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Patrick Hodgens, Managing Director & Portfolio Manager & Kyle Macintyre, Investment Specialist

At Firetrail, we believe that high quality, high conviction investment managers can outperform the index over the medium to long-term. Over the short-term however, even an investor with perfect foresight will have periods of underperformance.

In the article below, we explain the findings from an experiment we conducted to assess the risk and return profile of a high conviction stock picker with perfect foresight. The amazing excess returns generated over the long-term may not surprise you. What might surprise you, is the conviction and long-term thinking required to stay the course and reap the rewards from our ‘perfect stock picker’.

The Warren Experiment: Designing the ‘perfect stock picker’  

For our experiment, we wanted to assess the performance of a perfect high conviction stock picker over the short, medium and long term. To be clear, in order to conduct this experiment our ‘perfect stock picker’ is required to have perfect foresight. That is, they know which stocks will win prior to investing. For fun, we named our perfect stock picker Warren, after one of the greatest stock pickers of our time, Warren Buffet.

For the Warren Experiment, we selected parameters that reflect the Firetrail high conviction investment strategy and style. The key inputs for Warren’s portfolio are summarised below:

  1. Investment universe and benchmark: S&P/ASX 200 Accumulation Index
  2. # of positions held: The top 20 performing stocks in the universe over the period, equally weighted at the beginning of the period
  3. Holding period/rebalance: 3-years, to reflect our own medium-term forecasting and holding period
  4. Time period: 31st December 2000 to 31st December 2018

How did Warren’s portfolio perform over the long-term?  

The long-term results of Warren’s stock selection are unsurprisingly impressive. As the table below highlights, Warren generated 32.8% per annum above the Benchmark over the 18-year period. If you had invested just $10,000 in Warren’s high conviction portfolio, you would have over $4.5m at the end of the experiment. If you invested the same amount in the market, which still provided a solid return of 7.7% per annum over the same period, your investment would be worth $38,000. Due to the power of compounding, excess returns can have a significant impact on return outcomes for investors over the long-term.

The Warren Experiment: Return Statistics

Source: Firetrail Research

Of course, Warren has perfect foresight in our experiment and the portfolio returns are theoretical. So, the incredible performance result is to be expected. In reality, the risk required to generate the above returns would make Warren’s strategy ‘uninvestable’ for the typical investor.

The Warren Experiment: Risk Characteristics

Source: Firetrail Research

The table above highlights the Risk Characteristics of Warren’s portfolio. To put this into context, an average high conviction manager would expect to have a Tracking Error of 3% to 5%. Under normal conditions, the investor would expect to out/underperform the Benchmark by approximately the same range of 3-5% p.a. over the long-term. Warren’s portfolio had a Tracking Error almost 3 times the average high conviction manager. The Portfolio Volatility is also higher than the market. Whilst the theoretical returns in the Warren Experiment are high, so is the active risk taken to achieve those returns.

Long-term vs short-term performance  

To outperform the Index, your portfolio needs to be different to the Index. High conviction investors typically differentiate their portfolios through:

  1. Portfolio concentration: Typically investing in 20 to 40 of their best ideas
  2. Position sizing: Position sizing generally reflects the conviction the investor has in the underlying stock. Higher conviction = larger position size
  3. Risk management: Which differs among investors. Our approach aims for the risk and returns of the portfolio to be driven predominantly by stock selection, where we believe we have an edge (as opposed to macroeconomic factors which we believe are largely binary and unpredictable)

Due to the differences in a high conviction portfolio’s positioning, the performance outcomes can vary significantly from the Index and the average investor. Put simply, if a high conviction investor gets more stock calls right than wrong, they will outperform. Conversely, if they get more stock calls wrong than right, then they will underperform.

In our view, a high quality, high conviction investor should get 60% or more of their stock calls right over the medium to long-term. After all, even Warren Buffet (arguably one of the greatest investors in our history), doesn’t get every stock call right. But an investor who gets 60% or more of their stock calls right should generate meaningful outperformance over the long-term.

However, in the short-term, even an investor with perfect foresight will experience performance volatility. The below chart highlights the significant drawdowns experienced by Warren in our perfect stock picker experiment over multiple short-term periods. Despite getting 100% of stock calls right over the medium-term, Warren experienced 17 significant short-term underperformance periods of 5% or more under the Benchmark.

The Warren Experiment: Short-term underperformance of 5% or more below the Benchmark

Source: Firetrail Research

The largest drawdown Warren experienced was 26% below the Benchmark between June 2008 to October 2008. This drawdown took almost 2 years to recover and raises the question as to whether Warren would have survived as an investment manager post the GFC?

The second largest drawdown was over 12% and occurred during the December quarter of 2018, a period where many active Australian equity managers including Firetrail underperformed. Interestingly, despite the underperformance, Warren’s theoretical portfolio still delivered 45.3% pa over the 3 years to 31 December 2018, 38.6% pa above the Benchmark return over the same period. An impressive result if you were able to maintain conviction and stay the course.

Conclusion: High conviction investing requires a long-term mindset  

Finding a high conviction manager that can deliver excess returns can have a material impact on your returns over the long-term. However, a high conviction approach is not for everyone. It requires a long-term mindset and a belief that your investment manager will get more of their stock calls right than wrong over the medium to long-term.

As our Warren Experiment shows, even an investor with perfect foresight will experience short-term periods of underperformance. These periods of short-term underperformance are painful for investors and investment managers alike. In our experience, high conviction investors that maintain conviction, stay true to their approach and focus on the longer-term will be rewarded over time.

If you would like more information including presentation slides, charts or underlying data from the Warren Experiment for use with your clients, please contact us at


Firetrail Investments Pty Limited ABN 98 622 377 913 (‘Firetrail’), Corporate Authorised Representative (No. 1261372) of Pinnacle Investment Management Limited ABN 66 109 659 109 AFSL 322140.

Any opinions or forecasts reflect the judgment and assumptions of Firetrail and its representatives on the basis of information at the date of publication and may later change without notice. Any projections contained in this article are estimates only and may not be realised in the future. The information is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This communication is for general information only. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice relevant to their particular circumstances, needs and investment objectives. Past performance is not a reliable indicator of future performance.

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