When investors invest in a fund and it performs poorly over the years, it’s easy to blame the money manager for his or her lack of ability. The statistics also support the case, as my colleague Morgan Housel once showed: “[A]ccording to the Vanguard Group, 72% of actively managed funds underperform their benchmark over a 20-year period, removing the effects of survivorship bias.” But, there’s also another angle to this story – and that is the behaviour of the investors themselves. Paul Sullivan had recently written an article for The New York Times titled “The Folklore of Finance:…
When investors invest in a fund and it performs poorly over the years, it’s easy to blame the money manager for his or her lack of ability. The statistics also support the case, as my colleague Morgan Housel once showed:
“[A]ccording to the Vanguard Group, 72% of actively managed funds underperform their benchmark over a 20-year period, removing the effects of survivorship bias.”
But, there’s also another angle to this story – and that is the behaviour of the investors themselves. Paul Sullivan had recently written an article for The New York Times titled “The Folklore of Finance: Beliefs That Contribute to Investors’ Failure.” The article contained the following titbit of information:
“Fifty-four percent of institutional investors said they feared they could lose their job if they underperformed for only 18 months; 45 percent of people managing money at asset management firms said they felt the same.”
Notice the ridiculously short time-frames (18 months!) which institutional investors feel they’re being judged upon. Although the high fees money managers charge do play a part, their investors’ short-term judgments are also why managers tend to underperform over the long-term. Think about it: If your attention is focused on trying to survive in the job over the next year and a half, how can you invest for the long-term even if you know that’s the best way to invest?
As I was reading Sullivan’s article, I was reminded of a 2010 interview which financial journalist Jason Zweig had conducted with investor Seth Klarman. Klarman might not be that well-known outside investing circles, but he’s pretty much attained legendary status within. A well-known value investor, he’s the founder and president of Baupost Group, a hedge fund company that has compounded returns at an annual rate of close to 20% since 1992.
This is what Klarman said in the interview about how clients can also play a huge role in determining the returns a money manager can earn (emphases mine):
“We have great clients. Having great clients is the real key to investment success. It is probably more important than any other factor in enabling a manager to take a long-term time frame when the world is putting so much pressure on short-term results.
We have emphasized establishing a client base of highly knowledgeable families and sophisticated institutions, and even during 2008, we could see that most of our institutional clients – although some of them had problems – understood what was going on.”
From the excerpt, it’s easy to see that Klarman does not suffer from any short-term career risks and so, can invest fearlessly for the long-term utilizing the best strategies he knows of. That’s a completely different situation to what most money managers find themselves in, as depicted in Sullivan’s article. Taking it one step further, Klarman’s comments makes it seem that it might even be the case where the Baupost Group’s returns would suffer if not for the long investing horizons that the company’s clients have.
Besides injecting job insecurity, poor investor behaviour can also seriously undermine a money manager’s efforts to invest well in other ways. For instance, when the markets fall, investors tend to redeem their capital from funds – managers are thus forced to sell shares to meet the redemption even if they think that the decline would be a great time to invest. I trust it’s obvious to see that being forced to sell when bargains are abound can be a serious obstacle to being able to invest well.
A Fool’s take
Of course, there would definitely be cases where a money manager’s lack of investing ability is the main cause for poor returns for investors. But, there would also be situations where it’s poor investor behaviour that’s the root-cause for the poor returns earned by money managers.
Finding the most talented manager to manage your capital would be a useless endeavor if you’re judging him or her on unrealistically short timeframes or if you’re selling when the markets fall. Keep this in mind when you’re on the hunt for someone to manage your money.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.