Why Barry Ritholtz Fired His Fund Manager

Barry Ritholtz, fund manager and author of theThe Big Picture blog posted last week that he fired one of his mutual fund managers. Without getting into details, he offered this as his criteria for firing a money manager. I think they apply to us individual traders too. We won’t fire ourselves (well I guess we can quit), but perhaps this list will help us get back on track if our performance slips. My comments are in blue.

Here are his 5 criteria:
When they suffer from style drift: This happens quite often; a manager developed an expertise in a given areas, but is looking beyond that. Maybe they got bored, maybe the new cow in the pasture caught the bull’s eye. Whatever it is, they are doing less and less of why you bought them in the first place. That’s a signal to move on.
You’ve heard me say 1000 times…focus on being good at one thing; ignore everything else. In this game we play, he who specializes in one thing wins; he who wears too many hats loses. Don’t jump from one strategy to the next, one time frame to the next, one product to the next. Find one thing that works, that jives with your personality, that works, and stick with it.
When they become too big: Some managers find a niche that they can profitably exploit. But beyond a certain size — and that can range from $1 billion to $5 billion dollars — they no longer can create alpha with that strategy. This may be true for eclectic segments like convertible arbitrage, but I have found its especially true for small cap and emerging technologies.
The catch-22 here is that if you’re good enough to build up an account that gets “too big,” then you should be very good at controlling risk and not falling into the trap of wanting more more more…otherwise you wouldn’t have gotten there in the first place. This criteria is more appropriate for a fund manager who has some success and then gets a huge influx of money that he has no idea what to do with.
When they fight the dominant market trend: Bill Miller’s streak came to an end amidst a value trap. He bought more and more of his favorite holdings — banks, GSEs and investment houses — right into the financial collapse. Doubling down again (and again) is not a valid investment strategy. Whatever advantages he had heading into 2008 disappeared.
After you had a couple losses, perhaps step back and see if you’re fighting the tape. If so, don’t go on tilt. Don’t double down and try to get it all back at once. Take a deep breath and take baby steps in the right direction. If you are trading in the direction of the trend, then perhaps you’re trading stocks in the wrong group because even when the market is trending up, not all groups participate.
When they become a closet indexer: When a fund owns 100, 150, 200 names, they effectively become a high cost index. Even if they have the top performing stocks, it will be in such small quantities as to not move the needle. This is an easy fix — you replace them with a low cost, passive index.
I don’t think owning half the S&P is an issue we face, but owning too many stocks in one group may happen. If this is the case, might it be better to buy the ETF (or preferably the leveraged ETF) and not worry about the individual stock picking?
When they seem to lose their edge: Whether its success or money or a loss of interest, managers sometimes lose the fire in the belly. Determining this is admittedly challenging in real time, and we often find out after the fact about some personal issues.
We all get burned out from time to time, and there’s nothing wrong with turning the computer off to recharge.
Notice that Performance is not a factor in any of the 5 bullet points above. There are two reasons for that.
1. Process, not outcome: I want to be focused on creating a reproducible methodology, regardless of luck or misfortune in any given quarter. Investing is a probabilistic process, and performance can slip for a quarter or two even when the manager is doing everything right.
You’ve heard me argue many times: Judge yourself based on whether you did right, not whether you made money, because over the long haul, doing right will keep you in business. For the baseball player who focuses on hitting the ball hard, hits will follow.
2. Mean Reversion: The opposite of chasing performance (and buying high) is dumping a weak quarter (selling low) that then snaps back.
If you’re doing everything right but have run into a string of bad luck, shake it off and keep going. You’re due for a string of good luck.