Father of momentum investing’ shares tips for stock picking
Synopsis
Although Driehaus was not as popular as the likes of Warren Buffett and George Soros, his performance as a fund manager was truly phenomenal and he was well respected in the investing circle.
Investing legend Richard Driehaus says investors frequently have to challenge conventional wisdom, as opportunities for truly attractive investments are often not obvious.
“This is what I call ‘right brain’ investing. Where my intuition, or gut feeling, leads me to an investment decision different from that reached through traditional, analytical research or ‘left brain’ investing,” he said in a speech at DePaul University.
Although Driehaus was not as popular as the likes of Warren Buffett and George Soros, his performance as a fund manager was truly phenomenal and he was well respected in the investing circle.
His extraordinary success can be attributed to his expertise in “aggressive growth” style of investing, for which he is also known as the ‘father of momentum investing’. Driehaus identified and bought stocks when they are in a strong upward price movement and stayed with them as long as the upward move
“This is what I call ‘right brain’ investing. Where my intuition, or gut feeling, leads me to an investment decision different from that reached through traditional, analytical research or ‘left brain’ investing,” he said in a speech at DePaul University.
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Although Driehaus was not as popular as the likes of Warren Buffett and George Soros, his performance as a fund manager was truly phenomenal and he was well respected in the investing circle.
His extraordinary success can be attributed to his expertise in “aggressive growth” style of investing, for which he is also known as the ‘father of momentum investing’. Driehaus identified and bought stocks when they are in a strong upward price movement and stayed with them as long as the upward move
The basic concept of momentum investing is that short-term performance is repeated with winners continuing to be winners and losers continuing to be losers in the short run.
In his early days, he often distributed newspapers to earn money and bought his first shares with that money when he was only 13. Later Driehaus went on to earn a bachelor’s degree and an MBA from DePaul University, and in 2002, the university gave him an honorary doctorate.
Driehaus began his career in 1968 with AG Becker, where he worked in the Institutional Trading Department as a Research Analyst. He also worked at various other brokerage firms such as Mullaney, Wells & Co. and Jesup & Lamont before forming his company in 1982
Driehaus founded Driehaus Capital Management in 1982, which now manages over $13.2 billion through its mutual funds and other accounts. It produced a compounded annual return in excess of 30% over 12 years. In 2000, Barron’s named Driehaus to its “all-century” team of 25 individuals it identified as most influential in the mutual fund industry.
Investment philosophy
Driehaus was of the view that investors’ expectations of a firm’s earnings growth was the main driver of its stock price. "Companies that have a record of strong and consistent earnings growth have been the most successful ones,” he said.
Driehaus said the key to extraordinary performance in the stock market is picking companies with the greatest earnings growth potential. He focused on picking smallcap stocks, instead of largecaps.
His approach for picking stocks was in sharp contrast to the more conservative approach that most investors used called ‘value investing’ whereby an investor tried to find undervalued stocks having relatively low valuations evident by their low P/E ratios.
"Such an approach of buying stocks only with average to below-average P/Es automatically eliminates many of the best performers," he said.
Driehaus invested mainly based on fundamentals. But to improve his entries and exit timings and to confirm his stock selection, he considered technical analysis as a helpful tool.
Driehaus once shared his wisdom in a speech at DePaul University where he talked about what he had learnt over the years from the stock market and how he thinks investors can avoid the common pitfalls that lead them to mediocre performance.
- Stock prices heavily influenced by market dynamics: Driehaus says a stock’s price was rarely the same as the company’s value as he felt that the valuation process was flawed. He believes stock prices were heavily affected by market dynamics and by investors’ emotions which widely swung from pessimism to optimism.
“While the information they are using to invest may be valuable, it is often the wrong information for their investment time-frame. If people invest in a company based on current information, they have to be prepared to make any changes in that information in a much shorter time frame than most investors are prepared to do," he said.
- Don't hold stocks for the sake of diversification: Driehaus says some sectors and industries were much greater beneficiaries of secular changes than others. He felt investors were best suited to concentrate on their investments.
"Look for companies in favored sectors with strong market positions and improving outlooks. In doing so, you may be able to identify trends or secular changes earlier than the herd and “deal with what will become big while it is yet small.” Additionally, by selling stocks of companies with poor outlooks, one may be able to “take care of what is difficult while it is still easy”. he said.
- Adjust to new ideas: Driehaus says investment managers should constantly adjust to new concepts and ideas.
"Many investors find comfort with money managers who say they have rigid disciplines that they have adhered to consistently. Unfortunately, those managers may be making decisions without the full benefit of the rapidly changing technology that is available today," he said.
Driehaus says investors needed to be willing to do things differently from most other investors. He felt many investment managers followed a set of investment paradigms, which lead them to mediocre results.
The legendary investor says there were some conventional wisdoms or investment paradigms worth avoiding as they were now almost outdated and were really no longer true. He says investors make the mistake of holding on to these beliefs and often search for clues to support them and reject information that conflict with the paradigm.
