15. THE CULT OF PERFORMANCE

If you listen either to Successful Operator, eaves-dropping on the great Keane, or to Odd-Lot Robert, eavesdropping on the sister’s friend from City Hall, you will notice one attitude in common: There is a They out there in the market. They, says Successful Operator in 1881, are about to pull another Bear Raid on the Erie; They, says Odd-Lot Robert, are about to split the stock.

Who are They? Well, They are the people who move stocks. They get the information first, maybe They even create the information, and They are about to put the stock up or down. They are mysterious, anonymous, powerful, and They know everything. Nothing fazes Them. They are the powers of the marketplace.

Is there really a They? Only a few years ago, such a question would have been greeted with hoots of laughter. Sure, the answer would have been, there was a They in the days of the great Keane, when you had to stay out of the way of J.P. Morgan and James J. Hill, because when the elephants fought, the grass was trampled. Sure, there was a They in the twenties, when if you didn’t know what Joe Kennedy and Mike Meehan were up to, you had better stay away from Radio lest they move the Pool right over you. But now we have full disclosure, the Securities and Exchange Commission, the Justice Department, the Internal Revenue Service, regulations, examinations of books by Peat Marwick and Haskins & Sells, Investigate Before You Invest, Merrill Lynch offices on every street corner, and twenty-six million investors. Reforms have reformed. They have gone away.

Have They? Well, They, in the sense of Joe Kennedy and Mike Meehan and James J. Hill, have indeed gone away; the market is too broad. Even Charley Allen is not what J.P. Morgan was in 1907. So there is no They, it is all a myth?

No, Virginia, there is still a They, which may come as a surprise. They do get information first, They do have the ability to move stocks, and it helps a lot if you know what They are doing.

There is a difference. There are few tycoons these days; most corporations are run by managers for thousands of shareholders, the managerial revolution, the New Industrial State, all that. The same thing has happened in the investment business. The tycoons have been replaced by managers, the managers of what are called Institutions: mutual funds, pension funds, insurance companies.

For years, it didn’t really matter that the managers had taken over. The portfolio was not yet an Instrument of Personality. The Portfolio Manager was instructed to leave speculation to the speculators; he was participating in the Long-Term Growth of the American Economy. His portfolio had two hundred stocks, and they were the two hundred biggest companies in America. The two hundred stocks were only two thirds of the portfolio; the other third was bonds. The portfolio manager’s charter came from an ancient case, Amory vs. Harvard College, 1831, which ruled that a fiduciary act “as would any Prudent Man.” To be a Prudent Man, one preserved capital, one was conservative, one ate breakfast, lunched at the Club, and died with an estate that won the admiration of the lawyers for its order and efficiency. The Prudent Man managing securities did his business with his classmates who happened to be brokers, and in a radical move he might reduce Steels from 3.3 percent to 2.9 percent of the portfolio, and buy a little more Telephone.

Then a couple of things happened. One was that a new group of managers came along. You remember—there is a Missing Generation on Wall Street because nobody went there from 1929 to 1947. The generation that came in during the twenties is now in its sixties and seventies; the next generation is in its thirties or early forties. The difference in the attitudes of the generations is even greater than the usual fracas between fathers and sons. To the elder generation, the Depression of the thirties was a profound, traumatic experience. Stocks crashed in 1929, but that was not the worst. They rallied in 1930, and then started a steady erosion that scarred for life anyone who experienced it. United States Steel, which sold at 262 on September 3, 1929, drifted down to 22. General Motors slipped to 8 from 73. Montgomery Ward went from 138 to 4. It was even worse for the investment trusts. United Founders dropped from seventy dollars to fifty cents. American Founders made it to fifty cents from $117.

It is a sobering experience to read through—as once I did—all the Wall Street Journals and Barron’s from 1929 to 1933. Quarterly, reports came out saying, “the outlook is favorable,” “a sustained recovery is on its way,” and so on. But nobody was listening. Those on margin had been sold out in 1929 and 1930. But from 1930 to 1933, a real blight of the spirit took place. The Prudent Men, not on margin, believing in the Long-Term Growth of the American Economy, saw their unmargined holdings in the bluest of American blue chips drop by 80 to 90 percent. Professor Irving Fisher of Yale, who had immortalized himself by stating, on October 17, 1929, that “Stocks have reached what looks like a permanently high plateau,” had to move the plateau down 90 percent and join the ranks of Gustave Le Bon. “It was the psychology of panic,” he explained. “It was mob psychology, and it was not, primarily, that the price level of the market was unsoundly high.… the fall in the market was very largely due to the psychology by which it went down because it went down.”

