Evaluating Discretionary Stockbrokers and Money Managers

Some stockbrokers function as money managers, having discretionary investment authority over some or all of their clients' funds. Practices such as these may entail serious conflicts of interest since compensation is made on the basis of trading commissions rather than investment results. Nevertheless, you would select a discretionary stockbroker just as you would choose a money manager. The questions to be asked are virtually identical. In both cases, while there are large pools of people from whom to choose, selecting someone to handle your money with prudence and fiduciary responsibility is never easy. 

The ultimate challenge in selecting a stockbroker or money manager is

• understanding precisely what they do, 
• evaluating the validity of their investment approaches (do they make sense?) and 
• their integrity (do they do what is promised, and is it in your best interest?). 

How do you begin to evaluate stockbrokers and money managers? 

There are several important areas of inquiry, and one or more personal interviews are absolutely essential.

There is no better place to begin one's investigation than with personal ethics.

• Do they "eat home cooking"- managing their own money in parallel with their clients'? 
• I can think of no more important test of the integrity of a manager and the likelihood of investment success than his or her own confidence in the approach pursued on behalf of clients. 
• It is interesting to note that few, if any, junk-bond managers invested their own money in junk bonds. In other words, they ate out. 

Another area of inquiry concerns the fair treatment of clients.

• Are all clients treated equally? If not, why not, and in what ways? 
• Are transactions performed for all clients contemporaneously? If not, what method is used to ensure fairness? 

A third area of interest concerns the likelihood of achieving good investment results.

• Specifically, does the broker or money manager oversee a reasonably sized portfolio, or have the assets under management grown exceedingly large? 
• One way to judge is to examine the manager's track record since the assets under his or her control reached approximately the current level. Investors can also examine the records of other managers to determine in general how increased size affects performance. 
• From experience, large increases in assets under management adversely affect returns. The precise amount that can be managed successfully depends on the specific investment strategy employed as well as the skills of the manager under consideration. 

A fourth area of inquiry concerns the investment philosophy of the manager.

• Does the broker or money manager have an intelligent strategy that is likely to result in long-term investment success? (Obviously, a value-investment strategy would be optimal.) 
• Does he or she worry about absolute returns, about what can go wrong, or is he or she caught up in the relative-performance game? 
• Are arbitrary constraints and silly rules, such as remaining fully invested at all times, absent?

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. 

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

Understanding these changes in the investment world allows investors to earn superior returns

The changing scenario in the investment world

The investment world has changed over the last several decades.

From 1950 to 1990, the institutional share of the market rose from 8% to 45%.

During the same period, institutions comprise 75% of market trading volume. 



The short-term mindset of the institutional investors

The institutions are hampered by a short-term mindset.  

Here are some reasons.

1.   Money managers tend to be rewarded not on what they return to clients, but rather as a percentage of their assets under management. 

A larger base of cash actually makes it more difficult to generate returns.

Thus there is a conflict between what's best for the manager and what's best for the investor.

2.   Institutional investors are also "locked into a short-term relative performance". 

Frequent comparative rankings among institutional investors forces a short-term mindset, as a long-term view can quickly send a manager to the unemployment line. 

As a result, these managers act as speculators rather than investors.

They try to guess what other managers will do, and try to do it first!

Only the brokers, who benefit from frequent trading, win this, as short-term market fluctuations are random. 

3.   Institutional investors are also constantly compared (and comparing themselves) to index benchmarks. 

Due to this relative comparison, they tend to prefer being close to 100% invested, even if things don't look cheap on an absolutely basis, which hurts investors when stocks are expensive.

4.  Money managers rarely invest their funds along with their clients.

In this conflict of interest situations, it is clear that the management firm wins.

Economist Paul Rosenstein:

"In the build­ing practices of ancient Rome, when scaffolding was removed from a completed Roman arch, the Roman engineer stood beneath. If the arch came crashing down, he was the first to know. Thus his concern for the quality of the arch was intensely personal, and it is not surprising that so many Roman arches have survived."

