I recently participated in a conference call with a mutual fund and hedge fund manager. He talked about his process and his strategy. While his knowledge and experience can’t be adopted from nothing more that hearing about how he works, it’s interesting to me to understand his approach. I then see if my own strategy or procedure can be improved. Not being a full-time investment fund manager, I feel that I always have more to learn. Every improvement should increase the likelihood of reaching my financial goals and avoiding ruin.

The manager I was talking with works with a team, which is different from many investment managers. Most seem to see themselves as high-flying rock stars, and try to maintain their prestige without the help of others. But this gentleman had two of his partners on the call. They each have their area of expertise and they collaborate on their funds. In this way, they are able to more closely monitor a large number of companies. If a mutual fund manager every tells you that he or she is able to understand the businesses and prospects of over 150 companies, ask them how. I’m genuinely curious. For me, I have two ways of making informed decisions, since I don’t have an investment management team. First, I talk about my ideas with my wife, who asks the right questions and helps me crystallise my ideas. Second, I read the opinions of analysts about the companies. Stock analysts have a poor track record of predicting prices, but they are often insightful about the relative strengths and weaknesses of a company. Their opinions can inform my decisions about outlook and risk.

Our mutual fund manager talked about “names we like.” Knowing his strategy to be bottom up, based on fundamentals, I know that he does extensive research. The goal is to find companies that we are comfortable holding. In fact, being part owner of the business, we should be confident that it is worthwhile, profitable and well managed on our behalf. I do this by reading financial statements and especially management’s discussion and analysis and by participating in conference calls, held each quarter. I’m sure that our fund manager visits the companies and meets personally with management. It sounds like he maintains a list of companies whose shares he would like to own. This watchlist makes future decisions quicker, being able to buy when the price is attractive.

He gave an example of making his purchases based on the price. His fund focuses on income, so he was buying BCE. He had been buying around $23, where it provided a yield around 6%. Recently, the price has surged, and he continued buying up to $30. At that point, he stopped buying and it is now trading around $32 (with a yield close to 4%). He has made a nice profit, but he is waiting for the price to fall back below $30 (a yield over 4.5%) before buying more. I would guess he also has a price in mind that, if it traded that high, he would prefer to sell and take profits. These prices can be adjusted based on the company’s performance and outlook, but setting them prior to buying and selling keeps the process rigourous. I know that this is important, and I have always attach a buy price and a target price to stocks I buy.

Our fund manager didn’t talk about portfolio weightings or diversification. I know that he prefers focused portfolios of 30-40 names. This may have increase slightly with the growth of his team, but he knows that owning only the best companies is the only way to beat the index. Owning as many companies as the index is a sure way to fall behind. In the past, he’s talked about starting with small positions. When he finds a company that’s worthwhile, he will buy a small position. If the price is flat or falls, he will buy more and build up its weighting in the portfolio. He talked about loading up on cheap companies.

The strategy requires constant monitoring. An investor needs to be aware of changes in the companies’ fundamentals which affect either the current or future profitability. This can be done quarterly by listening ot conference calls with management and reading financial statements. Further, being aware of price changes may allow to take advantage of market inefficiencies. I have found that it’s easier to buy a stock that has fallen when I am confident that the company is profitable and well-managed. It is more difficult, but possible, to sell after the price has jumped and then buy back when it falls.

Buying and selling stocks requires time for research and patience to buy at the right price. That makes weathering storms and selling at a profit easier. Differentiating good companies from weak companies takes judgement and intuition. This is an ability that anyone can develop, if they have the desire and inclination and they learn from experience.

Building and Maintaining a Portfolio of Stocks

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