Know what you are buying – investment products, insurance and mutual funds.

 Know what you are buying – investment products, insurance and mutual funds.

Elaboration of Section 30

This section serves as a crucial consumer protection and due diligence guide. It warns investors to look beyond the marketing name of a financial product and understand its underlying mechanics, costs, and true purpose. The core message is that complexity and opacity are often used to hide poor value.

1. Scrutinizing Investment Products: The "Capital Guaranteed" Trap
The section uses the example of "Capital Guaranteed Funds" to illustrate a common pitfall.

• The Alluring Name: The name suggests absolute safety of your principal.

• The Ugly Reality: Upon investigation, the product structure often reveals that 90% of your capital is invested in safe, low-return government bonds (which actually provide the guarantee), and only 10% is invested in equities.

• The Problem: After accounting for high sales charges and management fees, the potential upside from the tiny equity portion is so minimal that the investor would likely have been better off simply putting their money in a fixed deposit. The lesson is to always look under the hood and understand the asset allocation and fee structure.

2. The Right Role for Insurance: Protection, Not Investment
This part delivers a clear, rule-based distinction:

• Buy Insurance for PROTECTION: The primary purpose of insurance is to cover catastrophic, unforeseen financial losses (e.g., death, critical illness). For this, term insurance is the most efficient and affordable product because it offers pure protection with no investment component.

• Do NOT Buy Insurance for INVESTMENT: Insurance products that combine protection with investment (e.g., endowment, whole life, investment-linked policies) are generally poor investment vehicles. They come with high costs, and the investment returns are often low because the funds are managed ultra-conservatively to meet regulatory and liability requirements. The smart strategy is to "buy term and invest the rest" separately.

3. Selecting Mutual Funds: Philosophy Over Past Performance
When choosing a mutual fund, the section advises looking beyond recent returns and focusing on the manager's core philosophy.

• The Example of Magellan Funds: The section holds up this fund as a model because its stated investment philosophy is a mirror of this entire guide. It explicitly aims to:

  • Minimize the risk of permanent capital loss.

  • Find outstanding companies with wide "economic moats."

  • Buy these companies at a discount to intrinsic value (a Margin of Safety).

• The Due Diligence: This means an intelligent investor should read a fund's prospectus and understand its stated philosophy, ensuring it aligns with sound, business-like investing principles rather than short-term speculation.

4. The Critical Factor of Integrity
The section ends by circling back to a theme from Section 23: the paramount importance of integrity. Judging the integrity of a product provider or fund manager is difficult but essential. A lack of integrity means the seller's interests (to earn fees) are not aligned with your interests (to grow wealth). This is why understanding the product structure and philosophy yourself is a non-negotiable form of self-defense.

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Summary of Section 30

Section 30 is a practical guide to financial self-defense, warning investors to thoroughly understand any financial product before buying it and to use different products for their intended purposes.

• Investment Products: Look beyond the name. Analyze the underlying structure and fees. Often, "safe" products are structured in a way that offers minimal real return after costs.

• Insurance: Use it for protection only. Buy affordable term insurance for pure financial protection. Avoid using insurance as an investment vehicle, as it is a costly and inefficient way to build wealth.

• Mutual Funds: Judge the philosophy, not just the performance. Select funds whose stated investment philosophy aligns with value investing principles—seeking quality businesses with a margin of safety.

The Overarching Principle: The biggest risk is often buying something you don't understand. Complexity is frequently used to obscure poor value and high costs. The intelligent investor's duty is to perform this due diligence to ensure their capital is deployed efficiently and in alignment with their goals.

What you must know about Mutual Funds.

What you must know about Mutual Funds.

Elaboration of Section 27

This section provides a crucial reality check on using professionally managed investment funds (Unit Trusts or Mutual Funds). It outlines the pros and cons, helping an investor decide whether to use them and, if so, how to choose wisely. The tone is one of caution, grounded in the data that most active funds fail to beat the market.

