think most will again agree that we seem to be lacking anything resembling wisdom in Washington today.
But we are here to manage money, not to fix our national woes, and in doing so something worth mentioning happen here not long ago. Every quarter we have an investment committee meeting during which the analysts and I sit down and review the results for every outside mutual fund manager we use with our clients. This list includes all the mutual funds we have chosen for our private client accounts and the ones we have recommended for our institutional clients. It also includes some we may not have chosen but rather inherited, or some that may not have been our first choice but were what we considered the best from which we had to choose. Usually in these meetings we focus on what happened in the quarter and the rolling three-year return rankings (and to a lesser extent five-year return rankings). However, this summer we celebrated Iron Capital’s 10th anniversary as a firm, and I started looking at those ten-year return numbers. Something amazing emerged: In every asset class except two, every manager we cover (approximately 90 managers) had delivered better investment results than their market benchmark. The two exceptions were the domestic large blend category, where we never recommend active management but have inherited a few; and high-yield bonds, where no manger we would consider would have been as risky as the benchmark over that time period, which included the financial crisis (although our favorite manager is outperforming). Other than those two, every manager we have in every major asset class was doing what many in academia say is impossible: beating “the market.”
One of the most famous voices in this academia chorus, Professor Eugene Fama, just won the Nobel Prize for his work proving that firms like Iron Capital can’t possibly exist…which reminds me of something a hedge fund manager once told me. This manager had a Ph.D. in mathematics and I was talking to him about considering going back to school and getting a Ph.D. in finance or economics. He looked at me like I had two heads and asked, “Why?” (He actually said more than that, but this is a family newsletter.) His point was that finance is a practical field; one can practice it in real life. It isn’t like Russian literature, or ancient dead languages. One does not have to hide in the ivory tower to study finance since he can practice it in real life. This brings us back to the difference between knowledge and wisdom.
There are lots of knowledgeable people who will tell you to put your money in an index fund and invest passively. Yet, all of my experience tells me that they are wrong. I know that I have a great team here at Iron Capital and we are very good at what we do. I believe we are better than most, but we are not miracle workers. I do not believe we have done something that no other firm could do; I do not even believe that we are that unusual if really compared to only our true peers. Many firms like ours across the country probably have similar results. The point is that active management does add value over time. More importantly, in my opinion, it adds value usually at the most important time, when markets are down or moving sideways. Active management also promotes caring about what one owns and how the management of these companies behave.
There is a trend in our industry to go more and more toward passive index products, funds or ETFs, and I personally believe this is dangerous. It is a fact that our clients would have been worse off if we had done that ten years ago, and my experience tells me that going in that direction is unwise. Experience also tells me that the more passive investors get, the more reckless management becomes. We saw that in the accounting scandals of the early 2000’s and again in the financial crisis. But wisdom comes with age and we live in a youth-obsessed society. So I will likely remain in a small minority who believe the words “young” and “senator” should never be used in the same sentence, and that being active is the best way to invest.
Then again, I didn’t care that my own staff called me “hokey” for telling them they must strive for wisdom. I hope you are pleased about that.
Chuck Osborne, CFA