e-fundresearch: Which benchmark do you adhere to?
Riley: My goal is to achieve returns in excess of the S&P 500 with a lower level of volatility. And my strategy has worked so far. Over the ten years ended June 2010, we achieved an annualized alpha of 3.03% on a beta of 0,83. Risk, as measuured by standard deviation, was also better than the general market: The quarterly standard deviation of our clients was 15,63% versus 18,03% for the S&P. For detailed information and disclaimer, please see the fund-flyer.
e-fundresearch: Are you also responsible for other funds at the moment?
Riley: This is the only mutual fund I manage, but I also manage separate accounts for clients of the firm that want an account directly in the U.S.
e-fundresearch: Regarding the performance: which performance did you achieve since the beginning of the year and in the years 2003-2008? Absolutely and relatively to the relevant benchmark?
Riley: Even after deducting all fees and transaction costs, our clients experienced a cumulative return of 36.7% between 2003 and 2008, versus a return of 15.2% for the S&P 500, which includes dividends. And in 2009 the fund did very well with a return of 27.61%, versus 26.45% for the index. As of July 31, 2010, the year-to-date return for the fund has lagged the index by a measure of -2.92%, versus -0.11%.
e-fundresearch: How content are you with your own performance in the last years and this year?
Riley: Over the past 10 years, the volatility of returns, as measured by standard deviation, has been only 15.5%, compared to 18.0% for the S&P 500. Considering the outperformance of returns, plus the success we’ve had at controlling risk, I have been fairly satisfied with the results. However, I have been less than satisfied this year. We’ve had a couple unpleasant investment surprises in both the Energy and Technology sectors, and I generally under estimated the strong rebound in consumer discretionary stocks. But, thanks to our efforts at proper diversification, and tactics such as our limiting exposure to any one position at less than about 6% of the total portfolio, the effects of most errors are reasonably limited.
e-fundresearch: How are you able to deliver added value for your investors with your performance?
Riley: A key element to our philosophy is that the world is in a constant state of flux, but also that each point in time has its own unique qualities. I very much am a data driven portfolio manager, and I run a wide variety of quantitative models that are used to measure variables at the macro level, and on down to the micro level such as models used to estimate gross profit margins or individual company research and development expenditures. Nonetheless, quantitative models have limitations because the relationship between variables is unstable over time. I think you can draw an analogy to the medical field where a doctor can look at three cases of cardiovascular disease, and in each case the elements involved—age, weight, family history, lifestyle habits—are significant in some cases but not others. Each case has to be examined on its own merits with fresh thinking. We are trying to add value for our clients by using the structure of quantitative methods, but adding to it an overlay of qualitative analysis that helps us see the individual circumstances before us.
e-fundresearch: How long have you been a fund manager already?
Riley: I started as an equity analyst after I completed my undergraduate university degree in 1983, and I became a portfolio manager in 1991.
e-fundresearch: What were your biggest successes and your biggest disappointments in your career as fund manager?
Riley: My two biggest successes were anticipating the collapse of the technology bubble in 2000, at which time I sharply reduced my client exposure to the tech sector, and in anticipating the collapse of the housing bubble in 2007, at which time I eliminated client exposure to real estate equities and very sharply reduced the exposure to financial stocks. My biggest disappointment was my failure in 1998 to quickly recognize the rush into technology and the bullish case for a handful of very large capitalization stocks which I did not own.
e-fundresearch: What kind of capital market situation do we have at the moment? How do you act in this environment?
Riley: Capital markets are currently dominated by fear. After the trauma that occurred to the markets following the failure of Lehman Brothers, people now care little about earning returns on their capital. Capital preservation is the dominant theme and risky assets like equities are in little demand. The beauty of this environment is that it is easy to purchase shares in very high quality businesses at very attractive prices. Andrew Carnegie built his steel empire in the 19th century by buying out his weaker competitors during the steep downturns in business. When others trembled, he acted. From our perspective, now is a great opportunity to gradually accumulate a broad portfolio of high quality equities in anticipation for what we believe will be the inevitable rebound in confidence and prices.
e-fundresearch: What are the special challenges in this environment?
Riley: The greatest challenge in this environment is to divorce your emotions from the investment decision process. It is a natural response for us to feel unhappy and grow fearful when we see asset prices decline. The trick is to let your reasoning process to override your fears: Recessions and Bear Markets are normal and will always be with us. But they are inevitably followed by business expansion and all means of human progress. So the greatest challenge always is to buy equities when you are most afraid, and sell when you are most delighted.
e-fundresearch: What objectives do you have till the end of the year and in the mid term for the upcoming 3 to 5 years?
Riley: I am Bullish. In the months ahead, volatility is likely to be high with stunning spikes upward, and sudden and frightening falls afterward. Washing out all the jagged moves, I expect equities to return a respectable 8%-to-10% over the next year or so and easily out perform fixed income securities. Looking further down the road looks even better. Human history entered an important epoch during the last quarter century because of the fall of Communism and the movement of China into the realm of global capital markets. We are now working our way through a period of financial turbulence, but business opportunities and the potential for profit is expanding in ways that could not be imagined a generation or two ago.
e-fundresearch: Do you model yourself on someone? Any ideals?
Riley: There have been many great minds that have influenced my own thinking including Andrew Carnegie, Friedrich von Hayek, Milton Friedman and Benjamin Graham.
e-fundresearch: What motivates you in your job?
Riley: Being a portfolio manager is a great challenge because you are always objectively measured by the returns earned by your clients. But I find that motivating. It’s like playing sports because you know each day if you are winning or loosing and it emboldens you to work harder and smarter.
e-fundresearch: What else do you want to achieve or do you have any further aims as a fund manager?
Riley: My aim as a portfolio manager is to grow in knowledge and make fewer mistakes.
e-fundresearch: What other profession would you have taken interest in, apart from becoming a fund manager?
Riley: When I was quite young I wanted to be a psychologist. I often think about that in my current job because in a significant way being a portfolio manager requires one to analyze the human mind as much as the corporate balance sheet.
e-fundresearch: Thank you for the interview!