1. The Core Trade-Off: Delegation vs. Cost & Performance
The section starts with the fundamental trade-off mutual funds present:

• The Benefit (Delegation): Funds are ideal for investors who lack the time, inclination, or expertise to research individual stocks. You are paying a professional to handle this complex task for you.

• The Major Drawback (Cost & Underperformance): The section highlights the well-documented fact that a majority of actively managed funds underperform the market index over the long run. The primary reason for this is the fees they charge (management fees, sales loads), which create a performance hurdle that is difficult to overcome.

2. The Intelligent Investor's Guide to Funds
The section provides a clear framework for deciding on the role of funds in a portfolio:

• For the Defensive Investor (The Default Recommendation): The most strongly endorsed option is low-cost index funds. These funds simply track a broad market index (like the S&P 500 or the FTSE Bursa Malaysia KLCI). They are recommended because:

  • They are passively managed, leading to very low fees.

  • They are highly diversified.

  • By definition, they will match the market's return, which historically beats most active fund managers after fees.

• For the Enterprising Investor (Using Funds Strategically): More knowledgeable investors can use funds in specific ways:

  • As a Starting Point or Core Holding: Use a fund for the bulk of your portfolio while you learn to pick stocks, then gradually take over.

  • To Access Specialized Areas: Use funds to invest in areas outside your circle of competence (e.g., foreign stocks, specific sectors).

  • As a Source of Ideas: Study the top holdings of successful fund managers to generate stock ideas for your own research.

3. The Critical Factor: Assessing the Fund Manager's Integrity
The section raises a profound and difficult question: how do you judge the integrity of a fund manager? It compares this to choosing a business or life partner—it's a subjective judgment based on reputation, transparency, and alignment of interests. It warns that without integrity, a manager's intelligence and energy can be used to enrich themselves at the investors' expense.

4. A Case Study in Philosophy: The Magellan Funds Example
The section provides a real-world example by outlining the investment philosophy of the Magellan Funds. This philosophy reads like a summary of the entire document:

• Primary Goal: Minimize the risk of permanent capital loss.

• Method: Find outstanding companies (with wide economic moats, low business risk, and high re-investment potential) and buy them at an appropriate discount to intrinsic value (a Margin of Safety).

This example shows what a truly excellent, philosophically sound fund looks like and sets a high bar for selection.

---

Summary of Section 27

Section 27 offers a critical guide to mutual funds, concluding that for the majority of investors, low-cost index funds are the most intelligent choice, while also providing a framework for how more enterprising investors can use funds strategically.

• Core Problem: Most actively managed funds underperform the market index after fees, making them a poor choice for many.

• Top Recommendation for Defensive Investors: Low-cost index funds are the simplest, most reliable, and most cost-effective way to achieve market-matching returns and broad diversification.

• Strategic Use for Enterprising Investors: Funds can be used as a core holding, to access specialized markets, or as a source of investment ideas.

• The Ultimate Challenge: Selecting an active fund requires assessing the manager's integrity and philosophy, which should align with the value investing principles of seeking wonderful businesses with a margin of safety.

In essence, this section warns against blindly trusting "professional" money managers without understanding their fees and strategy. It empowers the individual investor by stating that for most people, the best fund is not one that tries to beat the market, but one that efficiently is the market—an index fund. This is fully consistent with the advice of Benjamin Graham and Warren Buffett for defensive investors.

Mutual Funds

Mutual funds are, in theory, an attractive alternative for the individual investor, combining

• professional management, 
• low transaction costs, 
• immediate liquidity, and 
• reasonable diversification. 

In practice, they mostly do a mediocre job of managing money. There are, however, a few exceptions to this rule. 

For one thing, investors should certainly prefer no-load over load funds; the latter charge a sizable up-front fee, which is used to pay commissions to salespeople. Unlike closed-end funds, which have a fixed number of shares that fluctuate in price according to supply and demand, open-end funds issue new shares and redeem shares in response to investor interest. The share price of open-end funds is always equal to net asset value, which is based on the current market prices of the underlying holdings. Because of the redemption feature that ensures both liquidity and the ability to realize current net asset value, open-end funds are generally more attractive for investors than closed-end funds.' 

