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Vulcan of Bay Street refuses to let emotion get in the way

Bear Stearns' James O'Shaughnessy has 'scientific approach' to investing


TORONTO -- Ignore the soaring price of oil. Dismiss the chaos in the Middle East. Sarbanes Oxley? Background noise. For James O'Shaughnessy, it's cold, hard data that holds the secrets to understanding the equity market.

Emotional decision-making based on the latest headlines is the road to financial ruin, the fund manager says.

"If you are a Star Trek fan, we are the Vulcans of investing," said Mr. O'Shaughnessy, who oversees about $2.4-billion (U.S.) in assets for Bear Stearns Asset Management Inc., including three U.S. and Canadian equity funds on behalf of RBC Asset Management Inc.

The 44-year-old New York portfolio manager has developed a computer-driven quantitative model for stock picking that is showing strong results. For example, the RBC O'Shaughnessy Canadian Equity Fund reported a 17-per-cent return for the 12 months ended Aug. 31. The $769-million (Canadian) fund has posted an average annual return of 10 per cent since its inception in 1997.

"There are four horsemen of the investment apocalypse. And they are fear, greed, hope and ignorance. Think about that. Only one of them is not an emotion -- ignorance. Fear, greed and hope have lost people more money than any recession, any bear market," he said.

"We are trying to take a more scientific approach; this is a hypothesis we can test . . . and we are going to be emotionless. Emotions are the biggest bugaboo for investing."

The methodology is deceptively simple. Mr. O'Shaughnessy, author of What Works On Wall Street, uses a concept he calls strategy indexing. The discipline involves being fully invested, holding a portfolio of 50 stocks that best meet his criteria and then rebalancing once a year.

For example, the aggressive RBC O'Shaughnessy U.S. Growth Fund buys liquid stocks with a market capitalization of between $200-million and $2-billion (U.S.). A strict price-to-sales ratio is applied and each potential investment must show profit growth over the past year.

The best 50 equities are bought and a year later, the model run again. The model is strictly adhered to and both momentum plays and laggards may be dumped.

Unlike his rivals in the fund industry, Mr. O'Shaughnessy ignores company forecasts, equity analysts' reports and never visits firms in his portfolio. In general, the three RBC funds have performed well, outperforming in bear markets, keeping pace in bull runs but generally lagging when speculation is driving share prices. For example, Mr. O'Shaughnessy avoided Nortel Networks Corp. in the late nineties but picked it up after the stock collapsed in 2000.

"We want to offer growth without the hangover," he said. "We will participate and do okay but we are not going to be ahead of the market because we are not willing to take those risks."

The strategy -- and returns -- win positive reviews.

"So far, it's worked very well for him," said analyst David O'Leary at Morningstar Canada.

The independent fund rating firm gives the three RBC funds near-perfect marks -- five stars for the Canadian Equity and U.S. Value funds and four stars for the U.S. Growth fund.

"The approach has worked well in a variety of markets and outperformed it peers too," Mr. O'Leary said, noting the group's low fees. All have annual management expense ratios of less than 2 per cent. "It's a good compromise between an index and an active fund."

Dan Hallett, president of Dan Hallett & Associates Inc., is somewhat skeptical of mechanical investing models but concedes Mr. O'Shaughnessy's strategy "makes sense."

"This is essentially investing done by a computer," he said. "As long as they don't interfere with the model, there's no potential for an emotional decision."

Fund comparisons

Percentage growth, as of Aug. 31, '04


RBC O'Shaughnessy Canadian Equity... 17.37......10.61.....13.40

RBC O'Shaughnessy U.S. Growth...... - 2.09.......3.70.......8.63

RBC O'Shaughnessy U.S. Value........ 14.68........5.77.......6.46

S&P/TSX total return.....................13.50.........6.13.......5.44

S&P 500 composite total return........... 5.94.......- 4.49....- 4.53


© 2007 The Globe and Mail. All rights reserved.

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