What are the most significant
differences between IMI’s investment strategies and others?
Successful investing is based on
three principles: the management of return, risk and costs.
Just like a three legged stool needs all three legs to stand,
we believe all three aspects of the investment process have to
be tended to produce good, long-term results. IMI’s
strategies are engineered to enhance the return potential,
minimize the costs and manage the risks that are inherent in
any investment portfolio. IMI achieves this feat by designing
extremely low turnover, highly cost and tax efficient, long
Q. Why do IMI strategies concentrate
on both the return and the cost side of the investment
A very brief answer to this
question is that returns are probabilistic, whereas cost
savings are deterministic. In other words, in the short term,
whether or not a particular portfolio is going to be rewarded
is unknowable. So, the best an investment manager can do is
to position the portfolio in such a way that it has beneficial
attributes. These are attributes that the market has
historically rewarded. However, the portfolio manager can not
control by how much and when these rewards will be realized.
The outcomes are entirely probabilistic.
On the other hand, any cost savings that
can be realized while implementing a portfolio accrue directly
to the investor. At the portfolio level cost savings can be
realized at two distinct areas: by reducing transaction costs
and by deferring taxes on gains.
IMI’s investment strategies are developed
with the expectation to earn excess return, not only from
market inefficiencies, but also from savings realized due to
extremely low turnover portfolios. As far as we are
concerned, there is no difference between earning a dollar and
saving a dollar. And being able to do both simultaneously is
the key to building wealth.
Q. Why low turnover?
A. Turnover, that is, buying and
selling securities from the portfolio, triggers two
significant sources of performance drag:
Transactions costs: Brokerage commissions
capture but a very small percentage of transaction costs. The
full impact of transaction costs include: commissions, bid-ask
spreads, market impact and other opportunity costs such as
timing costs, lost trades, etc. In sum, it costs around 1% of
principal to trade a large cap, highly liquid position. The
costs are 4-5 times as large for small cap or illiquid
positions. Since these costs are incurred with every trade,
the only way to control them is by reducing the frequency of
Capital gains taxes: For a taxable portfolio,
with every trade one stands to lose either 20% or 40% of the
capital gains realized. The impact is that a manager
operating with typical institutional turnover parameters has
to earn 2 ˝ - 3 ˝% more than the market in order to
match the post tax return of an index portfolio. On the other
hand, unrealized capital gains appreciation is the best tax
shelter. As long as one build assets rather than income there
is not tax liability.
Low turnover portfolios have one other
beneficial trait, namely time. Since the outcomes of a
portfolio strategy are realized somewhat randomly, having the
luxury of time gives the strategy a higher probability of
achieving the expected results.
Q. What are the differences between
IMI low-turnover strategies and others?
A. There are very few long only
managers who claim to be tax efficient in their investment
process. Turnover awareness is not in the lexicon of
long/short managers. Among the long only managers who are low
turnover, one popular technique utilized entails adopting a
core and satellite approach to allocating assets. Under this
methodology, the core is comprised of index funds and the
satellites are actively managed portfolios. The manager is
able to achieve lower turnover by taking advantage of
inherently lower turnover characteristics of index funds, and
by paying careful attention to realization of gains and
harvesting of losses.
We see two drawbacks with such a
process. First, under a core and satellite approach, the
investor ends up paying active management fees for a process
that only actively invests 40-50% of funds. Second, any tax
efficiency achieved is entirely due to back office
operations. Unless the manager utilizes a long term
investment strategy that is built from the ground up,
postponing gains from a short term strategy might cause these
unrealized gains to become realized losses.
Tax efficiency is a
fundamental part of the IMI long and short stock selection
strategies. Our investment process takes a long term
approach, and the timing of gains and losses, both on the long
and short sides of the portfolio, is entirely determined by
the portfolio management rules. Also, because we utilize a
tax efficient process, IMI can put 100% of funds into an
actively managed portfolio.
Q. Isn’t there a lot of uncertainty in
A. As Warren Buffett has very
eloquently expressed, “In the short term the market is a
voting machine but in the long run it is a weighing machine.”
