With well-earned cynicism.

Yesterday, a friend sent me a presentation on a new fund; this was my response.

Dear Jasmine (not the real name);

Thank you for this information. I’ll read carefully, and while I would be ecstatic to be proven wrong, I wouldn’t hold my breath on the chances of me discussing this with any of my clients.

Today, investing is less complicated and cheaper to implement than people think: set your objectives, determine your liquidity needs and pick a suitable asset allocation. You also need patience, and herein lies the problem expertly exploited by investment managers all over the world. It’s lunacy, but it’s true (see below).

Investors want portfolio managers to work wonders and smooth returns over time. This is akin to wishing to go out in the rain without an umbrella and stay dry, but as silly as it may sound this fact hasn’t stopped many investment management firms to build fortunes on marketing “invisible umbrellas” and lure many in believing two myths:

– smoothing returns can be regularly achieved;

– markets can be beaten with ease.

(A side note: why do people feel a need to beat the market? what’s wrong with just earning what the market gives you?)

Do investors following these dreams have a chance of getting acceptable results? Exceptional cases notwithstanding, the answer is no:

– most managers never come close to beating the market or their benchmark;

– of those who do, most vanish from the top and fall behind the market in subsequent periods;

– together, these two points mean that virtually nobody beats their benchmarks on a consistent basis;

– watch out: some managers achieve attractive gross performances (which they will aggressively publicize), but when you take away the fees the clients are under water;

– you also need a lot of data to determine if a manager’s performance record is due to skill or luck (according to a study some time ago, 83 years of quarterly data to be sure; you better hire only Methuselahs); which is why I smile when you say “he made money in the financial crisis and even more money in the following recovery;” it’s just two data points and without more details the observation is equivalent to praising someone for having flipped a coin and gotten two heads in a row.

On fees, I think they generally are way too high and I usually advise against performance fees: they are asymmetrical (so not aligned with the client’s interests) and too complicated to be transparent or fully understandable.

Finally, you kindly remind me that ‘as a good portfolio manager you would do your clients a disservice if you did not give them sound investment ideas’. While I’m not even sure the “good portfolio manager” qualification applies to me (thank you, though!), I’m acutely cognizant of the fact that there is a fine line between “sound investment ideas” and “run-of-the-mill-but-timely-and-well-presented stuff.” For me the disservice would be to propose new ideas and themes more frequently than the appearance of Halley’s Comet.

Be good,

Rp

Happy Easter to all!

Roberto Plaja, April 20, 2019

-Photo Sources-
Cover: Maurizio Cattelan, “L.O.V.E.”, 2010, Milano,  https://www.perrotin.com/artists/Maurizio_Cattelan/2/l-o-v-e/19335