“We really can say no in 10 seconds or so to 90% of all the things that come along simply because we have these filters.”

– Warren E. Buffett

The Preconditions for Investment Success
The following characteristics are what we consider to be important preconditions for investment success. We persistently search the investment management universe to identify managers who possess these attributes. We believe that adherence to these preconditions leads to a higher probability of success.

Limit capacity: We believe that in order for a manager to continue to execute a successful strategy over time, limiting AUM is paramount. When a manager fails to close their strategy at an appropriate level, performance tends to suffer. A bloated asset base often leads to a smaller opportunity set for the fund; a reduction in nimbleness as it relates to the impact of trading in or out of a security; and a less intimate, often weaker partnership with the fund’s client base.

Remain independent and employee-owned: Managers must protect their independence and create a viable succession strategy. We have found that firms with outside ownership have more difficulty limiting capacity. Employee-owned firms can more effectively attract and retain investment talent by using their equity or revenue sharing strength as part of a portfolio manager’s compensation.

Concentration: Build a portfolio of your highest conviction opportunities and know them well. In our view over-diversification increases portfolio risk and destines investors to mediocrity.

“The idea that it’s hard to find good investments, so concentrate on a few, seems to me to be an obviously good idea.”

– Charles T. Munger

Alignment of interests: A portfolio manager who places the majority of their investable assets in the fund they manage is better aligned with investors. There is no better evidence of a manager's level of conviction than their willingness to invest significantly alongside their fellow shareholders.

Formulate a differentiated view: Finding value in investing often means taking a contrarian view of a situation. By not relying on the traditional industry screening methods or sell side research, our managers can distinguish themselves through internally developed, differentiated idea-sourcing and due diligence.

Valuation sensitivity: Only buy when a security is attractively priced. Sell a security that is overpriced. In the absence of compelling ideas, hold cash. Too often managers are compelled to be fully invested, sacrificing strict valuation adherence to eliminate a perceived “cash drag.”

Remain size and sector agnostic: We identify managers who invest where and when they find compelling ideas.

Be selective when partnering with investors: This is a crucial distinction. Patient investment capital is often a critical component in enabling a fund to achieve a successful long term track record. Being able to ride through a particular period of market dislocation without having to sell securities to meet redemptions is perhaps one of the least recognized components of investment success.

Provide access and transparency: By interacting directly with clients and providing ample transparency through reports and letters, our managers tend to create stronger bonds with their investors. By limiting capacity, our managers are better able to provide investors with direct access and a more intimate partnership, which in turn leads to a more stable client base.

Avoid outsourcing investment work to junior analysts: When the investment work is conducted by junior analysts it often leads to the phenomenon of "outsourcing" of ideas. Naturally, this leads to portfolio managers becoming one-step removed from the research process. In our experience this phenomenon is often a precursor to diminishing investment returns.

Resist proliferating product: Each manager should focus on a single strategy; they should not divide their time amongst multiple products.

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If you’re an investment manager that meets these preconditions and would like to submit your strategy for our review, please email information to: tpeters@lyndhurstllc.com.