We vote with our emotions; therefore, in the short run the
market can behave erratically, shooting up one day only to
reverse course the next. Short-term investing can be an
emotional roller-coaster, whereas in the long run, the only
thing that matters is the weight of the evidence: did we
acquire companies with solid fundamental characteristics at
reasonable prices and did we sell short companies trading at
excessive valuations? If our answer to this question is “yes”
then we can weather the storms of the market with patience and
In summary, our claim is the exact
opposite of conventional wisdom: in that there is
significantly more uncertainty in investing for the short term
than investing for the long term. Time is the investor’s
friend, but many choose not to befriend this ally.
Q. Why does IMI use a quantitative
A. IMI is a fundamentally based,
quantitative investment manager. This means our approach
relies on financial relationships that are extracted from
balance sheet, cash flow and income statement line items. We
also take into account estimates from sell side analysts and
historical price behavior.
Although we share some similarities with
purely fundamental investment managers, we have a number of
significant differences. First, we quantify the predictive
ability of each factor that is included in our process.
Financial statements offer a multitude of factors to judge a
company’s profitability, valuation, efficiency and risk
characteristics. However, only a subset of these
relationships is predictive of price behavior. Since our
focus is excess return generation, we concentrate on
relationships that have demonstrated a consistent historical
ability to predict price behavior. By using such an approach,
we are better able to distinguish between information that
could be interesting but useless, and knowledge that is price
Second, this highly methodical process
also brings with it a number of additional benefits.
Consistency and discipline are two of the least developed
traits in humans, yet success in investing absolutely requires
it. A quantitative approach allows us to add these extremely
crucial qualities into our process. Another extremely
important quality that comes with such an approach is
objectivity. Typically, the CEO’s and presidents of large
companies are charismatic and have considerable power in
swaying opinions; otherwise, they would not have risen to such
a position. This trait has the potential to bias the opinions
of portfolio managers or analysts who visit companies. Our
process allows us to distinguish between speculation and
Finally, a disciplined quantitative
investment process brings with it a considerable amount of
transparency. Just like a plant manager can improve the
throughput of a factory by being able to measure, monitor, and
change, this transparency gives us the ability to enhance our
process. In addition, a fully described process reduces
risk. Neither the firm nor the clients are reliant on one
gifted portfolio manager.
In our opinion, any investment process
that is not methodical, consistent and objective embeds
randomness. The markets already incorporate a sufficient
amount of randomness; we see no reason to add to that by
making the process less than it can be.
Q. Why don’t investment styles play a
role in IMI strategies?
A. Creating an investment
discipline that has a distinct investment style, such as
value, growth or momentum, invariably subjects it to periods
of underperformance. As the preference of investors
oscillates between value, growth and momentum, one or more of
the stylistic strategies go out of favor. Each time a
strategy goes out of favor the investors risk losing money.
By creating strategies that do not have a
distinct style, but incorporate the best of all styles, we are
able to assure that a certain number of strategy components
remain in favor the majority of the time. That way, we are
able to minimize the number of periods when our strategy is
out of favor and create a much more consistent investment
Q. How does IMI manage risk?
A. All active investment managers,
whether quantitative, fundamental or qualitative, make bets.
They further assume that company characteristics that they
prefer will be favored and rewarded by the market. This is
how active investment managers hope to earn returns in excess
of their benchmark – excess return. Our strategy is no
exception to this fundamental rule of active investing. Among
other attributes, we favor companies that have demonstrated
Traditional risk management and portfolio
construction platforms are designed to reduce bets that they
do not understand. In the process they end up curtailing the
exact bets the manager is attempting to make. Since these
bets are the source of excess returns, they end up
constraining or eliminating the manager’s ability to earn
We believe we have a better method of
controlling the risk of our investment process: one that does
not make us sacrifice our ability to earn excess return in
exchange for risk control. During the development stage of
our investment strategy we try to quantify where our planned
and unplanned bets are. For any bet that is unplanned, we try
to build offsetting conditions that would constrain the
strategy from venturing in that direction. In addition, we
try to incorporate risk control into our portfolio management
rules. By taking this two-pronged approach we maintain that
we are able to control the risk parameters of the strategy
without having to sacrifice portions of our returns.