Morgan Stanley Investment Management’s Dennis Lynch shares his strategy on how to help survive equity market volatility.
As stock markets were hurtling toward bear territory in the first weeks of 2016, Dennis Lynch, like most of us, was glued to the screens, his fingers hovering over the keyboard. But Morgan Stanley Investment Management’s head of Growth investing wanted to buy stock, not sell.
After 18-years of running funds specializing in dynamic growth sectors like technology, Lynch has honed a recipe for potential success which has three main ingredients: Thinking long-term; building a team of introspective people who don’t think like the crowd, and seeking to profit from the foibles of human behavior.
“The stock market essentially is a crowd,” he explains. “It reflects the aggregated view of all the participants. So in order to beat the market you have to be willing to be different from everyone else.”
Lynch is the first to admit that it can at times be an uncomfortable strategy to follow in the short-term. “A lot of people say they are long-term investors, but it’s a lot easier to talk the talk,” says Lynch. “In times like these it’s really, really hard to walk the walk.”
But it has paid off. The Morgan Stanley Institutional Fund Growth Portfolio out-performed 95% of its Large Cap Growth Category peers over a five-year return period ending 2015, according to fund database firm Morningstar. During that time there were great years, like 2013, when the class I shares of the fund delivered 15.12% of excess return versus the Russell 1000 Growth index. And there were times when returns were dragged down in the short-term by certain IPOs that took more than a year to show their staying power over the longer term.
Morningstar performance rankings for MS Institutional Fund Growth Portfolio,
as of December 31, 2015.1
Lynch’s investment strategy relies as much on the personality type of his team members, as their ability to crunch the numbers. He insists on investment analysis that emphasizes the five-10 year competitive outlook for a company. That means sticking with names that could take years to show their true worth. “We’re successful not because we’re geniuses…it’s about temperament. Being willing to be apart from the crowd is almost a pre-requisite for the job,” he says.
Lynch puts team members through a series of mental exercises to strengthen their anti-crowd behavior. They all take personality tests like Myers Briggs, to increase self-awareness. Reading material from academic articles and thought-leadership pieces that often have nothing to do with Wall Street are distributed on a weekly basis and then formally discussed at a meeting. Team members mix up their daily routines to stop habits from forming and each has an extra day off a month to have time away from work for creative thinking. Team members invest in their own funds, and each "investor" on the Team covers at least two unrelated sectors to avoid over-specialization.
To test the staying power of a high-growth name, the Team draws on the work of their disruptive change researcher Stan DeLaney. DeLaney analyzes what game-changing trends are on the horizon, and Growth Team investors in the funds test the staying power of new and existing investments with those trends in mind. He sees block-chain and automation as two potentially disruptive trends going forward.
Going against the crowd isn’t just in terms of market direction. It also dictates where the Growth Team looks for opportunities.
Market specialization is one major downfall of the market, says Lynch. “People naturally like to categorize things, and often a lot of companies just don’t quite fit into any one sector. That’s an area where we go fishing.”
Other opportunities arise around market reactions to short-term events, like quarterly earnings. The market’s fixation with price-earnings multiples is also another place to go fishing. “Looking at P/E methodologies is limited because they don’t incorporate a company’s return on invested capital profile and competitive advantage over a five or 10-year horizon,” says Lynch.
Lynch also shies away from giving market outlooks. “On that subject I try very hard to say ‘I don’t know’. Because If I say out loud what I think might be happening, then I’m at risk of eventually believing it. The worst thing is to say you know something that is essentially unknowable.”