The market has become inundated with amateur investors. New investors attempting to enter the marketplace
as day traders, remind me of 5-year olds left alone in a candy shop, free to eat everything in sight without
regard to future consequences. These "5-year olds" may receive immediate gratification, but have no idea of
possible future negative consequences. Similarly, the inexperienced analysts who have been attracted to the
securities industry by the latest bull market, have continued waving their pom-poms and cheering on the "5-year
old" inexperienced investors by adding more and more candy with little concern for the dangers that may lurk in
the future. I believe cash flow and basic research have been abandoned, with scant attention paid to the
quarterly earnings being manipulated by many company managers to satisfy many Wall Street analysts and
amateur investors seeking immediate gratification. The good news is that this type of behavior may be setting
up tremendous opportunities for the Fund. We react against the excessive thinking of the general public and
buy good companies that are being abandoned by investors fighting to get into the candy store. Patience is
required, as the price to be paid for taking advantage of these excesses is volatility and, at times,
underperformance.
We hope that the Fund?s shareholders understand that commitment to a long-term strategy should not be
derailed by short-term results. Unfortunately, we cannot escape periods of disappointment over a 3 to 5-year
time horizon when implementing the Fund?s eclectic value philosophy. We react to stock prices created during
periods of investor pessimism. For example, beginning in April of 1998 and culminating in October of 1998
some of the Fund?s assets were employed by purchasing oil service companies and semiconductor-related
companies. Investors abandoned these stocks in droves as an overreaction to the Asian and Latin American
crises. We agreed that the short-term economic outlook for oil and semiconductors was bleak, but we believed
we were being compensated for the pessimism through the prices we were paying for these stocks. As is
typical, when one purchases out of favor companies, the negativity surrounding them may go further and last
longer than predicted. However, to counteract the short-term pessimism and give us the patience that is
required for our values to potentially be recognized, we buy companies that generate excess cash flow, employ
realistic accounting practices, and have the financial ability to weather a storm. In our opinion, oil is not
disappearing, and semiconductors are vital components in the computer/Internet revolution, even though
short-term pricing and demand may have been bleak. We stuck to our discipline, despite short-term
underperformance (6 months) and were richly rewarded for our patience. We cannot be right all the time and
the attempt to accomplish this feat would probably cause us to be wrong over time.
An example of why one must keep a 3 to 5-year investment horizon follows: A shareholder visited our offices in
March of 1998. He was retiring and was seeking to invest a good portion of his IRA in the Fund. At the time, the
Fund had appreciated approximately 15% in the first quarter of 1998, and approximately 100% cumulatively in
the prior 2-1/2 years. As always, Erik Olstein (VP of marketing) sought to inject realism into the potential
investor?s expectations, counseling the shareholder that he should not expect similar performance in the future.
Erik explained to him that we employ a defense first philosophy, should only be judged over 3 to 5-year
periods, and that periods of jubilation could be followed by periods of temporary disappointment. Unfortunately,
nobody can time these periods precisely, and short-term performance in the Fund was basically random. The
shareholder acknowledged our warnings and proceeded to make a significant investment at the Fund?s then
all-time peak price. Approximately 6-months later, Erik received a call from the shareholder, who was now
down approximately 20%, expressing his disappointment with our short-term performance. Erik again
counseled the shareholder regarding the Fund?s 3 to 5- year orientation, and that we do not have the ability to
control short-term volatility in today?s markets. By January of 1999, as our values were again beginning to be
recognized, the shareholder?s capital was restored in its entirety (in fact, the shareholder was up approximately
3%). While the shareholder was happy to have his capital restored, he expressed mild disappointment that the
large-cap growth funds had exceeded our return by a material percentage over the past year. The shareholder
was again counseled as to the Fund?s 3 to 5-year philosophy. Erik said that we do not take the concentrated
risk to be number one, but rather our goal was to exceed the return of US Treasury securities by 50% or more
over a 3 to 5-year period. Erik reminded the shareholder that he had only been with the Fund for 10-months. By
April of 1999 oil prices were making a comeback, semiconductors were again in demand, and the Fund?s
portfolio was going through a period of value recognition. Now, the shareholder who had been invested in the
Fund for a year, was up about 20%. One day in April of 1999, this same shareholder called once again and
stated that he had decided to increase his investment in the Fund. Although past performance is no guarantee
of future results, investment decisions should not be based solely on an investment manager?s short-term
performance record.
The facts are that we were never that bad when the Fund dropped far greater than we had ever expected
between March and September of 1998. We were also not as good as when the Fund made a rapid 60%
comeback between October 1998 and April 1999 as the negative psychology lifted, and many of the Fund?s
value stocks sprinted to what we believed were realistic prices. Momentum players trading in the market may
have given the appearance that the Fund was volatile. If the measurement period had been 1-year rather than
6-months, there would have appeared to be less volatility. In our opinion, short-term performance is never a
reason to select a Fund. The characteristics that we believe are the most important when selecting a fund
include:
A clearly articulated investment philosophy that one believes is sound
An appropriate investment objective combined with a risk profile that one can tolerate
Independent thinking and unencumbered decision making within the investment manager?s organization
Personal discipline to follow the articulated philosophy when it is temporarily out of favor
Flexibility, or the ability to reverse wrong decisions, as new information evolves regardless of whether or
not the original conclusion was wrong
Above average 3 to 5- year returns
A passion for the business
Although heavily biased, we believe that we possess each one of these attributes.
olsteinfunds.com |
