“One of the great investors” explains his portfolio strategy

Lou Simpson, former chief investment officer of Geico – a subsidiary of Berkshire Hathaway – and current chairman of SQ Advisors, has been called “one of the investment greats” by none other than Berkshire chairman and legendary investor Warren Buffett. At the time of his retirement from Geico in 2010, Simpson managed a portfolio valued at over $ 4 billion. Today, he is also a Senior Researcher and Assistant Professor of Finance at Kellogg, and a member of the Advisory Board of Kellogg’s Asset Management Practicum as well as a member of the Board of Trustees of Northwestern University.

Robert Korajczyk, professor of finance at the Kellogg School, spoke with Simpson to discuss his remarkably successful investment strategy.

This interview has been edited for length and clarity.

Robert korajczyk: What do you think is the essence of your investment philosophy?

Lou simpson: The essence is simplicity. The basic scenario for investing in any sector of the market is a passive product, such as an index fund. It is something that any investor can access.

If you are a professional investor, the question is: How can you add value? The more you trade, the harder it is to add value because you absorb a lot of transaction costs, not to mention taxes.

What we do is manage a long term portfolio of ten to fifteen stocks. Most of them are based in the United States and all have similar characteristics. Basically, these are good companies. They have a high return on capital, consistently good returns, and they are led by executives who want to create long-term value for shareholders while treating their stakeholders well.

Korajczyk: So you focus your investments on your best ideas.

Simpson: You can only know a certain number of companies. If you manage 50 or 100 positions, the chances that you can add value are much, much lower.

So far this year we have purchased a new position and we are seriously considering one more. I don’t know what we’re going to decide to do. Our turnover is 15, 20 percent. Usually we add a thing or two and we get rid of a thing or two.

Warren [Buffett] I used to say you should think of investing like someone who gives you a rate card with 20 punches. Each time you make a change, drill a hole in the card. Once you’ve made your twentieth change, you need to stick with what you own. The point is just to be very careful with every decision you make. The more decisions you make, the more likely you are to make the wrong decision.

One thing that a lot of investors do is cut their flowers and water their weeds. They sell their winners and keep their losers, hoping the losers will even come back. Generally, it is more efficient to cut your weeds and water your flowers. Sell ​​the things that didn’t work and let the things that work run.

Korajczyk: Are investors afraid to let the good ones run?

Simpson: If I made a mistake in managing the investments, it was selling very good companies too early. Because generally, if you have made good investments, they will last a long time. Of course, things can change. Amazon is radically changing retailing.

Korajczyk: What is the right balance between quantitative and qualitative skills in your approach to investing?

Simpson: Well I think you need a combination of quantitative and qualitative skills. Most people now have quantitative skills. Qualitative skills develop over time.

But, as Warren told me, “Better to be pretty much right than dead wrong.” Everyone talks about modeling — and it’s probably useful to do modeling — but if you can be roughly right, you’ll be okay with it.

For example, one thing you need to determine is: Are the leaders of the company being honest? Do they have integrity? Do they have a huge turnover? Are they treating their people badly? Does the CEO believe in running the business for the long haul or is he focused on consensus earnings for the next quarter?

Korajczyk: It seems that qualitative skills can help you assess the downsides of having a concentrated portfolio i.e. concentrated risk. What are some of the factors you look at when you’re concerned that an investment could explode and damage your portfolio?

Simpson: There are a few factors that we are looking at. First of all, is this the company we thought we were? If you find out that a business is not what you thought it was, that’s a bad sign.

The second factor is management, which may also be different from what you think. Unfortunately, a lot of managers are very short term oriented, and this can be another reason to sell. It comes down to basic integrity and the guidance of those in charge.

The third factor is too high a valuation, and it is often the most difficult, because you are investing in something that you would not buy at current prices, but you do not want to sell because it is a very good deal and you think it’s ahead of itself on a price basis. It might be worth hanging on for a while.

Korajczyk: I have the impression that you and Warren Buffett have very compatible investment styles. Is there something interesting differences between you and Warren?

Simpson: The biggest difference between Warren and me is that Warren had a much harder job. He managed 20 times more money than us. We manage five billion. In stocks, he could have managed 80, 90, 100 billion. So he was much more limited in what he could buy if he wanted to have a concentrated portfolio, which he did.

Korajczyk: You focus on a long-term vision and a low turnover rate. It seems true that the more you trade, the lower your returns.

Simpson: Yes, I think there is a strong correlation. There is also a negative correlation between the number of people making the investment decisions and the results. If you have a lot of people involved, you tend to have the least competent person making the decision because you need consensus.

One thing I tell people is if you really don’t think you can add value — and most people can’t — then I think your core investment case should be a passive product to. low cost.

Korajczyk: Is there a way for someone to be an active investor but only spend a few hours on weekends researching?

Simpson: You probably could. But even among professionals who trade full time, the majority do not add value. Because, again, you have fees, you have transaction fees.

Yes, I think there are people with the right mindset and maybe connections, and certainly lucky, who could outperform the market. But if someone wants to invest using tricks, or listening to CNBC, or investing with so-called wealth managers in brokerage firms, I think it’s a loser’s game for them.


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Don F. Davis

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