Unfortunately for their shareholders, because open-end mutual funds attract and lose assets in accordance with recent results, many fund managers are participants in the short-term relative-performance derby. Like other institutional investors, mutual fund organizations profit from management fees charged as a percentage of the assets under management; their fees are not based directly on results. Consequently, the fear of asset outflows resulting from poor relative performance generates considerable pressure to go along with the investment crowd. 

Another problem is that open-end mutual funds have in recent years attracted (and even encouraged) "hot" money from speculators looking to earn quick profits without the risk or bother of direct stock ownership. Many highly specialized mutual funds (e.g., biotechnology, environmental, Third World) have been established in order to exploit investors' interests in the latest market fad. Mutual-fund-marketing organizations have gone out of their way to encourage and even incite investor enthusiasm, setting up retail mutual fund stores, providing hourly fund pricing, and authorizing switching among their funds by telephone. They do not discourage the mutual fund newsletters and switching services that have sprouted up to accommodate the "needs" of hot-money investors.

Some open-end mutual funds do have a long-term value investment orientation. These funds have a large base of loyal, long-term-oriented shareholders, which reduces the risk of substantial redemptions that could precipitate the forced liquidation of undervalued positions into a depressed market. The Mutual Series Funds and the Sequoia Fund, Inc., are among some favorites; the Sequoia Fund, Inc., has been completely closed to new investors in recent years, while some of the Mutual Series Funds periodically open to accommodate new investors.

Investment Alternatives for the Individual Investor

The unfortunate fact is that the individual investor has few, if any, attractive investment alternatives.

Investing, it should be clear by now, is a full-time job. 

Given the vast amount of information available for review and analysis and the complexity of the investment task, a part-time or sporadic effort by an individual investor has little chance of achieving long-term success. 

It is not necessary, or even desirable, to be a professional investor, but a significant, ongoing commitment of time is a prerequisite. 

Individuals who cannot devote substantial time to their own investment activities have three alternatives:

• mutual funds, 
• discretionary stockbrokers, or 
• money managers. 

Why do retail mutual fund investors do so badly?

Why do retail mutual fund investors do so badly?

1.  Charges are part of the explanation.

Mutual fund investors pay not only management fees but also the trading costs within the funds they hold.

They also pay further trading costs when they themselves buy and sell, which they do too often.


2.  But the principal explanation is bad timing.

Retail investors buy high, and sell low.  They are late into fashionable sectors, and late out of unfashionable ones. 

There is probably no worse investment strategy than following the conventional wisdom with a time lag, and that is precisely what many small investors do - often with the encouragement of their advisers.

Concentrated portfolio of stocks or Index funds or Mutual/Hedge funds

How should I invest in the stock market?

Should I invest in my own selected stocks and manage my own portfolio?

Should I entrust my money to the fund managers in mutual funds or hedge funds?

Or, should I just buy an index-linked fund or an ETF?

Investing in mutual funds and hedge funds

The problem here is, as an aggregate, these funds underperform the market, after taking into consideration the costs incurred.  

Over a one year period, these costs maybe small, but over a long period, these costs compounded into a huge amount that is leaked out of your portfolio, not available to you to reinvest into your portfolio.

It is generally sound to avoid these funds, since there are better alternatives.

Investing in index linked funds or ETF

Index linked mutual funds have on the aggregate given you the chance to capture the returns of the market at low costs.    

They have in general outperformed the mutual funds and hedge funds, as a group over the long term.

Due to recent awareness of the performances of the mutual funds and hedge funds due to the higher costs involved, more and more money are flooding into index linked funds or ETFs.

Investing in a concentrated portfolio of  a selected group of stocks

I believe this is possible for those with a good and sound philosophy and method; who are hardworking, knowledgeable and disciplined.

These constitute less than 5% of the investors in the market.

An example of a sound philosophy:

• Know the business you are investing.
• The business has durable competitive advantage.
• The management has integrity and are capable.
• The company is available at a fair or bargain price.
• The investing time horizon is long term (> 5 years or more).
• Dividends are reinvested.

