Investors always are trying to get inside the heads of legendary investors, hoping to increase their chances of success by digesting crumbs from the disciplined, methodical approach of the masters.
Most are way out of their league in this endeavor. John Reese isn't one of them.
For nearly three years, Mr. Reese's West Hartford, Conn.-based company, Validea, has crafted portfolios of stocks based on the investment strategies of 11 top shelf investors. Through Thursday, Validea's Hot List, a hypothetical portfolio of 10 stocks based on the consensus of the market gurus, has generated returns of 167 percent since it was launched in mid-July 2003, vs. 26 percent for the Standard & Poor's 500.
"Across the board, all the guru strategies have significantly outperformed the market," says Mr. Reese, 53, a Harvard MBA who worked for a unit of GE Capital before founding his own networking integration firm.
Mr. Reese began the project after selling his networking company. When he went to invest the cash from the sale, he was unhappy with the advice he was getting and mutual funds that underperformed the market. So Mr. Reese began studying investors such as Peter Lynch, the former manager of Fidelity's Magellan Fund and author of "One Up on Wall Street."
He developed an investment model based on his interpretations of Mr. Lynch's writings. When that worked, he did the same for other great investors, including Warren Buffett, Forbes columnist and contrarian investor David Dremen, and Martin Zweig, a conservative growth investor who is a frequent guest on PBS' "Wall Street Week."
What Mr. Reese didn't do was actually talk to any of the gurus. None of them has endorsed his interpretation of their work.
Instead, Mr. Reese closely read books they had written or, in Mr. Buffett's case, a book written about him by his ex-daughter-in-law. He compiled a list of more than 300 factors the gurus considered in weighing a stock's value, from the simple such as price/earnings ratio to the more sophisticated, such as the relationship between a stock's P/E ratio and the rate at which the company's earnings are growing.
For each guru, Mr. Reese judged how important each factor was to their strategy and assigned it a weight. He then collected financial information on more than 8,000 stocks and ran it through the 11 model portfolio strategies. The result: lists of each guru's top 10 and top 20 stock picks based on Mr. Reese's interpretation of their strategy. The Hot List is a consensus portfolio based on the stocks in the guru portfolios, with stocks recommended by the gurus with the best long-term, risk-adjusted performance given more weight.
How well have the gurus done since Mr. Reese started tracking the hypothetical portfolios on July 15, 2003?
Through Thursday, Mr. Zweig was the top guru. His 10-stock portfolio generated pretax returns of 141 percent, followed by Mr. Lynch at 133 percent. Benjamin Graham, whose "The Intelligent Investor" is one of the best-selling investment books of all time, is in third place with returns of 132 percent followed by Mr. Dremen at 122 percent.
Each portfolio holds the same dollar of each of the 10 stocks. The portfolios are rebalanced monthly, which involves selling and buying securities. Those costs are not reflected in the returns. Neither are dividends.
"There are a lot of strategies that work, but only if you adhere to them when they appear to be badly out of favor," Mr. Reese said.
So far, about 2,000 investors have agreed to pay Validea $75 a quarter for access to the guru portfolios and the Hot List.
Mr. Reese says a minimum of 10 stocks are given for diversification purposes. Investors are supposed to take equal positions in all 10 stocks and rebalance their portfolios monthly, quarterly or annually.
Selling monthly means investors would pay full income taxes on their gains instead of the maximum 15 percent capital gains tax rate on investments held more than one year. Mr. Reese insists that even with that burden, investors with portfolios of $10,000 or more will do better rebalancing monthly instead of annually or quarterly.
Validea also lets subscribers look at individual stocks the way one of the gurus would. Mr. Reese says that, in general, a score of 80 percent to 89 percent indicates a stock meets most of a guru's criteria. Scores of 90 percent or more indicates the stock passes essentially all of a guru's tests.
Wesco International is the only regional stock listed among the top 20 stock picks of the gurus. The Station Square-based electrical products distributor gets a 100 percent from James P. O'Shaughnessy, author of "What Works on Wall Street." Peter Lynch gives Wesco a 91 percent rating, not good enough to make his Top 20.
Three years is enough time to conclude that Mr. Reese is doing a lot of things right. What investors do with his information is another matter.
Investors have a way of overriding the disciplined approach advisers recommend, whether the advice comes from a real person or the computer-generated model of human beings Validea is offering. Individual investors are also prone to be lazy, which can lead them not to think hard enough about taxes, commission costs and other issues that should be on their minds.
No computer model can diminish the importance of investors doing their homework. I'm sure that's one thing all of Mr. Reese's gurus could agree on.
Len Boselovic can be reached at email@example.com or 412-263-1941.