The senior generation—those who hung on—lived not only to see better days but to see real prosperity. But for most of them, the shadow of Deflation hung always over one shoulder; there was always a chance that it might happen again, and this feeling, even unconscious, took a lot of conscious effort to overcome.

To the next generation the Depression was only a dim memory, and Inflation was much more visible: The haircuts that once cost fifty cents cost seventy-five cents and then one dollar and then two. The next generation also arrived at positions of responsibility without the thirty-year apprenticeship that can bank the fires of the most ambitious. So there was the new generation, itching to shake things up because the old boys had been in the wrong game for twenty years.

Simultaneously, discretionary income—what is left after the essentials for food, clothing, and shelter are taken out of the paycheck—began to burgeon. Middle-class savings turned into a torrent of money. Investments in mutual funds went from $1.3 billion in 1946 to $35 billion in 1967. Pension funds increased in size to $150 billion.

And then one day there was a pool of money $400 billion strong accounting for half the business done on the New York Stock Exchange, and run by a group of tigers who knew they were right just because the old boys had been so wrong. The stage was all set for “performance.”

“Performance” is just what it sounds like. It means your fund has performed better than all the other funds. Its net asset value went up a greater percentage. In other words, all the stocks of your fund went up more.

Now, as we have seen previously, the great mature American companies do not consistently offer the greatest possibilities for capital gains. So the “performance” fund managers moved out of the two hundred biggest companies into, quite simply, stocks that would go up. They bought the growth stocks, the senior sisters like IBM, Polaroid, and Xerox, though they were not so senior in those days because they had not yet gone up the last 1000 percent.

Not only did the “performance” fund managers buy the growth stocks—they traded them. Trading was not for the Prudent Man; the short-term fluctuations in the market were not for him. The “performance” fund managers figured the safest way to preserve capital was to double it.

Up until a very few years ago, you were safe as a fund manager if you bought the great blue chips, Alcoa and Union Carbide, Telephone and Texaco. You couldn’t be criticized even if they performed badly, because that would be like criticizing the United States of America. If you bought Polaroid at sixty times earnings, however, you could very well be criticized unless Polaroid went up from there. And if you bought it at 40 and sold it at 70 and bought it back at 55 to sell it at 90, trying to catch the swings, you had really better be right.

A couple of funds and a couple of managers turned out to be very right. Then the salesmen of mutual funds noticed that when they spread the literature from all the funds before prospective customers, a lot of the customers weren’t interested in nice, balanced, diversified funds any more. They wanted the funds that had gone up the most, on the idea that those were the funds that would keep going up the most. So the assets of the Dreyfus Fund and Fidelity Capital and Fidelity Trend grew by the hundreds of millions of dollars, and all the salesmen everywhere called up the mutual-fund management companies and said, “give us more of these funds that perform like Fidelity.” Thus was performance born, out of distrust for fixed income, out of suspicion of the erosion of the dollar, out of the capital gains available from the companies that had some sort of lock on something, technological or otherwise.

You can almost see the point in time when “performance” surfaced. In February, 1966, Gerry Tsai, born in Shanghai and tutored at Fidelity, came to New York. He had been running Fidelity Capital. He had a reputation as a shrewd trader, and he was doing well, but, as he told Mister Johnson, “I want to have a little fund of my own.” Gerry thought maybe he could raise $25 million, and so did the underwriters, Bache & Co. But the spirit was abroad in the land. The orders went over $50 million to $100 million, finally to $274 million on the first day, and within a year to more than $400 million. Gerry Tsai was not the first “performance” manager; Mister Johnson and Jack Dreyfus had pioneered that well. But he was the first real “star.” Joe Namath may not have been the best quarterback in a decade, but the idea that Sonny Werblen had paid $400,000 for a quarterback gave a new dimension to a pro football league because nobody had ever paid that much for a quarterback. So Gerry Tsai became a part of They, and men could sound wise by watching the tape and saying, “Ah, Gerry is buying again.”

Once the tide of “performance” started, there was no stopping. More fund managements started aggressive, capital-gains-oriented funds. The officials responsible for pension funds thought they could use a little growth in those funds, instead of sticking to bonds all the time. The University of Rochester and Wesleyan University turned small investments into sizable endowments by aggressive investing, and pretty soon the trustees of other universities were coming into the great trust companies which handled their endowments and saying, “Rochester has come from nowhere to the fifth-richest university, and Wesleyan is building new buildings all over the place, and they did it with Xerox, find us another Xerox.” McGeorge Bundy, head of the Ford Foundation, said, in a blast that is still echoing:

It is far from clear that trustees have reason to be proud of their performance in making money for their colleges. We recognize the risks of unconventional investing, but the true test of performance in the handling of money is the record of achievement, not the opinion of the respectable. We have the preliminary impression that over the long run caution has cost our colleges and universities much more than imprudence or excessive risk-taking.

