Print Version [PDF]       

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:

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.

read more

Since more than 95% of mutual funds are actively managed, the various mutual fund ratings exist primarily for manager pickers. However, a recent review of these ratings show a wide variation in rating methods and results. For example, the same four funds were rated according to four different publications. Table 5-1 reveals the results.

Table 5-1

On this table, funds A, B, C, and D are actual mutual funds. They are not identified because the purpose of this illustration is not to sell a particular security. It is to emphasize that ratings, in and of themselves, do not provide enough information for making an investment decision.

These systems measure criteria about managers that is about as useful as a tipster giving advice at the race track. To make matters worse, there are countless stockbrokers, money managers, hedge fund managers, investment advisors, private money managers, and newsletter publishers, who do not operate publicly traded mutual funds. They are not required to report the same detailed information that is required of mutual fund managers. These managers are often criticized for the smoke and mirrors they have created to mask their results.

Luckily, investors received a gift from the SEC that blew away some of the smoke. In 2001 the SEC adopted a rule that requires mutual funds to disclose after-tax returns in their prospectuses. This requirement equipped investors with a more accurate report on returns.
The ruling also helped open the eyes of investors, especially those using actively managed funds in taxable accounts.

read more