Please, No More Success Stories

November 25, 2010

Last Saturday’s Globe and Mail featured a story about one Mike Henderson, a retired university professor who has enjoyed staggeringly good returns over the last decade. While chumps who invested in a Canadian index fund settled for a 72% total return over the last ten years, Mr. Henderson shot the lights out with a 305% windfall.

How did he reach investing nirvana? With a “blazingly simple, must-have portfolio” of seven carefully selected stocks. “I basically sat down and thought, what is absolutely essential to our society, and who provides those essentials?” says Mr. Henderson.

I don’t want to take cheap shots at this gentleman, and I don’t begrudge him his investment success. This isn’t personal. But I do think there is a danger in stories like this. The clear implication is that if you just follow the same strategy, you too can beat the market. I’m not buying it.

A keen grasp of the obvious

So many investing success stories begin with the premise that picking winning stocks is just common sense. Big line at the Tim Hortons drive-thru every day? Then it must be a great company. The population is getting older? Buy health-care stocks. Governments pouring trillions into public projects to stimulate the economy? Invest in infrastructure. In the case of Mr. Henderson, it was just a matter of identifying “what is essential to our society.”

The problem here isn’t that these observations are wrong: it’s that they’re glaringly obvious. It’s what Larry Swedroe calls confusing information with knowledge: “Ask yourself: ‘Am I the only one who knows this information?’ If the answer is no, the market has already incorporated that information into prices — and the information can’t be exploited.”

Does Mr. Henderson truly believe that identifying good companies in key economic sectors is a unique insight? Funny how it didn’t occur to the 96.7% of Canadian equity fund managers who failed to beat the market benchmark over the last five years.

Some essentials are non-essential

A solid investment strategy can be clearly defined and consistently applied, and Mr. Henderson’s fails on both counts. The idea described as “blazingly simple” is, in fact, stunningly arbitrary.

Using his “essential” criteria, he decided that modern capitalism runs on pipelines, banks and railroads. Then he loaded up on seven stocks in these sectors: Fortis, Enbridge, TransCanada, TD Bank, RBC, CN Railway and CP Railway.

I’m curious why pipelines made the cut, but not the oil and gas producers that fill those pipes. Why are railroads essential to society, but not cars or airplanes? Why banks, but not insurance companies? And where are the companies that produce our food, build our homes, or make the medicines that save our lives?

The fact is that Mr. Henderson took a hugely concentrated bet on three sectors and he got lucky. His portfolio is hopelessly undiversified, and a serious problem with one or two of his companies would have blown him to bits. To suggest other investors can learn from his “strategy”  is ridiculous. There is no strategy.

“All my stocks were winners except the losers”

All of this would be reason enough to cancel the parade, but it gets better. Near the end of the article we learn that, “The Essentials Portfolio has been the core of Mr. Henderson’s retirement fund for years, but it’s not all he owns.” He’s also had “some success” with income trusts, and he has a “gambling account.”

So Mr. Henderson used his keen insight to identify seven stocks that would go on to beat the market over the next decade. But he also invested in a lot of other stocks that didn’t beat the market. (“Some success” is an investing euphemism for “very little success.”) Of course, we don’t know what those losers were, or what blazingly simple criteria he used to select them. Do you think it’s possible that our market-beating genius is using some selective reporting here?

It’s so easy to be seduced by stories like this. Who wouldn’t want to be profiled in the media as an investment czar who picked all the big winners?  No one wants to read about the guy who is broadly diversified, keeps his costs low, admits that he’s not smarter than the market, and accepts a tracking error of 0.5% — geez, I’m falling asleep just writing this sentence.

Wake me up in 30 years so I can check my portfolio.

{ 21 comments… read them below or add one }

brad November 25, 2010 at 7:17 am

The outliers are always more newsworthy and interesting than the masses who reside in the hump of the bell curve. This kind of story has parallels in a zillion other categories: for example, the guy who “cured” his cancer by meditating and eating kumquats gets written up in the newspaper, while the millions of people who died from cancer despite meditating and eating kumquats get no attention. People read the newspaper story and decide that, if they ever get cancer, they will ignore whatever their doctor advises and instead they will meditate and eat kumquats. A small handful of them will survive and their success stories will be retold.

Anecdotes are powerful because they appeal to our emotions and they concern individual, tangible human beings–people we can relate to and envision in our minds– instead of dry, faceless, and nameless statistics.

These success stories combine the newsworthiness of outliers with the universal appeal of anecdotes. It’s like a drug, and it sells newspapers.