That shook everyone up so much that they forgot Mc-George Bundy’s foundation had one of the doggier records around.

What is it “performance” fund managers do? No one ever schooled “performance,” so there are no tenets, only what has grown up pragmatically. The characteristics of performance are concentration and turnover. By concentration, as I said before, I mean limiting the number of issues. Limiting the number of issues means that attention is focused sharply on them, and the ones that do not perform well virtually beg to be dropped off. If you have two hundred stocks, no one of them can make a real difference to you, but if you have only six stocks, you are really going to be watching all six. Furthermore, you are going to be scouting for the best six ideas, because if you find a really good one it may bump one of your other ones off the list. Turnover means how long you hold the stocks. If you buy stocks and put them away, your turnover is 0. If on December 31 you have replaced all the stocks you had the previous January with other stocks, your turnover is 100 percent. It used to be that a bank trust department would have a turnover of 2 percent or so and a mutual fund might turn over at 10 percent. Now the bank trust departments are turning over at 10 percent and the aggressive funds are turning over at more than 100 percent. All that turnover has doubled the volume in the last couple of years, and the brokers are getting very rich.

You can see that if the “performance” fund managers like a stock, and it is not a great, broadly traded stock, that stock is going to go up. And if they own it and something turns sour, there can be a stampede for the exits. There were some remarkable examples of this in 1966, when Fairchild camera, up from 28 to 220 in a year, dropped 100 points in six weeks. With all that concentration, the time horizon shortens considerably. If the report for the next quarter is going to be disappointing, you are going to try to beat the other managers out of the stock, perhaps to buy back in some other day.

So there derives a great hunger for short-term information. Add to this the “technical” and computer work of Albert and Irwin, which flags every movement, and you can get a very volatile and nervous group of stocks, if not an entire stock market. It all began to bug William Mc-Chesney Martin, the head of the Federal Reserve, last year. He made some headlines with this statement:

Increasingly, managers of mutual funds, and portfolio and pension fund administrators, are measuring their success in terms of relatively short-term market performance. In effect, they set a target on a growth stock, attain that target, unload, and then seek other opportunities. Given the large buying power of their institutions, there is an obvious risk that speculative in-and-out trading of this type may virtually corner the market in individual stocks.… however laudable the intent may be, it seems to me that practices of this nature contain poisonous qualities reminiscent in some respects of the old pool operations of the 1920s.

All you have to do is say “the 1920s” and people get nervous, because everybody can remember what happened after that, or at least they have read some stirring stories about it. But when Mr. Martin said the managers “set a target … attain that target, unload, and then seek other opportunities,” the managers replied, “What does he want us to do, ride the stock back down again?”

There is obviously one genuine threat in “performance,” and that is the threat to liquidity. All the funds simply can’t get through the exit door at the same time.

On the floor of the Stock Exchange stand, at various posts, gentlemen called specialists. They are supposed to make sure the market is orderly and smooth. When a broker arrives with a stock to sell, they buy it from him; if he arrives with cash to buy, they sell stock to him. Perhaps they sell the stock to him out of their own inventory, and when they buy, they use their own capital. Thus they cushion the swings in the market. It all works pretty well for 100- and 500-share orders, although I (and everybody else) have been witness to specialists who do not exactly hold their ground when the first shot is fired. This is not the place for a discussion of the Role of the Specialist, but that Role is the subject of some professional discussion.

When three funds, each with 100,000 shares to sell, arrive at the opening on the same morning, the specialist simply cannot handle it. He calls a Governor of the Stock Exchange and asks for time to round up buyers. They “shut the stock down” it simply ceases trading. If you arrive five minutes later with fifty shares to sell, you are out of luck. You might as well sell them to your brother-in-law. The stock may reopen that day, or the next day, or the day after. For that moment; liquidity has come to a halt and liquidity, you remember, is the cornerstone of the market. (When the stock does reopen, it is likely to be a good 20 points lower, and if you haven’t heard the same news the fund managers have, you will begin to get the true feeling of They.)