The stock markets have returned averagely about 10.5% per year for a long period.  The returns of the stock market over the short term is extremely volatile; inflation over this short period is small.   On the other hand, the returns of the stock market for any 5 years or more rolling period have always been positive.   Those who choose the "good quality stocks" bought at "bargain prices" can expect to perform better than the average and should have returns better than the 10.5% per year.

In summary:

1.   If you are knowledgeable, do invest on your own.

Own a concentrated portfolio of good quality stocks (those with durable competitive advantage).

Do not overpay to own them.

Keep them for the long term, reinvest the dividends, and allowing compounding to give you the higher returns.

2.   If you are not so knowledgeable, but still intelligent in your investing.

Go for index linked funds.

Do you have the uncanny ability to pick out the best mutual or hedge fund managers?  If you have, you may wish to park your money with them.  If not, avoid these products altogether and go for index linked funds or ETF.

Index funds and active management - Warren Buffett is a vocal critic of active management.

Towards his later life, particularly following the global financial crisis of 2007-8, Buffett became an increasingly vocal critic of active management, i.e., mutual funds and hedge funds. 

Buffett is skeptical that active management and stock-picking can outperform the market in the long run, and has advised both individual and institutional investors to move their money to low-cost index funds that track broad, diversified stock market indices. 

Buffett said in one of his letters to shareholders that "when trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients."

In 2007, Buffett made a bet with numerous managers that a simple S&P 500 index fund will outperform hedge funds that charge exorbitant fees. By 2017, the index fund was outperforming every hedge fund that had made the bet against Buffett by a significant margin.

Buffett slams Wall Street 'monkeys', says hedge funds, advisors have cost clients $100 billion

Andrew Harrer | Bloomberg | Getty Images

Warren Buffett, chairman and chief executive officer of Berkshire Hathaway Inc.

Warren Buffett on Saturday devoted more than four pages of his 29-page annual shareholder letter to criticism of active managers on Wall Street, excoriating what he perceived as exorbitant fees they charge for returns that fail to live up to lofty assumptions.

Meanwhile the legendary stock picker extolled the virtues of passive investing and its advantages for regular investors. The 'Oracle of Omaha' even compared active managers to monkeys, and estimated that financial advisors, in their futile search for ways to beat the market, had cost clients $100 billion in wasted fees in the last 10 years.

"When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients," stated the widely-read letter released on Saturday morning. "Both large and small investors should stick with low-cost index funds."

Chris Kleponis | Bloomberg | Getty Images

'The results were dismal'

Buffett started this critical section of the letter with an update on a 10-year wager against Wall Street's active management he made nine years ago, with the proceeds going to a charity. This is how the billionaire described his original challenge:

"I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?"

To his surprise, only one person stepped up to take the other side of the bet: Protégé Partners' Ted Seides, a 'fund of funds' manager. According to the bet, Seides selected five funds of hedge funds, whose results after fees would be averaged and compared to Buffett's selection, a Vanguard S&P index fund.

Here's what happened, according to the letter: 

"The compounded annual increase to date for the index fund is 7.1%, which is a return that could easily prove typical for the stock market over time...The five funds-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000."

In fact, none of the basket of funds came even close, according to Buffett:

Source: Berkshire Hathaway 2016 shareholder letter

"The results for their investors were dismal – really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed," Buffett wrote. "As Gordon Gekko might have put it: 'Fees never sleep.'"

Investors seem to be heeding Buffett's anti-active advice, as more than $20 billion flowed out of U.S. active equity funds in January despite a rising stock market, according to Morningstar. In the last 12 months, more than half a trillion dollars have flowed into passive funds, while active funds have experienced outflows, Morningstar's data showed. 