Let's look at some of these paradigm he felt should be avoided by investors-
- Paradigm #1: Buy low and sell high
He said there was obviously a risk of buying near the top in this strategy, but he believes investors should much rather be invested in a stock that is increasing in price and take the risk of it declining later, than to invest in a stock already in a decline and trying to guess when it will turn around.
- Paradigm #2: Buy stocks of only good companies... and hold on to them
“Buy good stocks of good companies and hold onto them until there are unfavorable changes. Closely monitor daily events because this will provide the first clues to long term change," he said.
- Paradigm #3: Don’t try to hit home runs. You make the most money by hitting a lot of singles.
Driehaus says investors can make the most money by hitting "home runs" and not by hitting a lot of singles, but they should also remain careful and disciplined of not striking out. "I cut my losses, and let my winners run. Perhaps that’s a paradigm, too, but it is one that works," he said.
- Paradigm #4: A high turnover strategy is risky
Driehaus says most investors believe a high turnover strategy is risky. "I think just the opposite. High turnover reduces risk when it is the result of taking a series of small losses in order to avoid larger losses. I don’t hold on to stocks with deteriorating fundamentals or price patterns. For me, this kind of turnover makes sense. It reduces risk," he said.
- Paradigm #5: An investment process needs to be very systematic
- Paradigm #6: You must have a value-based process
"In the short run, valuation is not the key factor. Each company’s stock price is unique to that company’s place in the market environment and to its own phase in its corporate development," Driehaus said.
- Paradigm #7: You need to buy good Street research and have contact with the best analysts
- Paradigm #8: The best measure of investment risk is the standard deviation of return
But he feels volatility is only a risk for short-term liquid assets and investors should rather focus on long-term objectives. "For many, if not most investors, their greatest long-term risk is the lack of sufficient exposure to high returning, more volatile assets. In my opinion, investment vehicles that provide the least short-term volatility often embody the greatest long-term risk," he said.
- Paradigm #9: It’s Risky to place your money with a ‘Star System’ manager
These paradigms from Driehaus provide a different insight into market behaviour, which reveal that sometimes going against the conventional wisdom can lead to bring in investment opportunities.
Driehaus always felt it was important for investors to use both “right brain” and “left brain” in the decision-making process. “Always remember to keep that sense of awe with respect to the stock market. Remember the stock market is illogical and the only constant is change. Finally, remember that the “mind is like a parachute; it is only good when it is open,” he said.
- Develop your own trading philosophy
"A carefully crafted investing strategy will provide the confidence necessary to persevere with methodology during hard times. There are times when even the most successful strategies don’t seem to work well and traders who don’t have faith in what they are doing tend to get frustrated," he said.
Anthony Cross' investment tips to ensure steady long-term returns
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Synopsis
With over 20 years of experience at Liontrust Asset Management under his belt, Cross is among a very few fund managers, who have spent more than two decades at a company.
Globally renowned fund manager Anthony Cross says investing in the stock market is an intellectual battle against the market’s perceived mispricing.
And to win this battle, an investor needs to have a clear set of investment rules, that can help her make the correct investment decisions.
With over 20 years of experience at Liontrust Asset Management under his belt, Cross is among a very few fund managers, who have spent more than two decades at a company.
“I am a great believer that this is a really long game. If you quietly build your investment returns and your own brand, eventually people will recognise that and start to put money with you. It can take a long time. Often people jump in too early, but they should stay put,” he said in an interview with a financial website.
Anthony Cross joined Liontrust in 1997 having previously worked at Schroder Investment Management as an analyst
Sharing his views on what changed in his two decades of investing experience, Cross says managers now get access a lot of information easily, which has levelled the playing field to a great extent.
“Information is now released fairly to everyone. So we now have just as good information as fund houses, who are a lot bigger,” he
Revealing about what investors should look for in a company before investing, Cross says one should try to spot companies that can compound growth over time. “Any company we invest in must demonstrate either strength of intellectual property, strength of distribution network or high contracted recurring income of at least 70 per cent of turnover,” he says.
He says one should invest in companies that have spent a lot of money on research and development, have built superior world class products which are easily protected, and have sold those products throughout the world.
During his career spanning over two decades, Cross developed a number of simple investing rules and beliefs which can help investors generate better returns and avoid big mistakes in investing. Let's look at some of these rules.
"No one likes to crystallise a loss and selling will underline that an intellectual mistake has been made. Denial is frequently the default response that leads many investors to continue holding the stock," he says.
Cross believes if investors can create a set of investment guidelines that they can follow every time, then they can make better investment decisions and would be able to avoid emotional judgements while investing.
“When a company we have invested in encounters difficulties, we need to judge whether it is suffering from a general industry downturn or whether we should be questioning its long-term possession of competitive advantage. If there is evidence that its competitive advantage is undermined, then it is better to sell," he says.
“The Covid-19 pandemic has really illustrated that some events with huge economic significance can’t be predicted or pre-empted by investors. During such a crisis, as in all others, it is important to focus on a company’s ability to trade through a downturn and its potential to emerge on the other side in a position to take advantage of any subsequent upturn,” he says.