If this makes you nervous as an individual investor, think how mousetrapped a fund manager can get. He heart the news that trading has been stopped in Zilch Consolidated, he quickly finds out the Story, and there’s nothing he can do about it. If a couple of funds have already sold, the market is going to be lower. But if he still shows the stock in his portfolio at the end of the quarter, when results are published, that caved-in, bombed-out stock fires off yellow smoke flares from the printed page and says “Our portfolio manager got sandbagged.”

That is how gunslingers are made, not born.

All this is new only in degree. Our good Lord Keynes had it all spotted in 1935, in one of the most acute passages ever written:

It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it “for keeps,” but with what the market will value it at, under the influence of mass psychology, three months or a year hence. Moreover, this behavior is not the outcome of a wrong-headed propensity. For it is not sensible to pay 25 for an investment of which you believe the prospective yield to justify a value of 30, if you also believe that the market will value it at 20 three months hence.

Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced … (thus) there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment today is “to beat the gun,” as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.

This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; it can be played by the professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs—a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.

That is the way it is, and no one has ever said it better.

Nothing, for the foreseeable future, is going to hinder the impulse to volatility. If all the fund managers have been piling into airlines, and if (as they did recently) the funds own more than 40 percent of Northwest Airlines, and if a number of funds want to get out of Northwest Airlines at the same time, it may be hard to find buyers, and Northwest Airlines is going to have some wide swings.

There is, of course, yet another danger, one spoken of only in hushed tones. A mutual fund, an “open-end” mutual fund, is by definition a fund which will redeem the shareholder’s shares for cash any business day he desires. If a bunch of shareholders all redeem together and the mutual fund doesn’t have enough cash, it has to sell some stocks to carry out the redemption.

Recently the thirst for performance got to the point where a number of funds were buying stock in companies that had no public markets, hoping for a nice gain on the day hence when the companies would go public. If the fickle redeemers gang up, those funds will have to find buyers in a market that can make the market for 1956 De Sotos look like a marvel of liquidity. Other funds have bought restricted stock, called “investment letter stock,” which they cannot legally sell for a certain period of time. That’s a procedure which can provide a manager with nice discounts from the market, or with a block of stock that would be hard to accumulate. But it also, needless to say, cuts down on liquidity.

For a while, in 1968, the fund leading the performance derby was called the Mates Fund, after its president Fred Mates. The young fund made its short record in some volatile stocks that turned out to have less than total liquidity. Before the year was over, the Mates Fund had to cease redemptions because of a couple of stocks it held that were, for various reasons, illiquid. So if you were a Mates fundholder as of the day redemptions ceased, you were locked in until the day they started again, unless you could get your brother-in-law to take the shares off your hands.

Obviously, if the fickle redeemers all gang up one day and present their shares for cash and the cash is not there and the stocks are illiquid, that will not be a very good day. In fact, it might just make the vest-wearing Prudent Man an object of affection, and the swinging, sideburned performance manager an object of tar and feathers. But let’s not think about that.

There are some corrective forces at work. For one thing, at the rate they are now being consumed, there may not be enough Gelusil and tranquilizers to serve all the fund managers with their triggers filed hair-thin. More reasonably, some fund managers are going to bring in the factor of the other fund managers, and expand their intended holding periods back again to a more manageable distance. The legal beagles may even make some rules, though if history is any guide, they will be rules that treat the situation as it was when people began thinking of rules, and not with the situation as it will develop to be.

You should make one note of my own bias in this account. From the previous list of biases you can see that anything other than “performance” is, to use the words of the Master, “intolerably boring and overexacting.” The name of the game is making money, not sitting on it.

I happen to know a number of fund managers, and they belie the old stereotype of Wall Street. To most Vassar juniors—and to many other people—a money manager has to be a dull fellow. He wears a vest and is boring, pretentious, and pompous. “Performance” managers can be very good company, just as diplomats or foreign correspondents or any group that represents a cross of disciplines can be. They have to be alert, they must keep constantly scanning for changes in the environment and for new ideas, because literally anything that happens can have an effect on all that money. They have to be good brain pickers, and a good brain picker is usually alive enough to be a good dinner companion.

Of course, the “performance” funds still represent only a tiny fraction of all the managed money. The influence of the trend extends far beyond the actual amounts of money involved. There are still a lot of vests around, and a lot of bankers who disapprove of everything that swings. It may all go too far, and they may be right. At the moment “performance” seems like the logical reaction to a worldwide inflation, an inflation that reflects the aspirations of much of society running ahead of society’s ability to pay for these aspirations on a current basis, or at least the discipline of paying for aspirations in the traditional way.