In his letter, Buffett criticized how the whole Wall Street complex is still set up to send pension funds, endowments and other investor types into under-performing active vehicles. He claimed that the wealthy investor classes are getting ripped off the most:

"In many aspects of life, indeed, wealth does command top-grade products or services. For that reason, the financial 'elites' – wealthy individuals, pension funds, college endowments and the like – have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. This reluctance of the rich normally prevails even though the product at issue is –on an expectancy basis – clearly the best choice. My calculation, admittedly very rough, is that the search by the elite for superior investment advice has caused it, in aggregate, to waste more than $100 billion over the past decade. Figure it out: Even a 1% fee on a few trillion dollars adds up. Of course, not every investor who put money in hedge funds ten years ago lagged S&P returns. But I believe my calculation of the aggregate shortfall is conservative."

Buffett stated that he knows of only 10 managers that he spotted early on who could outperform the S&P 500 over the long term, and they did so. He acknowledged there are more out there who may be able to beat the market, but they are the clear exception. 

"Further complicating the search for the rare high-fee manager who is worth his or her pay is the fact that some investment professionals, just as some amateurs, will be lucky over short periods," Buffett wrote.

"If 1,000 managers make a market prediction at the beginning of a year, it's very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him."

The billionaire heaped praise on Jack Bogle, the founder of the Vanguard Group who started the first index fund 40 years ago.

"If a statue is ever erected to honor the person who has done the most for American investors, the hands down choice should be Jack Bogle," the letter stated. "In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned."

"He is a hero to them and to me," Buffett added.


John Melloy | @johnmelloy
Saturday, 25 Feb 2017
CNBC.com

http://www.cnbc.com/2017/02/25/buffett-slams-wall-street-monkeys-says-hedge-funds-cost-100-billion.html

Your investments using Mutual Funds or Money Managers

There are various avenues individual investors may exercise in managing their investments. 

Investing properly is a full-time job, and that it would be very difficult for individual investors to manage their own money if they have other employment. 

This leaves them two options:

1) Mutual Funds

2) Money Managers

Open-end mutual funds

Open-end mutual funds offer the investor access to both liquidity and the ability to sell for net asset value. 

On the other hand, many funds are driven by relative performance and often grow to sizes where market-beating returns are not possible. 

Since managers are compensated by assets under management, they are also prone to follow short-term trends in order to avoid falling behind their peers in the near-term which could trigger a mass exodus of investors.

Closed-end funds

Closed-end funds do not offer investors ready liquidity at net asset value.

However, they may be prudent investments when they trade at substantial discounts to their net asset values. 

Money Managers

In evaluating money managers, individual investors should raise the following questions which will help select a manager:

• Do they manage their own money in parallel with their clients'?
• Has the size of the portfolio grown exceedingly large?
• What is the investment philosophy of the manager? Does it make long-term sense?

In evaluating investment results, investors must look deeper than a manager's historical investment returns. 

• For example, any manager can generate phenomenal returns within a certain period of time. 
• Are the returns described over at least one full business cycle? 
• Also, were the returns generated using leverage?
• Or were they generated despite the portfolio holding large amounts of cash (in which case risk is much lower)?

Take Home Message

Investors who adopt a value-oriented investment approach should be able to invest safely with promise of a satisfactory return. 

If they do not have the time to manage their money full-time, find a trustworthy manager who employs this value investing philosophy.

Read also:

• 
  
• Your investments using Mutual Funds or Money Managers
• Trading and portfolio management from a value investing point of view
• Value Investor's Opportunities in Distressed Securities
• Value Investing Opportunities in the Banking Sector
• Look at FUNDAMENTALS and POTENTIAL CATALYSTS when making investment decisions
• Where to look for Investment Opportunities
• Business value cannot be precisely determined. Make use of ranges of values
• Central elements to a Value Investing Philosophy
• The Philosophy of Value Investing and Why It Works
• Philosophy of value investing. Need to have clear strategies too
• How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s
• Understanding these changes in the investment world allows investors to earn superior returns
• What's good for Wall Street is not necessarily good for investors
• Speculators, Investors and Market Fluctuations

What is the strategic and tactical orientation of your fund?

HDFC Equity: Top gun

 

This perennial winner has a massive fan following. And rightly so! Like a magician repeating a trick, HDFC Equity has beaten the category average every single calendar year since 1997. Its ability to identify opportunities at the right time is the key factor contributing to its success. For example, when the Supreme Court halted PSU disinvestment in September 2003, the fund sold its entire energy holding and built a fresh position in March 2004, when PSU stocks started rallying.

