There is no place like New York for exceptional investment professionals.

Yet with the world’s best and brightest just a cab-ride away, the challenge of building superior investment teams that can endure and outperform is daunting and seldom achieved.

Consistent, multi-decade superiority isn’t impossible, but it’s exceedingly rare, and many redoubtable firms have just vanished.

There are a very few, semi-mythical beasts like David F. Swensen and Warren Buffett, of course.

Swensen built a process for identifying superior outside managers, cementing relationships, and staying with them as long as they are judged to have the edge.  He was also an innovator with first-mover advantage in many respects which can’t be replicated.

One of my professors at The University of Chicago once remarked that some money managers seem to have the touch.  And we can theorize, not always correctly, about how they do it.  But most of them have a run bracketed by a certain period or a set of conditions, and then they are gone.

Why is this?

Paul Wachter, the outgoing investment chair of the University of California Regents, was recently asked by Leanna Orr, in an interview for CIO Magazine, about the criteria used by the UC regents during their search in 2014 for a chief investment officer. 

Mr. Wachter listed three principal qualities the UC board looked for in a candidate.

Number one: Organizational skills.  Someone with serious organizational skills, who could work effectively with a big institution like the UC system.

Number two: Personality.  Someone with the personality to work constructively with all of those different constituents, from the board and president to student groups

Number three: Investment skill. 

But he added a caveat to number three.

Mr. Wachter said, “what you can’t tell in an interview is how good of an investor someone is.  If you look at their track record in their previous position, you’re seeing the product of an entire giant institution.”

See: http://www.ai-cio.com/channel/RISK-MANAGEMENT/U–California-s-Chair-on-How-to-Hire-a-Great-CIO/

As regular readers of The Skorina Letter have probably noticed, we spend a great deal of time analyzing and comparing the investment performance and pay of chief executives and chief investment officers.  We look for top managers and investors and the data to support our recommendations.

But, as Mr. Wachter points out, identifying a superior investment leader is not that simple.

Why?

In a general, philosophical, way; I am convinced – after forty years in the investment business on Wall Street and as an executive recruiter – that investment success involves as much luck as skill.

I would put it this way.  Playing roulette (or the lottery) is a pure game of chance.  There’s no skill involved whatsoever.  And even if you have a good day at the wheel, it doesn’t mean that you’ve become a skillful player, or that you’re magically “hot.”

Chess, on the other hand, is mostly a game of skill.  You may have a headache on the day of the big match, or get seeded against a too-strong opponent, but it’s at least 99 percent skill over the long run.

Somewhere in between is a game like poker.  There’s a lot of randomness in poker.  You may be dealt a good or bad hand.  You can even be dealt an unreasonably long string of good or bad hands.

But there’s also a strong element of skill, experience, and mathematical reasoning.  Over the long run good players will generally beat bad players.  And that’s why experienced, professional investors usually do better than amateurs.

However, when professional poker players play other professionals the picture changes again.  They’re all pretty smart; they can all do the math; they’re all pretty good at profiling their opponents and predicting their behavior.

Even if you are a slightly better player than your opponent on a lifetime basis, you may be dealt some really lousy hands on a given day or in a given tournament.  Or, in the case of endowment and foundation CIOs, bequeathed a subpar portfolio by your predecessor.

Looking at investment performance as a statistical distribution with a large element of randomness leads to an interesting conclusion, as several writers have pointed out.  Most people will be clustered near the mean, with approximately average success, because that’s just the way the math works.  But there will always be a small number of investors in the tails of the distribution who experience a ridiculously long run of success or failure.

Some of those winners and losers will be obscure people no one will ever hear of.  But a very few will be well-known.  Maybe people like Buffet or Swensen who are known to be smart and hard-working.

It’s also interesting that both Buffet and Swensen have written extensively and publicly about their investment philosophy.  Swensen soaked up modern portfolio theory as it rolled out and was early to apply it to an endowment.  His book Pioneering Portfolio Management laid it all out and he was at the leading edge in the 70s and 80s.

Swensen’s mentor and PhD thesis advisor at Yale was James Tobin who won the Nobel Prize and was a key figure in developing modern portfolio theory. 

And, as everyone knows, Buffet studied under Benjamin Graham at Columbia.  Graham and Dodd’s Security Analysis is his Bible and he frequently alludes to it and uses its terminology.  He even named his son Howard Graham Buffet.

So, in each case we have a manual for Buffetism or Swensenology.  And those rigorous intellectual platforms made a lot of sense.

But thousands of people studied under Graham and read his book.  And many people studied under Tobin and read his papers and those of the other MPT pioneers.  It was all public knowledge.

So, if their basic strategies are well-known, why doesn’t everyone do as well as Buffet or Swensen?  Does it all come down to some extraordinary ability to identify opportunities and investment talent?  Or organizational skills and execution?

Howard Marks, chairman of Oaktree Capital Management, and a University of Chicago and U Penn alum, refers to this quality as “Second-Level Thinking” and he put it this way in his September 9, 2015 memo titled “It’s Not Easy”. 

Remember your goal in investing isn’t to earn average returns; you want to do better than average. Thus your thinking has to be better than that of others – both more powerful and at a higher level. Since others may be smart, well-informed and highly computerized, you must find an edge they don’t have. You must think of something they haven’t thought of, see things they miss, or bring insight they don’t possess. You have to react differently and behave differently. In short, being right may be a necessary condition for investment success, but it won’t be sufficient. You must be more right than others . . . which by definition means your thinking has to be different.

See: https://www.oaktreecapital.com/docs/default-source/memos/2015-09-09-its-not-easy.pdf?sfvrsn=2

The challenges we face as recruiters are: can great investors build great investment staffs and firms?  Does this different thinking lend itself to executive and managerial excellence?  And, how can we identify these qualities in candidates?

In the end, the justification for hiring the best available investment talent may simply come down to our example of professional poker players playing against each other.  Who do you want playing your hand for you at a table full of pros?  An amateur or a professional? 

Postscript:  I sent a draft of this article to a prominent chief investment officer I know.  His comments are below.

I would agree with Mr. Wachter that the ability to work with the various stakeholders and constituents is essential; and, of course, with your ultimate conclusion. He and you make a good point about track records, their statistical validity and luck. A senior mentor of mine told me: you may do all the right things at […..], make all the right decisions, and yet be unlucky; it goes with the job.