I don't know if it's because I've spent 99% of my life on islands (Guadeloupe, O'ahu, Manhattan) or the fact that I was born a Pisces.
Whatever the reason, nothing is more restorative for me than hanging out by the sea; regular pilgrimages to the ocean are key to my happiness.
One such excursion took me to the Gulf Coast of Florida where I spent many blissful hours walking up and down the shore. I won't lie down for long on a beach, but I will walk for miles on one, and will compulsively start gleaning for something
- anything - pebbles, mermaid purses, or in this case, since I was on Captiva, the shell capital of the U.S., seashells.
There's a lot of wildlife to be spotted in and around the Gulf Coast - dolphins, pelicans, ospreys. But shells? Oh my goodness, yes. Ridiculous amounts have been belched up by the sea,
each receding tide leaving another heaping layer in its wake.
I was in heaven and spent hours bent over the shoreline. The most common shell was a scallop, followed closely by conch shells.
Occasionally I'd stumble upon a whelk or an olive shell. At first I picked up any
undamaged shell, which meant I returned to home base weighed down with bulging pockets. But very soon I became a shell snob,
picking up only those scallop shells that had an unusual color, or were unusually big or small, and only those conch shells that were completely blemish-free. Eventually, I only sought out the rare shells and didn't even bother with the scallop or conch. Each time I went out, I got pickier and pickier and came back with fewer shells.
Now mind you, getting pickier didn't take any less time, but it did mean more work. I had to turn over pile after pile of shells, because the rare ones aren't always deposited right on top
, and if they were, they would have already been snatched by some other gleaner who got there first.
And as I was turning over by hand, miles of shells, my mind wandered and I started thinking about turnover of another kind, the kind that happens in portfolios.
Questions about turnover are a fairly standard part of investment process due diligence, and I find that the answers these common questions unearth (usually point in time averages) are not unlike the common scallop shell - easy to find and ubiquitous, but not all that special.
Ask a banal question, get a banal answer.
If, instead, you want to uncover that rare flash of insight into a manager's investment process and performance, you've got to ask perfect, uncommon questions.
So, if you like to take long walks on the data beaches of your managers, read on for some questions to help you glean that which you seek. First and foremost, be specific.
Do you want to know about dollar or name turnover? Of these, name turnover, mapped out as a quarterly time series, is the most interesting. This will show you the ebb and flow of positions into and out of the portfolio.
It's normal for there to be changes in the pace of new ideas into the portfolio - as I've written about before
, new idea flow, especially in portfolios built from the bottom up, rarely occur at precisely the same rate year in and year out.
- Market environment. Does the manager turn the portfolio over more, or less? When markets are good? Bad? Sometimes, though, an environment with a lot of M&A can create turnover the manager can't control. It's important to find out.
- Assets under management. Overlaying changes in assets to changes in turnover will tell you if the investment process is changing in reaction to asset growth.
- Personnel changes. Is a new portfolio manager cleaning house? That may be a good thing or a bad thing, depending on what's in the portfolio, but unless you notice the change in turnover, you won't be able to zero in and ask questions that will allow you to tell the difference.
- Periods of underperformance or outperformance. Is the process influenced by performance? Does the manager get more conservative when outperforming and risk being left with a stale portfolio? Does the manager get desperate with underperformance and churn like mad trying to catch up? Changes in turnover associated with periods of notable under and outperformance can be very telling.
- Turnover derived solely from adds or trims. Is there a lot of trading around a position? If so, does it add any value? Is there a core group of names in a portfolio that never changes, including position size? Does this mean that a hunk of the portfolio is effectively indexed, with only a piece that's actively managed? If so, what's the difference in characteristics and performance between the portfolio that never changes and the portfolio that changes all the time?
- Abnormal distributions in the sale of winners vs. losers. Whether this is by length of holding period or by size of gains or losses, the goal is to find patterns within the turnover. If the names sold in any given year tend to be a stable mix of old and new positions and then one year it's all old positions, you'd want to know why. If it's normal for the sales to be half winners and half losers, and then all of a sudden it's only losers, you'd also want to know why.
There may be perfectly acceptable explanations, but insights are gleaned from anomalies. The quality of the question dictates the quality of the answer.
Finally, and if you really want to search for those rare and special shells of an answer, ask about changes in the fundamental characteristics of what's being bought and sold
- growth rates, returns, valuations, types of industry. Not all turnover is equal; all of this will deepen your understanding of what you're really after: your manager's process.
But there's only one way to find out - by turning over those piles of questions as if they were shells, in order to collect the rare and valuable insights.