Though the fund maintains a large-cap bias, it does not hesitate to invest substantially in stocks of smaller companies, as and when there are opportunities to exploit. Currently, large-caps account for 51 per cent of the assets while the mid- and small-cap allocations stand at 42 and 6 per cent respectively.

The fund manager has always boldly ridden his convictions. He refrains from taking cash calls and prefers to remain fully invested at all times. Historically, his portfolio has been a focussed 25-30 stocks. But the complexion of the fund seems to be changing on this front. The number of stocks has increased to over 45. And, the concentration in the top five holdings has been moderated from 35-40 per cent about a year ago, to just around 25 per cent now.

This is probably not reflective of his stance but rather an adjustment to the size. Investors have flocked to this fund in droves making it the largest diversified equity offering of Rs 5,000 crore. And this very factor may be detrimental to the strategy of the fund. The fund’s ability to identify opportunities and take meaningful exposure in them will be neutralised by its increasing size. The fund has displayed ample spunk till date, but it remains to be seen how it fares from here on.

Information
www.hdfcfund.com
NAV: Rs 182.838 (28/09)
Entry Load: 2.25% for investment less than Rs. 5 Cr.
Exit Load: Nil
Expense Ratio: 1.83%
Launch: Dec ‘94
Plans: Growth, Dividend
Min Investment: Rs 5,000
Benchmark: S&P CNX 500
Portfolio Manager: Prashant Jain

Top sector weights	% of Assets
Capital Goods	17.68
Energy	13.90
Financial Services	12.13
Consumer Non-Durable	8.85
Technology	8.43

Fund Manager: Prashant Jain

Hard to forecast

Jain is one of the most revered fund managers, known for his astute stock picking abilities. All his funds are five-star rated, be it equity or balanced. The impressive list includes HDFC Equity, HDFC Prudence and HDFC MIP Long Term.
Jain worked for two years with SBI Mutual Fund before joining Zurich India AMC. In 2003, HDFC Mutual Fund took over and he has been with the fund house ever since. An engineer from IIT, he holds an MBA from IIM.

Do you see a market crash in the near future? 
In my opinion, a “crash” is probably too strong a word for the Indian market. But a correction can never be ruled out.

It is true that the Indian market is somewhat expensive, but it offers a unique combination of size and growth. Global investors are increasingly looking at India as a mainline asset class and are therefore, investing with a long term view. If you look at Indian P/E's of nearly 20, 15-20 per cent earnings growth, interest rates of 4-6 per cent prevailing outside India and an appreciating currency, then Indian P/E's still look reasonable. India is somewhat expensive compared to the past and to the prevailing interest rates locally. But when viewed in the global context and in view of improved size, fundamentals and visibility of the Indian economy, the market does not appear to be unreasonably valued.

What is the strategic and tactical orientation of your fund? 
We refrain from taking significant cash calls, as we believe investors are doing the asset allocation at their end. Further, it is extremely difficult to time the markets. For instance, early 2000, when the market was at a peak, the cash levels in funds were extremely low. But in September 2001, when the market was at the bottom, cash levels were higher.

In view of the above and the attractive medium to long-term outlook of equities, HDFC Equity Fund continues to remain nearly fully invested.

In the case of HDFC Prudence, the fund has been overweight on equities since 1999. The exposure to equities is between 70-75 per cent and the rest is in bonds. One change that has been done in the last six months is that the maturity of the fixed income portfolio has been increased. This is because the risk reward equation of long maturity bonds is favorable.

Which are your top sector preferences?
Both funds are overweight on capital goods, banking, media and FMCG stocks. The Equity Fund has a lesser exposure to mid caps than Prudence.

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Comment:  Learning the working of a fund manager.  

How Many Mutual Funds Routinely Rout the Market? Zero

The bull market in stocks turned six last Monday, and despite some rocky stretches — like last week, when the market fell — it has generally been a very pleasant time for money managers, who have often posted good numbers.