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's good for Wall Street is not necessarily good for investors.

How Wall Street does its business?

It has a very short-term focus. 

For example, Wall Street makes money up-front on commissions (not from long-term performance).

Therefore the Wall Street will always push for churn and will always push "hot" investments.

Is this business model fundamentally wrong?

Some argue that there is nothing fundamentally wrong with this business model. 

After all, many professionals make money in this manner without being responsible for the long-term results. 

It is, however, important that investors recognise this Wall Street bias, or they will be robbed blind.

This business model also encourages very short-term thinking, and a bullish bias. 

If stocks are going up, Wall Street is able to make more in the form of commissions. 

This bullish bias is seen in the percentage of stocks that are recommended by analysts versus those that are deemed "sells".

There are many examples of Wall Street's short-term bullishness that props up prices of various securities, but where those prices eventually fall dramatically. 

Take Home Message for Investors

Investors are advised to keep Wall Street's biases in mind when dealing with the Street.

Investors are to avoid depending on the Street for advice.

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

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.

Legg Mason’s Miller fades away. Onetime superstar manager leaves a tarnished legacy

Nov. 17, 2011

By MarketWatch

BOSTON (MarketWatch) — The forthcoming retirement of legendary mutual fund manager Bill Miller will stop the clock on his track record, but the real question is whether the lasting image will be his legendary successes or his epic failures.

Click to Play

Legg Mason's Bill Miller steps down

After running Legg Mason Value Trust mutual fund for nearly 30 years, Bill Miller is stepping down at the end of April and will be succeeded by Sam Peters, WSJ's Mark Gongloff reports on Markets Hub. Photo: AP.

Over almost three decades at the helm of Legg Mason Value TrustLMVTX +1.72% , Miller made his mark with a 15-year steak of beating the Standard & Poor’s 500 index SPX +1.34% . It’s not that Miller’s fund made money every year from 1991 through 2005, but he was the anomaly, the active manager who did better than an index fund in all conditions. As mutual funds became mainstream investments through the 1990s, investors flocked to him.

Even as the Internet bubble burst, Miller was able to top the index despite big bets made on Enron and other troubled stocks, convincing investors that he had enough star power to overcome his mistakes.

Legg Mason said Thursday that Miller will retire from fund management in April, 30 years after he started running Value Trust. But in fact, most people wondered what had taken Miller so long.

When his market-beating streak ended, Miller went from the guy who could do no wrong to one who did no right. In 2007, when the market was up, Miller was down; in 2008, Legg Mason Value Trust lost a stunning 55% of its value. (His other fund, Legg Mason Opportunity LMOPX +2.21%   lost 65.5% that year.)

The mutual-fund press made him the poster boy for star managers letting their egos take over while their performance suffers, believing that they can somehow bend the market to the power of their will and their investment style.

It doesn’t work that way.

Miller’s 2009 gains of more than 40% for the Value Trust (and 83% for Opportunity) were too late; in four of the last five calendar years, Value Trust finished in the bottom 2% of its peer group, according to investment researcher Morningstar Inc.

While the fund still has $2.8 billion in assets, you’d be hard-pressed to find anyone who would buy it now; new helmsman Sam Peters has been Miller’s co-manager for about a year now, but expecting him to be “the next Bill Miller” is unrealistic, if you are pegging that hope to Miller’s stretch run. No one who followed Fidelity Magellan legend Peter Lynch ever truly proved to be “the next Peter Lynch,” and the number of top managers who have been succeeded by bright stars is tiny.

End of an era

While Miller won’t be the last star manager, he will be the guy known for killing off the genre. The next time someone has a hot streak or a run of great performance, it will be Miller’s heyday they are compared to, and Miller’s fall from grace that is the cautionary tale used to scare investors away.

