Monday, February 13, 2006

No Moving Parts

My business colleague is fond of remarking, about the portfolio management business, that it has "no moving parts."

In contrast to many businesses, such as producing automobiles, information feeds, cereal, or broadband capacity, managing an equity portfolio has a very simple operational structure.

Your manufacturing floor is open every day, from 9:30am-4pm. Somebody else pays all, or most, of the expenses associated with operating this facility. There is nearly always inventory to buy, or buyers for your unwanted items. No new "deals" to find every day, week, or even month.

In my view, portfolio management distills business to its essence. Are you capable of demonstrating a facility for adding value over the always-available option of simply buying the S&P500 Index? There are a host of equities from which to choose. And many styles to adopt, or adapt, with which to do so.

But at its heart, the business of managing equity portfolio has "no moving parts." It is the ultimate outsourced business model. True, one must manage the provision of normal business functions- sales, accounting, and finance. Nevertheless, the value-added portion of the business, outperforming the market, is chillingly clear-cut.

When I first developed the research on which my strategy is based, I knew there were only two potential applications. One was to market my knowledge to CEOs and CFOs of larger corporations, as performance improvement tools. The other was to skip trying to convince CEOs that they could do better, and simply select the promising companies which actually exhibited the consistently superior performances on which I focused.

To be honest, I really had hopes for the consulting applications early on. However, I suspect the same mediocrity that results in few consistently superior large-cap companies also accounts for why few CEOs are interested in learning how to improve their company's performances.

In the end, I guess it's better to just buy and sell equities of companies, based upon their ability to perform with consistent superiority, rather than attempt to guide CEOs of companies to achieve this lucrative performance pattern.

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