Thursday, March 16, 2006

Acceptance of Limits

Jesse Eisinger, of the Wall Street Journal's "Money & Investing" section, wrote a piece this week concerning how investors might see warning sign's of a company's demise before the management of the same company could.

Within the article, a fund manager is reported to have had a large position in one firm, Lear, a maker of automobile seats and interiors. The manager attempted to urge the management to take some specific actions regarding debt refinancing, which the firm's management evidently chose not to heed.

It appears that one of Mr. Eisinger's favorite topics is to cast institutional investors, such as the fund whose manager he quoted in his article, as frustrated, well-intentioned would-be saviors of incompetently managed firms across the US.

What is it about liquid markets and capitalism Mr. Eisinger and his favorite sources don't get? In my equity portfolio strategy, I select companies whose management I trust. Managements that have a clear track record of unambiguously superior fundamental and technical performance. Why on earth would I want to tell them how to run the company?

More to the point, why would any fund manager buy shares of a firm, hoping to persuade the management to do things differently? Doesn't that strike you as a rather low-probability, indirect and usually futile way to make money for retail investors? Counting on human behavior changing that easily seems to me to be a sure-fire recipe for disappointment.

Fund managers may occasionally win these battles. But it often becomes a private equity play, or, similarly, as in the case of Sears Holdings and Ed Lampert, a case of the fund manager buying the company for a public fund. Thus, his job changes, he owns the problem, and has foregone the benefit of market liquidity.

However, it seems to me that this is needless concentration of investor assets. And a lack of acknowledgement of the practical limits of being an institutional investor. One of the greatest benefits for a modern institutional investor is market liquidity. When a management no longer has the investor's confidence, it is relatively inexpensive and simple to sell the position and buy a more promising company's shares.

Why would any fund manager wish to complicate the already difficult job of out-performing the market by also trying to manage individual companies in his portfolio? And why does Jesse Esinger continue to write about those that do?

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