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I think the Rule Maker Portfolio has to be evaluated in light of issues that are somewhat endemic to one of RM's unique features: It sets guiding rules that are fairly specific but still not mechanical.

The primary difference between the Rule Maker (and RB) and a more typical, nondescript portfolio is that RM explicitly categorizes its pet theories while portfolio X mostly keeps its theories fluid. A key advantage of RM's categorization approach is that it provides pedagogical convenience, particularly to less experienced investors, who are able to more easily form a starting point for applying the methodology on their own. It is difficult for relatively inexperienced investors to attempt to apply the methods of a portfolio whose goal is simply to purchase "undervalued securities," or at least more difficult than applying a set of delineated guidelines. There's value in being able to kickstart through the confusion by completing simple tasks such as finding companies with X flow ratios or Y net margins. A seeming second advantage is that it allows a portfolio to change managers without losing everything but the portfolio name, which is generally what happens with a mere "value" "growth" "small cap" portfolio, something that might detract from the teaching goal of the portfolio.

In addition to these advantages over a more fluid portfolio, the RM also seems to have an edge over a purely mechanical portfolio in that it is makes sense as a teaching portfolio and does not require years of a robust empirical support. The potential advantage that I didn't mention, but will, is that the Rule Maker categories could be argued to be an effective way to pick stocks, if applied "correctly" and consistently.

Unfortunately, in the current context TMF's evolution, I wonder whether these advantages are actually enjoyed. And if they are, I wonder whether they outweigh the attendant disadvantages that may arise from TMF's RM Port.

Categories as Teaching Tools

There's no doubt that creating categories or guidelines can be a very effective way to teach, or initally understand, how to apply confusing material. If the teaching aspect were the primary motivation for the RM criteria, in such a way that almost any criteria would do, then it could still be justified in its approach. What probably isn't justified, though, is the creation of a tracked portfolio to follow those criteria. Insofar as the criteria is meant to primarily improve people's ability to jump into the stockpicking process, it would seem to best apply to investors looking to "index plus a few," (or simply to learn) such that the few matter little to their investing results. But as a teaching tool, then, the RM methodology might be better off presenting itself as a pathway rather than a strategy, and certainly wouldn't need to track its returns independently. It might be helpful to run a Port that tracks that returns of a mostly indexed portfolio along with a small percentage of Rule Makers to mimic the allocation impact rather than the RM picks impact, but it makes less sense to determine the stand alone returns of a teaching tool.

Of course, RM proponents will plainly argue that RM isn't merely a teaching tool, but is really a stockpicking strategy that also happens to be an effective teaching tool. I'll get to that, but I just wanted to point out that I don't think running a RM portfolio satisfies the isolated goal of teaching investing methodology. In fact, I think it quite possibly detracts from that goal because, disclaimers aside, its setup sends the message that RM is primarily a strategy for super stockpicking rather than a way to learn how to pick stocks.

Seamless Management Transitions

This advantage is pretty clearly hollow. While the RM guidlines could theoretically provide consistency over time and across managers, they have not in practice, and are not particularly likely to in the future. Like the RB, the RM is adorned with a very unique, but still infinitely flexible set of principles. That combination saddles new managers with the very specific and certainly controversial ideas of one of the Gardner Brothers with which they may not agree, but also allows them the latitude to break from them so violently as to make them inoperable. That's a tough tandem. It's not surprising that different managers bought stocks that clearly did not meet the language of the strategy, or at least stretched the language so badly as to make it virtually meaningless. In fact, it could be argued that even the strategy creators themselves did away with the crieria at times.

That rigidity/flexibility paradox pretty much vitiates the purpose of having consistent guidelines, and it borders on creating a nondescript portfolio masquerading as a RB or RM portfolio. What's worse, the potential disadvantage of this dynamic is that it encourages murky rationalization by portfolio managers, who are forced to engage in post hoc fitting of a stock they want to purchase (JDSU) into criteria they'd prefer didn't bind them. That's the least effective of teaching tools, because it muddles rather than exposes and organizes the methodology behind the stockpicking. I think that's a disadvantage that's hard to overcome given the nature of the principles; management turnover in that context doesn't help. No categorization is much better as general matter than false categorization.

RM as an Effective Stockpicking Strategy

The last of the potential advantages of RM is universal to all portfolios. It works (we think). The best argument in support of having a RM portfolio probably combines all of the advantages, by claiming that it is an educational, transferable method of tracking the success of a strategy that we think is better than indexing. I think it's difficult to plainly refute that logic in vacuum, besides noting that that 99% of investors won't beat the market over time, and that RM guidelines are simply one person's chosen, unsupported whim among the trillions of potential stockpicking guidelines that can be created (or by submitting your subjective opinion that the RM guidlines are themselves not the way to outperformance). Those endless arguments aside, I still think this combined line of the support for the current RM runs frail given the reality-stained non-vacuum-like TMF reality.

I would argue that the principles are nearly fated to be irrelevant. Because of the rigidity/flexibility of the principles, and the multi-headed management across time, the application of the principles are naturally going to mired with so much inconsistency as to render them moot. New principles such as "QuaVa" will appear, labeled as progress, while others will be eliminated or de-emphasized per the current managers. What will seem like evolution will actually be the natural strategic distinctions among managers initially bound to external formulae. In short, the Rule Maker strategy won't really exist. Instead, it will likely continue as a set of fairly arbitrary limitations upon a portfolio manager that will be forced to use them to rationalize decisions made for other reasons. And it won't help that those guidelines have the likely side effect of teaching stand-alone lessons that are clearly false (e.g. that high growth companies outperform, that high cash/debt companies will outperform), even if not intended. I think that an effective strategic, teaching portfolio should probably be less specific than RM in its guidelines, despite the teaching limitations this provides.

As a solution, I suggest the RM strategy be converted into a stockpicking approach, and be reflected in a portfolio that indexes the vast majority of its money be also delves into RM. The portfolio can be tracked to illustrate the very small impact a few RM makers might have, and you can continue to analyze companies under the RM method as a teaching tool without spotlighting on the success of the "strategy." That should allow "managers" to focus on consistently applying the principles as teaching tools, rather than motivating them to pick stocks under the rubric of RM investing. I still don't mind the idea of online portfolios, and I'd guess they tend to attract an audience. I just don't like the model of guidelined-based strategies that pay little attention to the more dense but objective aspects of investing being passed across managers who may or may not actually want to use them to pick stocks.

I admit, this epic may be colored by the fact that I personally don't see any strategic value in the RM Principles, which is totally subjective and uninteresting to anyone but myself. The RM and RB are especially problematic to me, because they de-emphasize valuation, which I would argue is the one objective "guideline" for investing decisions. In fact, I question the strategic validity of any set of overly specific "principles" without empirical support. But like I said, my opinion on that isn't relevant, I just thought I'd throw it in for disclosure.






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