Last week was the 2019 edition of the Sohn Hearts & Minds Investment Leaders Conference in Australia. Similar to the format of other Sohn investment conferences globally, top investors (many of whom rarely speak in public) present an 8 minute TEDx-style pitch on their ‘best investment idea’, committing their time and expertise in support of medical research. You can read coverage of this year’s event in the Australian press – see here and here (subscriptions required).

As I was reading about the event, I was interested to learn there is also an ASX-listed investment vehicle called Hearts & Minds Investments, which was formed in late 2018 to meet investor demand for an accessible way to gain exposure to the stocks pitched at the conference. The actual set-up is slightly more nuanced; Hearts & Minds Investments owns a concentrated portfolio of 25-30 long positions based on the highest conviction ideas from two groups of fund managers:

• 60% of the investment portfolio will be allocated to the highest conviction ideas of five core fund managers (Caledonia, Cooper Investors, Magellan Asset Management, Paradice Investment Management and Regal Funds Management).
• 40% of the investment portfolio will be allocated to the annual recommendations of the fund managers who present at the Sohn Hearts & Minds Investment Leaders Conference.

The company invests 12% of its portfolio in three recommendations from each of the five core fund managers. The investment committee meets regularly to review the portfolio and reblancing decisions are based on the recommendations of the core fund managers. For the conference stock picks, the company generally allocates an equal weight investment to each of the recommendations. These are expected to be held in the portfolio for a period of 12 months, after which they are removed in order to invest in the stock picks from the following year’s conference.

Instead of charging an investment management fee, Hearts & Minds Investments donates an amount equal to 1.5% of the company’s net tangible assets per annum to several leading medical research organisations in Australia. To help maximise their impact, the investment committee, fund managers and other key service providers have committed to waiving their usual fees.

Overall, this appears to be an attractive proposition for investors. A “best ideas” fund is conceptually appealing and plausible. Whether via such conference picks or 13F filings, why not simply ride the coattails of the best investors, especially if the cost of accessing these ideas is kept low? Specifically, why are there not more examples of successful “best ideas” funds?

Charlie Munger has previously discussed this topic at the Daily Journal annual meetings. He cited the example of the Capital Group, which tried to set up a “best ideas” fund several times, only for it to fail on each occasion. His explanation is that, as human beings, our bias toward commitment and consistency makes it difficult to change our mind, even if we are wrong. “When you pound out an idea as a good idea, you’re pounding it in. So by asking people for their best ideas they were getting the stuff that people had most pounded in, so they believed. So of course it didn’t work. And [the firm] stopped doing it because it didn’t work. They didn’t know why it didn’t work because they hadn’t read the psychology books, but they knew it didn’t work so they stopped.”

This explanation might well be true, but it is only part of the answer. I would perhaps add a couple of points. First, if the investment mandates of the underlying managers are narrower than the mandate of the “best ideas” fund, then you might be selecting ideas that appear attractive to these managers on a relative basis, but are not necessarily so on an absolute basis. For example, if the underlying manager is focused only on a single country or sector, they are still going to generate an idea, but you may be better off looking for investment opportunities elsewhere altogether. 

Second, picking the right stocks is only one part of the investing process. The other part is portfolio construction and management (e.g. sizing a position, hedging, thinking about the correlation between holdings, deciding when to add, trim or sell and so on). Thus, even if you can successfully outsource the idea generation, you can’t do the same for the portfolio construction and management. It is not easy to manage money if you are borrowing the conviction about the underlying ideas from others.

Finally, regarding conference stock picks, I would merely highlight the findings of this 2018 research paper by Patrick Luo. As per his abstract, his work shows that “hedge funds take advantage of the publicity of these conferences to strategically release their book information to drive market demand. Specifically, hedge funds sell pitched stocks after the conferences to take profit and create room for better investment opportunities. However, the pitched stocks still perform better than non-pitched stocks in the funds’ portfolios afterwards. Hedge funds do not pitch obviously bad stocks because maintaining a good reputation helps them raise money.” It’s an interesting read and, at very least, makes one reflect about the potential incentives that might be at play when considering such recommendations.

Please note that the points above are simply general observations and do not relate specifically to Hearts & Minds Investments, a company I have not studied in detail. There are, of course, ways to mitigate all the potential issues I have described and that is ultimately the role of their investment committee. As mentioned previously, the company supports several medical research organisations in Australia, so I certainly hope it can become a successful example of a “best ideas” fund.