Look more closely at those gaudy returns, however, and you may see something startling. The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years.

In fact, based on the updated findings and definitions of a particular study, it appears that no mutual fund managers have.

I wrote about the initial findings of that study last summer. It is called “Does Past Performance Matter? The Persistence Scorecard,” and it is conducted by S.&P. Dow Jones Indices twice a year. The edition of the study that I focused on began in March 2009, the start of the bull market.

It included 2,862 broad, actively managed domestic stock mutual funds that were in operation for the 12 months through 2010. The S.&P. Dow Jones team winnowed the funds based on performance. It selected the 25 percent of funds with the best returns over those 12 months — and then asked how many of those funds actually remained in the top quarter in each of the four succeeding 12-month periods through March 2014.

The answer was remarkably low: two.

Just two funds — the Hodges Small Cap fund and the AMG SouthernSun Small Cap fund — managed to hold on to their berths in the top quarter every year for five years running. And for the 2,862 funds as a whole, that record is even a little worse than you would have expected from random chance alone.

In other words, if all of the managers of the 2,862 funds hadn’t bothered to try to pick stocks at all — if they had merely flipped coins — they would, as a group, probably have produced better numbers. Instead of two funds at the end of five years, basic probability theory tells us there should have been three. (If you’re curious, I explained how the math works in a subsequent column, “Heads or Tails? Either Way, You Might Beat a Stock Picker.”

The study seemed to support the considerable body of evidence suggesting that most people shouldn’t even try to beat the market: Just pick low-cost index funds, assemble a balanced and appropriate portfolio for your specific needs, and give up on active fund management.

The data in the study didn’t prove that the mutual fund managers lacked talent or that you couldn’t beat the market. But, as Keith Loggie, the senior director of global research and design at S.&P. Dow Jones Indices, said in an interview last week, the evidence certainly didn’t bolster the case for investing with active fund managers.

“Looking at the numbers, you can’t tell whether there is skill involved in what they do or whether their performance is just a matter of luck,” Mr. Loggie said. “I believe that many of them do have skill. But even if they do have it, based on how they’ve done in the past you really can’t predict how they will perform in the future.”

Still, those two funds did manage to perform splendidly in that study. Their stubborn persistence at the top of the heap over that five-year period suggested that there was some hope for active fund managers. If they could do it, after all, others could, too.

But we’re now about two weeks away from the completion of another 12 months since the end of that study, and it’s been a mediocre stretch, at best, for those two mutual funds. When the month is over, to borrow from Agatha Christie, it looks as though we’ll be saying: And then there were none.

Here are the dismal statistics: The SouthernSun Small Cap fund has actually lost money for investors over the 12 months through Thursday. It was down 3.2 percent, according to Morningstar, and for the nine months through December, it was in the bottom quartile of funds in the S.&P. Dow Jones study. The Hodges Small Cap fund has done better, gaining almost 6 percent through Thursday. S.&.P. Dow Jones Indices says that put it in the third quartile — or second-to-worst one — through December. While it’s mathematically possible, it is highly unlikely that either will climb to the top quartile in the next few weeks, Mr. Loggie said.

Michael W. Cook, the lead manager of the SouthernSun Small Cap fund and the founder of the firm that runs it, was traveling last week and was unavailable to comment for this column. Craig Hodges, manager of the family-run Hodges Small Cap fund in Dallas, spoke to me on the telephone and told me that he wasn’t surprised that his fund had stumbled. “We’re not that good,” he said. “It was going to happen sooner or later. We’ve never expected to outperform all of the time.” And despite disappointing recent returns, both funds are still beating the market handily over the last five years.

Late last year, Mr. Hodges said, his fund was hurt by falling energy prices, which pulled down the returns of several of its holdings. “That kind of thing will happen,” he said. “You can expect that.” Last summer, he told me that over the long run — which he said is probably 50 years or more — he expects that his fund will do better than average. And he reiterated that view last week. “We’ll come out all right in the end,” he said. “I think if you pick a good manager, someone you believe in and you think you can trust, you’ve got to stick with him for a long time, and if he’s good, he’ll perform for you.”

