Industry Selection Is Important

http://www.cxoadvisory.com/blog/external/blog12-12-07/

1) Industry selection generates on average about half of mutual fund alpha.

2) The correlation between the industry and stock components of mutual fund alpha is 0.06, indicating that the underlying selection skills are largely unrelated. In fact, 47% of sample funds underperform one aspect of selection while outperforming the other.

4) Unlike stock selection, industry selection is not subject to diminishing returns. While outperforming funds are unable to maintain strong stock selection alpha as assets increase, they do maintain strong industry selection alpha. Industries appear to provide ample opportunities for incremental investment. This lack of relationship between fund size and industry selection alpha helps explain why this alpha persists.

I have been meaning at some point to write a full post on this but haven't gotten around to it. I found this very interesting. Buffett in different ways has said many times that he looks at companies and does not care about recessions or big macro events. I think he overstates it to make a point. If you read the Charlie Munger explanation of how they got into railroads at the Wesco annual meeting, his explanation sounded almost entirely like a industry play that then drilled down to a company play. It was top down approach to an investment. I am adamant about focusing on the company. I have always thought general asset allocation for small investors who were willing to do the work was stupid; however, I have argued, at times passionately, that "don't focus on the macro" in the value world gets way to much air time. The big picture showed you at some point that financials were not the thing to touch with a ten foot pole. It didn't matter if Corus had the best management for condo banking. They are still down like 75%. It didn't matter if what Delta Financial had an unbelievable management team in the securitization world for subprime. They are sill bankrupt.

Value guys typically way under play the industry and the sector calls which is one reason I liked this little blog post so much as it gives some numbers to what I have anecdotaly argued. You made huge returns by being betting on commodities no matter what company you invested in. You lost tons of money betting long on financials no matter what company you invested in. So you lost 30% instead of 70%. Great.

So big picture thoughts? If inflation is coming, which I strongly believe it is if we don't enter a serious recession or depression (I don't think a mild U.S. recession will stop it) you better think about owning timberland. Agriculture boom still has a ways to go. REITS will continue to go down. Globalization of markets will continue (think about owning stock in major exchanges). Just to name a few.