Empty Pockets

The Failure of Manager Pickers

Empty Pockets

Like stock and time picking, manager picking is usually a worthless endeavor; however, there are still investors out there who believe they can select an all-star manager or financial guru who can beat the odds. To be sure, there is no shortage of managers out there who are willing to try to beat the odds for their clients or mutual fund shareholders—for a hefty fee. Like all speculators, these managers do win occasionally, attracting lots of media attention and new clients. Truth be told, the majority of expenses and fees in the investment industry go toward money managers who gamble with other peoples’ money. Investors would be wise to pose the following questions to their money managers:

  1. Do you have skill or were you just lucky?
  2. Were you the beneficiary of the market’s random walk or did you really know tomorrow’s news and how it would affect the investments you picked for your clients?
  3. Will there be persistence in your performance?
  4. Is a three to five-year time period long enough to judge your success?
  5. Statisticians say we need about 20 years of data to judge success. Have you ever managed a mutual fund for 20 years or more or do you know anyone who has?

So-called star money managers attract about 75% of new mutual fund investors. This is despite the fact that what are considered “today’s top 10 mutual funds” often tank within three years.

Typically, investors first invest in a “star” fund run by a “star” manager when they read about the “latest and greatest funds.” Then they sell their investments within a few years when they become disenchanted by the fund’s shoddy performance. This trend supports the findings of the Dalbar study on investor behavior, which shows that investors hold mutual funds for an average of four years, buying at the highs and selling at the lows. This results in the average investor greatly underperforming the market.

Manager picking has become so popular among investors that an entire industry has sprung up to help identify future winners based on past performance. Media advertisements feature winning mutual fund managers boasting of their recent success. The performance histories of mutual funds regularly appear in such publications as Barron’s, BusinessWeek, Fortune, Money, and Consumer Reports. Even highly sophisticated consultants retained by multi-billion dollar pension plans use recent fund performance as the most important criterion in selecting “the best” money managers.