He says one of the clearest and simplest ways a company can possess substantial pricing power is through the value of a brand. “In simple terms, a company can maintain prices and protect profit margins in the face of competition or cost inflation. In more jargonistic terms, we would say that the company’s demand is relatively price inelastic," he says.
Cross advises investors to make full use of their valuation toolkit exploiting the strengths and recognising the weaknesses in order to make better investment decisions.
He feels investors should carry out an in-depth examination of valuation metrics to identify key business characteristics in a company, so that it becomes easier to make investment decisions.
“Some companies possess intangible assets which act as barriers to competition. This should allow them to sustain earnings growth, which will serve to erode ‘expensiveness’ and generate good long-term share price returns," he says.
And to win this battle, an investor needs to have a clear set of investment rules, that can help her make the correct investment decisions.
“I am a great believer that this is a really long game. If you quietly build your investment returns and your own brand, eventually people will recognise that and start to put money with you. It can take a long time. Often people jump in too early, but they should stay put,” he said in an interview with a financial website.
Anthony Cross joined Liontrust in 1997 having previously worked at Schroder Investment Management as an analyst
Sharing his views on what changed in his two decades of investing experience, Cross says managers now get access a lot of information easily, which has levelled the playing field to a great extent.
“Information is now released fairly to everyone. So we now have just as good information as fund houses, who are a lot bigger,” he
Revealing about what investors should look for in a company before investing, Cross says one should try to spot companies that can compound growth over time. “Any company we invest in must demonstrate either strength of intellectual property, strength of distribution network or high contracted recurring income of at least 70 per cent of turnover,” he says.
He says one should invest in companies that have spent a lot of money on research and development, have built superior world class products which are easily protected, and have sold those products throughout the world.
During his career spanning over two decades, Cross developed a number of simple investing rules and beliefs which can help investors generate better returns and avoid big mistakes in investing. Let's look at some of these rules.
- Avoid making emotional investment decisions: Cross says investors often fall in the trap of making emotional decisions while investing rather than remaining patient and unfazed by the noise in the market.
"No one likes to crystallise a loss and selling will underline that an intellectual mistake has been made. Denial is frequently the default response that leads many investors to continue holding the stock," he says.
Cross believes if investors can create a set of investment guidelines that they can follow every time, then they can make better investment decisions and would be able to avoid emotional judgements while investing.
“When a company we have invested in encounters difficulties, we need to judge whether it is suffering from a general industry downturn or whether we should be questioning its long-term possession of competitive advantage. If there is evidence that its competitive advantage is undermined, then it is better to sell," he says.
- Stop predicting macroeconomic events: Cross believes it is quite difficult to predict macroeconomic events successfully as exogenous economic shocks are unavoidable and unpredictable.
“The Covid-19 pandemic has really illustrated that some events with huge economic significance can’t be predicted or pre-empted by investors. During such a crisis, as in all others, it is important to focus on a company’s ability to trade through a downturn and its potential to emerge on the other side in a position to take advantage of any subsequent upturn,” he says.
- Look for companies having high pricing power: Cross says investors should look for companies that have the ability to maintain prices and profit margins in a crowded and competitive market.
He says one of the clearest and simplest ways a company can possess substantial pricing power is through the value of a brand. “In simple terms, a company can maintain prices and protect profit margins in the face of competition or cost inflation. In more jargonistic terms, we would say that the company’s demand is relatively price inelastic," he says.
- Make full use of your valuation toolkit: Cross says investors often make the mistake of relying on one-dimensional valuation metrics. He says although some of the valuation tools like price/earnings (P/E) ratio are quite simple to use, they also have their limitations.
Cross advises investors to make full use of their valuation toolkit exploiting the strengths and recognising the weaknesses in order to make better investment decisions.
- Conduct in-depth examination of valuation metrics: Cross says it is better to buy a company with characteristics of high quality such as good cash flow returns on capital invested than one that looks attractive on a simple valuation metric.
He feels investors should carry out an in-depth examination of valuation metrics to identify key business characteristics in a company, so that it becomes easier to make investment decisions.
“Some companies possess intangible assets which act as barriers to competition. This should allow them to sustain earnings growth, which will serve to erode ‘expensiveness’ and generate good long-term share price returns," he says.
- Buy high quality companies: Cross says investors should aim to buy high-quality companies with defendable barriers to competition. He feels investors should watch these companies very carefully to make sure the barriers remain intact and the financial performance is as expected.
- Avoid sectors lacking competitive edge: Cross says there are certain sectors of the stock market that are more likely to possess the competitive advantage characteristics that investors try to identify in companies. But he feels if a company or whole sector fails to provide the competitive edge that investors are looking for then they should be happy not to own them.
- Pick long-term 'outperformers': Cross says professional and amateur investors both struggle to consistently play ‘winners’ in the short term. “By attempting to pick consistently the best performing stocks over any particular short time period (a week, month or quarter, for example) – the equivalent of trying to play a winner in a game of amateur tennis on every point – one might pick a few stocks that shoot the lights out, but it is likely to come at the cost of a number of failures," he says.
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