ETF thinkin' November 25, 2010 at 8:08 am

It’s an interesting investment story, I would agree with CCP that it’s “skewed” to show the win and not the losses.

Reminds me of a gambling… Eventually you beat the house and win, but at what did it cost to get there?

Steve November 25, 2010 at 8:43 am

This is such a cheap shot…
Yes, I agree that the average joe can’t beat the market, but there are plenty of people who do by following a disciplined strategy…
BTW – I bet Mr. Henderson had lower costs than all you Index guys with your annual management fees and rebalancing costs…

Money Smarts Blog November 25, 2010 at 9:14 am

Good article. When you wake up in 30 years, make sure you check Henderson’s portfolio as well.

A 10 year return is just not long enough to evaluate an investment strategy. He’s done well in the last 10 years, but he could easily give all the excess gains back over the next 10 years.

Michael James November 25, 2010 at 9:34 am

I don’t see this as much different from reporting on lottery winners. Who wants to hear about the thundering herd of people who are net losers on lotteries?

Canadian Couch Potato November 25, 2010 at 9:36 am

@Steve: I think I was clear that no cheap shots were intended. My point is that holding up lucky investors as examples (note the term “must-have” in the headline) implies that beating the market is easy, when in fact it is extraordinarily difficult. It encourages other investors to follow idiosyncratic and highly risky strategies.

Nothing about his strategy was “disciplined”: he just followed an intuitive hunch.

Calvin November 25, 2010 at 11:41 am

For every success story there are nine fail stories and I doubt if any of those will be making a media appearance any time soon. Besides, I am sure he did not show his personal TD Waterhouse statement (or whatever brokerage he deals with) to the G&M for analysis. It is very easy to make up a rear view story. Often, there is an ulterior motive. e.g TRADE! TRADE! don’t just sit on you investments! Everyone else is making a killing! or they want to sell so they hype the stock in the media beforehand.

It is also easy to get caught up in rationalization. Internet revolution? – buy Nortel! Oil running out? -buy Encana! Getting older? – buy Retirement homes! These strategies almost never pan out. They do make nice bubbles though. I say, BUY GOLD!!

Canadian Capitalist November 25, 2010 at 11:42 am

An US investor with the same idea could have assembled a portfolio consisting of BAC, PFE, GE, MCD, WMT, HD, MSFT. Only two of those stocks beat the index (MCD and WMT). I didn’t have the heart to pick such “essentials” companies as AIG, Intel and Cisco. Any bets on whether we’ll see stories on US investors holding a portfolio of large-cap “essentials”?

Eric November 25, 2010 at 12:06 pm

If you believe XIU is a good broad market index, than his selection is not that bad ( XIU = 30% assets in top 5 holdings, including RY & TD) + dividend yield on cost is certainly more than 5%. It ‘s a hugely concentrated dividend growth investing portfolio, that’s all.

Avrom November 25, 2010 at 2:05 pm

Mr.Henderson was fortunate enough to have bought blue-chip dividend stocks that did very well over the time period, and recovered well from the 2008 crash. Nothing wrong with good quality blue chip dividend stocks, and generating a nice dividend stream on top of that as well :) Those are good stocks that most investors would do well to own (except most of those are now trading at their 52 week highs).

However there are a lot of investors out there loadign up 100% on dividend stocks, and even high yield dividend stocks of over 10%, they are getting exceptional returns at the moment – just like the Summer and Fall of 2008. But at the same time they are playing with a box of matches, and with everyone chasing dividend stocks I wonder if its yet another bubble waiting to pop.

If you want to sleep at night and save yourself the stress, then keep a diversified portfolio. Any investment strategy that tells you to invest 100% in one type of stock, is a high risk investment (even if its blue-chips). Index Investing isn’t going to give you exceptional returns every year, but in the long run you will be the winner.

Brian November 25, 2010 at 3:51 pm

Thanks Dan for this refreshing yet poignant article.

In this months money sense magazine, in the article retirement 100, MS brags about the returns of their dividend stock picking strategy beating the markets. One could argue that this performance is indeed “lucky”, and their “A” picks have no diversification what so ever.

LYLE LYLE CROCODILE November 25, 2010 at 4:44 pm

I believe the gentleman in question said he had over 200 stocks…

Canadian Couch Potato November 25, 2010 at 7:18 pm

@Lyle: The subhead of the online article says, “By picking only seven stocks, a retired professor generated stunning 10-year returns.” It later mentions that these are “not all he owns,” but there is no mention of a number as high as 200.

