“Any year that you don’t destroy one of your best-loved ideas is probably a wasted year.”
– Charlie Munger
Let’s start with a truism: successful long-term investing rewards conviction. Almost by definition, the businesses worth holding for years or decades are the ones that prove to be transformational and dazzlingly successful. With the benefit of 20/20 hindsight, these are the rare breed of firms that reward investors who have the patient and steadfast conviction to own their shares through multiple periods of market turbulence and volatility.
Heavy irony hides within this simple concept. Conviction and stubbornness look almost identical from the outside, but the line between courage and hubris is much thinner than most of us admit. We revere the small handful of investors whose conviction produced phenomenal returns and made them famous. We study them, quote them, and turn them into legends. At the same time, no one talks or writes books about the much larger group of brilliant, hard-working investors whose conviction eventually proved to be dead wrong. A few failed loudly and generated the blowups that ended up in the headlines, but most failed quietly. In a testament to banality, their returns simply lagged the broader market badly enough, for long enough, that they faded away.
In my opinion, this is the quiet tension embodied in the process of active investing. The moment conviction crosses over from well-founded confidence to unquestioned belief, a portfolio begins to grow brittle and prone to breakage.
Structural engineers learned long ago that the way to keep a skyscraper standing through an earthquake is not to make it more rigid, but to let it move. Buildings that survive seismic events are designed to sway and absorb the shock rather than resist it completely. A durable growth process works much the same way. It should stand firm in ordinary conditions but embrace flexibility when the fact pattern demands it.
Key Takeaways
- The greatest risk in growth investing is a stale or rigid thesis, because it can lead to compounding the impact of (inevitable) mistakes.
- JAG’s investment process is designed to keep every holding under active interrogation and evaluation. New ideas compete continually with current positions. Our proactive, unemotional sell discipline is as defined as our buy discipline.
- This flexibility is by design and reflects the increasing dynamism of the markets and the economy. Being continually open-minded allows our strategies to react when the evidence changes, especially when our own deeply held thesis is being challenged.
When Conviction Calcifies
An investment process can fail in dramatic ways, but many failures are quiet and slow journeys to habitual rigidity. A process calcifies when a purchase rationale is written once and questioned only rarely. It can freeze up when a conclusion that a company’s upside is “already priced in” hardens into a permanent verdict that excludes a business from all further consideration. Dismissively referring to falling prices or persistently poor relative strength as noise rather than valuable new feedback is a reliable path to ossification. The risk of calcification is even more pronounced in a focused portfolio, because a single unrevised view can compound into an ever-larger mistake.
What makes these failure vectors so difficult to observe is that they tend to masquerade as conviction. Patience, after all, is a virtue in investing. Right up until it is the opposite.
Destroying a Best-Loved Idea
These concepts are not just theory to me. I bear plenty of scars from my 30+ years as a professional investor.
As a relatively recent example, for several years (roughly 2019 through 2022) I held tightly to my firm conviction that the extreme concentration of the largest indices was unsustainable. I believed that market leadership would eventually broaden, which would tamp down the dominance of a handful of mega-cap technology companies. In my defense, it was a reasonable view. Lots and lots of smart people agreed with me. It was also pretty much dead wrong, which contributed to a difficult stretch of returns that rhyme with “pelative runderperformance.”
Destroying a best-loved idea is easier said than done, especially when you have defended it in public. But the fact is that our growth investment process is built so that discipline trumps conviction. Our framework not only allows us to change our minds; it demands that we change our approach when the facts dictate.
The Math of the Market
There is a deeper reason rigidity is so dangerous for growth investors. The fact is that successful active investing is really hard to do. Extremely low-cost index funds are indeed hard to beat, both figuratively and literally. Research by Arizona State University finance professor Hendrik Bessembinder found that, across nearly a century of US market history, most individual stocks failed to beat one-month Treasury bills over their lifetimes. Almost all of the market’s net wealth creation traced to a small minority of big winners, on the order of the top four percent of companies, while the rest collectively did no better than cash equivalents. Returns are powerfully skewed: a handful of extraordinary compounders carry everything, and a long tail of also-rans quietly destroys capital.
That skew cuts in two directions at once, and both demand flexibility. For active investors, it raises the stakes of two decisions in particular:
- Does your process allow you to identify and invest in the genuine “winners” long enough to capture enough of their full contribution?
