QUALIPORT
The Ups And Downs Of Beating The Market

By Maynard Paton (TMFMayn)
January 12, 2004

The Qualiport beat the market for the third consecutive year in 2003. However, the out-performance has not been a smooth ride. A 'big bold bets are best' approach has seen the portfolio diverge significantly from the market -- in both directions -- at certain times. Buy and hold investors adopting a similar focused strategy must also be prepared for regular bouts of acute out- and under-performance.

Holdings

At any point during the past three years, the Qualiport has held only four, five or six different equity holdings (accompanied by varying amounts of cash). The first table highlights how the portfolio has deviated from the FTSE 100 Total Return Index (i.e. the FTSE 100 with dividends reinvested) on a quarterly basis, while the second summarises the deviations on an annual basis:

Date	Qualiport value (£)	Quarterly change (Qualiport) (%)	Quarterly change (FTSE 100 TRI) (%)	Quarterly difference (QP- FTSE) (%)
31/12/2000	22,157
31/03/2001	21,275	(4.0)	(8.7)	4.7
30/06/2001	20,422	(4.0)	0.7	(4.7)
30/09/2001	22,324	9.3	(12.4)	21.7
31/12/2001	21,806	(2.3)	6.8	(9.1)
31/03/2002	23,086	5.9	2.1	3.8
30/06/2002	20,421	(11.5)	(11.2)	(0.4)
30/09/2002	18,337	(10.2)	(19.3)	9.1
31/12/2002	18,307	(0.2)	6.4	(6.5)
31/03/2003	17,006	(7.1)	(7.0)	(0.1)
30/06/2003	20,669	21.5	12.4	9.1
30/09/2003	21,377	3.4	2.6	0.9
31/12/2003	22,374	4.7	10.0	(5.3)

Year	Annual change (Qualiport) (%)	Annual change (FTSE 100 TRI ) (%)	Difference (QP-FTSE) (%)
2001	(1.6)	(14.1)	12.5
2002	(16.0)	(22.2)	6.1
2003	22.2	17.9	4.3

Though the numbers of relative out- and under-performing quarters are equal (six each), one point is quite clear: the portfolio's achievements during 2001,2002 and 2003 stem from large relative gains during one particular quarter of each year.

Towards the end of Q3 2001, the portfolio sold £5,000 of PizzaExpress in order to have "cash ready and waiting for attractive investment opportunities." Sure enough, a market fall came and the portfolio moved heavily into Carpetright (LSE: CPR), Johnston Press (LSE: JPR) and Emap (LSE: EMA).

Entering Q3 2002, 50% of the Qualiport was represented by Carpetright and Johnston Press. While the quarter was dominated by events at Worldcom, the two portfolio members actually recorded share price gains during the three months.

At the end of Q1 2003, the portfolio was fully invested and therefore benefited from the subsequent market upturn. The six Qualiport holdings all increased in value during Q2 2003, though luckily, Johnston Press (representing 32% of the portfolio, the biggest holding at the start of the quarter) reported the largest three-month leap (up 29%).

(But one point is not so clear from the quarterly data: why does the Qualiport always lag behind fourth-quarter FTSE rallies?)

Superinvestors

What can happen over three years though tells you little about the volatility to expect over an investing lifetime. Taken from Robert Hagstrom's book The Warren Buffett Portfolio, the next table shows how four accomplished long-term 'focus' investors have experienced spells of under-performance.

Investor	John Maynard Keynes	Charles Munger	Bill Ruane	Lou Simpson
Period	1928-1945	1962-1975	1971-1997	1980-1996
Average relative performance (%)	10.6	14.0	4.7	6.2
-- investor (%)	9.3	18.9	17.9	23.2
-- market (%)	(1.6)	4.9	13.2	17.0
Best annual out-performance (%)	50.6	51.1	48.7	26.6
-- investor (%)	44.8	71.7	72.3	57.1
-- market (%)	(5.8)	20.6	23.6	30.5
Worst annual under-performance (%)	(24.0)	(18.8)	(19.7)	(15.1)
-- investor (%)	(40.1)	(31.9)	12.6	(10.0)
-- market (%)	(16.1)	(13.1)	32.3	5.1
Out-performing years	12 out of 18	9 out of 14	17 out of 27	13 out of 17

Notes:
1) More on John Maynard Keynes can be found here.
2) Charles Munger is the vice-chairman of Berkshire Hathaway (NYSE: BRK.A), Warren Buffett's investment vehicle.
3) Bill Ruane attended Ben Graham's investment class alongside Buffett in 1951 and went on to manage the Sequoia Fund.
4) Lou Simpson manages the equity holdings of GEICO, an insurer wholly owned by Berkshire Hathaway.)

All four 'superinvestors' have endured spells of poor performance. In fact, the US market managed to outrun Ruane over four consecutive years, while Keynes and Munger once trailed their respective benchmarks for three consecutive years. Furthermore, all four have suffered particularly individual years, with each seeing their fund's annual performance lagging the market by at least 15% at times.

Of course, it was the out-performance during good years that made all the difference to the four investors (and their clients). Indeeed, Keynes, Munger and Ruane once recorded annual out-performances around the 50% mark.

Summary

Though the theory of buying a few, great companies and holding for the long term sounds simple, the psychological strength needed to make the theory work is often over-looked. Investors running a concentrated portfolio must expect a wild ride --  a good or bad quarter will make all the difference to annual returns. Watching the FTSE out-pace your portfolio -- for anything up to four years perhaps -- will test the patience and conviction of any stock-picker. But if the right business has been purchased at the right price, the market will always provide a suitable reward -- eventually! Going on the statistics concerning Keynes et al, buy and hold investors should expect to see the market beat them once every three years. That suggests the Qualiport could well trail the FTSE in 2004.

More: The Warren Buffett Portfolio | Should You Run A Focused Portfolio? | Big Bold Bets Are Best

The author own shares in Carpetright and Johnston Press.