Mr. Loggie and his crew are continuing their regular monitoring of mutual fund performance. Right on schedule, they did another winnowing of mutual funds through the five years that ended in September — and they will do another one for the five years ending this month.

The September performance derby produced more funds that ended up consistently in the top quartile — nine of them, Mr. Loggie said. “That’s not surprising,” he said. “Some periods you have more funds, some periods you have less.”

But what you never have, he said, is any indication that past performance predicts future returns. “It’s possible that any one of these funds will beat the market over the long term,” he said. “Some of them will do that. But the problem is that we don’t know which of them will do that in advance.” And that, in a nutshell, is the kernel of the argument for buying index funds.


http://www.nytimes.com/2015/03/15/your-money/how-many-mutual-funds-routinely-rout-the-market-zero.html?rref=collection%2Fcolumn%2Fbusiness-strategies

Asset Management Accounting 101 (A Conceptual Overview)

The single biggest metric to watch for any company in this industry is assets under management (AUM), the sum of all the money that customers have entrusted to the firm.

An asset manager derives its revenue as a percentage of assets under management, AUM is a good indication of how well -or how badly - a firm is doing.

Unlike a bank or insurer, where big losses can cause the firm to become insolvent, big losses in asset management portfolios are borne by customers.

Big losses will affect fee income by reducing AUM, but an asset manager could lose well over half the value of its assets under management and still remain in business.

In a worst-case scenario, customers could withdraw their remaining dollars and the firm could fold if its fee income became inadequate to support its operations.

But because asset management requires almost no capital investment, these companies can pare back to the bone to remain in business.



Additional notes:
Asset management firms run money for their customers and demand a small chunk of the assets as a fee in return.

This is lucrative work and requires very little capital investment.

The real assets of the firm are its investment managers, so typically compensation is the firm's main expense.

Even better, it doesn't take twice as many people to run twice as much money so economies of scale are excellent.

This means that increases in assets under management - and therefore, in advisory fees - will drop almost completely to the bottom line.

All this adds up to stellar operating margins, which are usually in the 30% to 40% range - something you won't see in many industries.

Investors care more about performance than fees

Critics say most fund managers are failing to reveal the true cost of investing.

More than a third of investors consider performance the single most important factor when choosing a fund.

More than a third of investors consider performance the single most important factor when choosing a fund 

By Emma Wall

2:35PM BST 08 Apr 2013

Comment

Consumers rank past performance as the most important consideration when choosing a prospective investment, followed by who the fund manager is and how the portfolio is distracted.

Although fees and charges are a hot topic among investment forums and financial advisers, the survey, conducted by the Association of Investment Companies (AIC) using survey data from Morningstar, revealed investors themselves care less about cost.

Jacqueline Lockie, at the AIC, said that investors should rethink their priorities when it comes to constructing their own portfolios.

She considered portfolio composition by far the most important of all the options.

"Research shows us that the way to control returns is to identify the asset allocation," she said. "It’s all about risk."

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She considers charges the second most important factor: "All charges on a fund drag back its performance and reduce it. If a fund increased by 7pc in the last year, but the total charges were 1.5pc, the returns to the investor would be only 5.5pc. The bigger the charge, the harder the fund has to work to stand still."

Last week, the chief executive of the Investment Management Association called on fund managers to reveal real investing costs and set out charges on annual statements as pounds and pence.

The charges levied on investments and pensions have come under intense scrutiny in the past two years. The Telegraph has led a powerful campaign against high fees on retirement savings, in particular.

Critics say most fund managers are failing to reveal the true cost of investing. The vast majority of managers of unit trusts and Oeics, the most commonly held investments, advertise an annual management charge, which is normally around 1.5pc.

But this doesn't include the other costs of investing. Analysts also use a measure called the total expense ratio (TER) to compare funds but even this does not capture the full cost.

http://www.telegraph.co.uk/finance/personalfinance/investing/9979154/Investors-care-more-about-performance-than-fees.html