- Are you operating a process that encourages you to let go of the positions that will eventually drift into the large cohort of long-term losers?
In my experience, many of my active manager friends tend to operate overly rigid processes. “Buy and hold forever” is a great goal, and Warren Buffett is a huge example of just how well this approach can work – when it works well. But this stance also leaves a portfolio exposed to the long-left tail of names that never recover. By and large, we believe the math of the market tends to punish inflexible conviction.
Flexibility by Design
“When the facts change, I change my mind. What do you do?”
– Attributed to John Maynard Keynes
Our Large Cap Growth (LCG) and Small Mid Cap Growth (SMG) strategies are built to bend because the process is repeatable, proactive, and applied to every holding continuously rather than only at the moment of purchase.
It begins with constant pressure on the names we already own. Our investable universe is continually scored and ranked by a proprietary multi-factor model, and our qualitative work on covered companies is refreshed on a regular cycle. New ideas compete directly with current holdings for a place in the portfolio, so a position is never grandfathered in on the strength of a thesis we wrote months or years ago. It has to keep earning its place against the best alternatives available to us today.
The clearest expression of that flexibility is our proactive sell discipline, which we regard as one of the most important parts of our approach. In risk management, we hold to a principle that former hedge fund manager and noted market commentator Jim Cramer has long preached and that we wholeheartedly share: discipline trumps conviction. We work to keep the sell process unemotional and repeatable, and we do not average down on a losing position simply because we expect (hope?) we will be proven correct. A range of signals can prompt us to trim or exit a name, including deteriorating relative strength, weakening momentum, materially negative revenue or earnings results and guidance, and accounting, legal, or governance problems. The purpose of our sell discipline is to mitigate the risk of permanent capital loss, which we believe is an underappreciated risk for growth investors. More broadly, we aim to mitigate the cost of our (sorry to say, inevitable) mistakes.
This is also why no single judgment can harden into a permanent verdict. Conclusions that a stock is fully valued, or that a former leader’s best days are behind it, are viewed as suppositions that will be re-tested as the facts evolve rather than a final decision. The flip side of that discipline is opportunity: the same disruption that impairs some business models almost always mints durable new winners. Indiscriminate or panicked selling routinely creates openings for investors willing to be open to building a new thesis. In this sense, JAG remains “open for business,” always and everywhere.
Altogether, these features mean that no holding ever earns a permanent place in our portfolios. In the context of our “best ideas” investment framework, each position needs to continually re-earn its place in our portfolio.
Discipline, Not Drift
None of this should be construed as a promise to call tops and bottoms. Our process is deliberately not built to embody perfect timing. We will rarely – if ever – pick the ultimate top or bottom in any of our holdings. We think this is OK, because in our experience longer-term shifts usually take several quarters to play out.
Flexibility is also not the same thing as restlessness. Re-underwriting our investment positions is discipline, not a license to trade for the sake of trading. Our portfolio turnover is moderate by design, and a process that changed its mind constantly would be no better than one that never changed it at all. As I know all too well, an adaptive process is far from perfect. But it is purposefully engineered to avoid being anchored to yesterday’s theses. We will do our best to ensure that the portfolio holdings will evolve if and when (as Keynes put it) the facts change.
In a discipline that beatifies conviction, the willingness to revisit one’s priors may be the most underrated edge of all.
Norm Conley
Chief Executive Officer and Chief Investment Officer
JAG Capital Management
Source for research cited: H. Bessembinder, “Do Stocks Outperform Treasury Bills?”, Journal of Financial Economics, 2018. The phrase “discipline trumps conviction” is a long-standing investing rule popularized by Jim Cramer in his book Real Money: Sane Investing in an Insane World (2005).
Disclosures
These comments were prepared by the staff of JAG Capital Management, LLC, an SEC-registered investment adviser. The information herein was obtained from various sources including but not limited to FactSet, Bloomberg, Reuters, Standard & Poor’s, ChatGPT, Claude, and the United States Bureau of Labor Statistics, and believed to be reliable; however, we do not guarantee its accuracy or completeness. The information in this report is given as of the date indicated. We assume no obligation to update this information, or to advise on further developments relating to securities discussed in this report. The opinions expressed are those of the adviser listed above as of the date of this report and are subject to change without notice. The opinions of individual representatives may not be those of the Firm. Additional information is available upon request.
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