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5.1
Like stock and time
picking, manager picking is 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 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 2004 Dalbar study on investor
behavior, which shows that investors hold mutual funds for an average
of 4.2 years, buying at the highs and selling at the lows. This results
in the average investor greatly underperforming a 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.
But, as Figure 5-1 clearly shows, that top performance
rarely repeats in following years. Only about 15% of the top 100 managers
from the one-year periods repeated their top 100 performance in the
second year. In 1999 and in 2007, 0% of the top 100 managers made
the list in the following year.
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"There is one final problem in selecting a winning manager. According
to Richard
A. Brealey, "...you probably need at least 25 years
of fund performance to distinguish at the 95% significance level
whether a manager has above average competence." Another
commentator accepted the 25-year time frame, "but only
if the pension executive is using the perfect benchmark for
that manager. Using a less than perfect benchmark may increase
the observation time to 80 years." |
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p.
177 Bogle on Mutual Funds, John C. Bogle, Founder,
The Vanguard Group |
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"Former Oakmark Fund manager Bob Sanborn, Yackman Fund's Don
Yackman, and former Internet Fund manager Ryan Jacob; these
once-revered fund managers have fallen to earth." |
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Susan
Dziubinski, University editor, Morningstar.com.;
Five Lies About Fund
Manager Talent |
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"People exaggerate their own skills. They are overoptimistic
about their prospects and overconfident about their guesses,
including which [investment] managers to pick." |
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Professor
Richard Thaler, University of Chicago; Investment Titans,
by Jonathan Burton, 2001 |
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"By day we write about "Six Funds to
Buy NOW!"... By night, we invest in sensible index funds.
Unfortunately, pro-index fund stories don't sell magazines." |
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Anonymous,
Fortune Magazine Writer, Fortune, April 26, 1999 |
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"Studies show either that most managers cannot outperform passive
strategies, or that if there is a margin of superiority, it
is small." p. 372 - b. " It will take Joe Dart's entire working career
[calculated to be 32 years] to get to the point where statistics
will confirm his true ability." p. 821 - c.
"In the end, it is likely that the margin of superiority
that any professional manager can add is so slight that the
statistician will not easily be able to detect it." p.
374 |
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Zvi
Bodie, Alex Kane, Alan J. Marcus, Investments,
Fifth Edition, McGraw-Hill |
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"Most depressing of all, the "superstar" fund managers
I encountered in the early 1990s had a disconcerting habit of
fading from supernova to black hole: Rod Linafelter, ..., Richard
Fontaine, John Hartwell, John Kaweske, Heiko Thieme. I soon
realized that if you thought they were great, you had only to
wait a year and look again: Now they were terrible." |
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"Yet even the smartest, most determined fund-picker can't escape
a host of nasty surprises."
"Next time you're tempted to buy anything
other than an index fund, remember this--and think again." |
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Robert
Barker, It's
Tough to Find Fund Whizzes, BusinessWeek.com, Dec. 17, 2001 |
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"Statisticians will tell you that you need 20 years worth of
data -- that's right, two full decades -- to draw statistically
meaningful conclusions [about mutual funds]. Anything less,
they say, and you have little to hang your hat on. But here's
the problem for fund investors: After 20 successful years of
managing a mutual fund, most managers are ready to retire. In
fact, only 22 U.S. stock funds have had the same manager on
board for at
least two decades--and I wouldn't
call all the managers in that bunch skilled." |
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by
Susan Dziubinski, University editor with Morningstar.com
Note: Index
Funds are the only source of reliable 20 year risk
and return data. |
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"None of us is as smart as all of us." - Anonymous quote
hanging in the office of James Vertin, Head of Wells Fargo Management
Sciences Department and backer of the first equally weighted
S&P 500 index fund in 1971. Also from James Vertin, "After
twenty years of watching investment practitioners dance around
the fire shaking their feathered sticks, I observe that far
to many of their patients die and that the turnover of medicine
men is rather high. There must be a better way. And there is!
[index funds] |
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from
Bogle on Mutual Funds, John C. Bogle, Founder, The
Vanguard Group |
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"Santa Claus and the Easter Bunny should take a few pointers
from the mutual-fund industry [and it's fund managers]. All
three are trying to pull off elaborate hoaxes. But while Santa
and the bunny suffer the derision of eight year olds everywhere,
actively-managed stock funds still have an ardent following
among otherwise clear-thinking adults. This continued loyalty
amazes me. Reams of statistics prove that most of the fund industry's
stock pickers fail to beat the market. For instance, over the
10 years through 2001, U.S. stock funds returned 12.4% a year,
vs. 12.9% for the Standard & Poor's 500 stock index." |
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Jonathan
Clements, Only Fools Fall in ... Managed Funds?, Wall
Street Journal, September 15, 2002 |
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"Contrary to their often articulated goal of outperforming the
market averages, investment managers are not beating the market;
the market is beating them.
...most
institutional investment managers continue to believe, or at
least say they believe, that they can and soon will again “outperform
the market.”
They won’t and they can’t." |
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Charles
D. Ellis, " The Loser's Game," Financial Analysts
Journal, (July-Aug 1975) |
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"The evidence on mutual fund performance indicates not only that
these 115 mutual funds were on average not able to predict security
prices well enough to outperform a buy-the-marketand-hold policy,
but also that there is very little evidence that any individual
fund was able to do significantly better than that which we
expected from mere random chance." |
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"... skepticism about past returns is crucial.
The truth is, much as you may wish you could know which funds
will be hot, you can't -- and neither can the legions of advisers
and publications that claim they can. That's why building a
portfolio around index funds isn't really settling for average.
It's just refusing to believe in magic." |
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Bethany
McLean, "The Skeptic's Guide to Mutual Funds," Fortune
Magazine, March 15, 1999 |
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