Wednesday, June 13, 2012

YOU CAN'T UNDERSTAND WHAT YOU DON'T READ...

I was responsible for handing out a pool of money to several money managers. They all seemed to have pretty consistent performance records (a couple of points plus or minus the yearly averages) and they averaged among them about sixty companies in their portfolios.

Other things being equal, I decided the money would be placed with those money managers who knew, at the least, the basic financial information of the companies they owned.

I want to put this in perspective. Each portfolio manager owned approximately 60 different companies. Each one of these companies issued an annual report and a SEC form called the 10K. In addition, each of these companies issue quarterly reports called the 10Q. Each of the companies issued at least another 15 financial releases of one sort or another throughout the year.

Since the average 10K is over 100 pages and the average 10Q is about 50 pages this means that for each company a portfolio manager, wanting to know about their investments, would read over 400 pages per company per year. Multiply this times 60 times for each company in their portfolio and you would be reading 24,000 pages. On each of these pages there are hundreds of numbers, thousands of words, hundreds of footnotes and confusing accounting explanations.

The SEC, in its great wisdom, along with other regulatory agencies has provided such extensive historical data on companies that practically no one is capable of effectively reading and analyzing the tons of data.

So the question we were going to put to the managers, most of whom ran billions of dollars, ran along the following lines, what are the sales of company, what are their gross margins, how many shares were outstanding along with similar other questions. Over 80% percent of the questions could not be answered by these very skilled money managers.

So what good does all the disclosure do the average investor if most skilled money managers aren't using it? We all know that over time professional money managers don't tend to outperform the major market averages and the value added is more towards portfolio structure and asset allocation. The average and sophisticated investor is not capable of getting any value from the pages of risk disclosure in financial reports.

Money managers cannot effectively use 24,000 pages of annual data. Their brains won't be able to parse the information effectively.

So what's to do. That's for another blog.

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