BadCaleb November 25, 2010 at 11:44 pm

Did Mr. Henderson call it a “must-have portfolio” or was that the author of the article?

FB @ FabulouslyBroke.com November 26, 2010 at 8:59 am

I’d rather have a 72% return with index funds than to take a gamble on just 7 companies.

Then again, he took the risk and got the returns. As high as his returns went, he could have equally lost as much.

Talk about all your eggs in one basket.

sam November 26, 2010 at 11:09 pm

This is the classic example of mass media. Which one of the following would attract more viewers?

1) Learn by the good example: how to win $ in the market? OR
2) Learn by the bad example: how to lose all in the market?

You decide..?!

Jay November 27, 2010 at 1:44 am

Actually, I thought the globe article was interesting. While I think it would be foolish to go out and buy these seven stocks and try to repeat the success, the idea of a concentrated portfolio of winners has been intriguing me for awhile. Note that Buffett has 22% of his portfolio in one stock, KO, and another 20% in WFC. I call that concentration and strong conviction. Mind you, I count 37 stocks among his holdings . The “US Quality” portfolio managed by Jeremy Grantham also has strong weightings in relatively few stocks, and one of the most successful US mutual funds, called the Yacktman Fund, with a CAGR of 12.35% (vs -0.43 for the index) , has a nearly 10% weighting in PEP. Grantham and Yacktman also heavily overweight just a few key sectors. Mr. Henderson also advocates long-term buy and hold investing, advice that many investors today are ignoring, as the average holding period for a stock has declined to just six months! The conclusion I draw is to pick some excellent companies, buy them at a reasonable price, and then hold them forever, ignoring media hype and periodic market downturns.

Balance Junkie November 27, 2010 at 9:56 am

The fact is that this gentleman’s strategy worked for him. It may or may not work as well over the next 10 years, but the same can be said for passive index investing.

Financial Cents November 27, 2010 at 6:50 pm

Although I’m primarily a dividend-investor, I’m with brad, your commenter above, in that “outliers are always more newsworthy and interesting than the masses who reside in the hump of the bell curve.” On that note, I agree with you Dan, there is danger in promoting Mr. Henderson’s approach to the average investor. They will likely lose their shirt.

On the other hand, an investor could do quite well with Mr. Henderson’s seven selections in the long-run, if he/she is VERY disciplined. Unfortunately the article “didn’t go there” enough in my opinion to discuss the risks of his selections. With great upside there could always be tremendous downside (preaching to the converted I know…). I simply wish the article was more forthright about the risks of his strategy; there was not a balance between Mr. Henderson’s risks and his outcomes.

Also, contrary to what Rob wrote, anyone who has a PhD from the London School of Economics, should be considered very much a “financial pro”. That’s like saying you’re not a professional hockey player in the NHL, but you play for a professional team in Europe.

I enjoyed your opinion on this G&M article.

Cheers,
My Own Advisor

Barry November 28, 2010 at 2:13 pm

You’re not rewarded for buying risky assets, you’re rewarded for buying cheap if I may paraphrase Jeremy Grantham. I own 6 of the above 7 in a portfolio of 12 Canadian dividend paying stocks – 11 of which I bought in February/March 2009. Call me lucky but they are rewarding me well. In addition the dividend income credits have brought my taxes to zero.

But don’t think for a minute that this is bullet proof. Its a beautiful ride while it lasts. Some may be recession resistant, or do well in a low interest environment (such as Emera a key cheaply bought asset in my portfolio) but each has its day. Any idea when PWF will raise their dividend? It was once a “sure thing” but not for the next while … I think. And I was once the proud owner of Manulife, a previous core holding in any dividend portfolio and a stellar performer for most of the decade.

As for the 96.7% of fund managers who didn’t beat the index it’s “simply” because they would rather fail conventionally than succeed unconventionally. Read Chapter 12 in Keynes General Theory – a “must have” read for any investor.

James McDowell December 8, 2010 at 8:53 am

Fairly new on this site, but glad to have found it. I’ve come to believe in using the diversified, re-balanced ETF/index fund approach for the core investment, and some more exciting approach – perhaps Mr. Henderson’s for some of us, or in my case, simply finding and tending my “stable” of star fund managers – for the recreational/creative side of the coin (about 1/4 of the total invested, and increasing by growth). The latter also causes me to research, and so to keep up with the field, including what’s happening in the ETF world. My adviser looks after the core, provides advice as well as account space for the star funds, and administers both our joint and my own decisions.

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