That’s not entirely fair. A $10,000 investment in Legg Mason Value Trust from when Miller took over in April 1982 is worth $235,089 today, a cumulative return of 2,251%, an annualized average return of 11.26%. The fund was one of just 14 large-blend funds to beat the S&P 500 over Miller’s management tenure (from April 1982 until now), tying for 10th place in the category over that time.

By comparison, a $10,000 investment in the Vanguard Index 500 VFINX +1.34%  is up 10.97% annualized (turning $10,000 into $217,457), and an investment in the average large-cap blend fund gained 9.76% over the last 30 years, according to Morningstar, turning $10,000 into $157,175.

The sad problem is that few people enjoyed that long record of performance. Instead, they bought in after Miller’s reputation was made, and lost money while he lost his edge. Over the last 15 years, the fund ranks in the bottom 30% of its Morningstar peer group, despite the fact that it beat the market in roughly half of those calendar years.

Evaluated by his long-term track record, Miller’s departure represents the end of an era of success that few managers have ever enjoyed. Few investors will remember him that way; instead, he’s the guy they were told was great who wound up disappointing them perhaps more than any star manager in history.

— Chuck Jaffe 

http://www.marketwatch.com/story/legg-masons-miller-fades-away-2011-11-17

Wall Street Warriors

The Fabulous Life of Billion Dollar Wall Street Ballers

Evaluating Investment Results of Yourself and Your Fund Managers

The decision to employ an investment professional should only be made after a thorough analysis of the past investment performance of the individual or organization under consideration. Some questions are obvious:

• How long a track record is there? 
• Was it achieved over one or more market and economic cycles? 
• Was it achieved by the same person who will manage your money, and does it represent the complete results of this manager's entire investment career or only the results achieved during some favorable period? (Everyone, of course, will be able to extract some period of good performance even from a lengthy record of mediocrity.) 
• Did this manager invest conservatively in down markets, or did clients lose money? 
• Were the results fairly steady overtime, or were they volatile? 
• Was the record the result of one or two spectacular successes or of numerous moderate winners? 
• If this manager's record turns mediocre after one or two spectacular successes are excluded, is there a sound reason to expect more home runs in the future? 
• Is this manager still following the same strategy that was employed to achieve his or her past successes?

Obviously a manager who has achieved dismal long-term results is not someone to hire to manage your money. Nevertheless, you would not necessarily hire the best-performing manager for a recent period either. 

Returns must always be examined in the context of risk. 

• Consider asking whether the manager was fully invested at all times or even more than 100 percent invested through the use of borrowed money. (Leverage is neither necessary nor appropriate for most investors.)
• Contrariwise, if the manager achieved good results despite having held substantial amounts of cash and cash equivalents, this could indicate a low-risk approach. 
• Were the investments in the underlying portfolio themselves particularly risky, such as the shares of highly leveraged companies? 
• Conversely, did the manager reduce portfolio risk through diversification or hedging or by investing in senior securities?

When you get right down to it, it is simple to compare managers by their investment returns. It is far more difficult - impossible except in retrospect - to evaluate the risks that manger incurred to achieve their results.

Investment returns for a brief period are, of course, affected by luck.  

• The laws of probability tell us that almost anyone can achieve phenomena l success over any given measurement period.  
• It is the task of those evaluating a money manager to ascertain how much of their past success is due to luck and how much to skill. 

Many investors mistakenly choose their money managers the same way they pick horses at the race track. They see who has performed well lately and bet on them.

It is helpful to recognize that there are cycles of investment fashion, different investment approaches go into and out of favor, coincident with recent fluctuations in the results obtained by practitioners.

• If a manager with a good long-term record has a poor recent one, he or she may be specializing in an area that is temporarily out of favor.  
• If so, the returns achieved could regress to their long-term mean as the cycle turns over time, several poor years could certainly be followed by several strong ones.

Finally, one of the most important matters for an investor to consider is personal compatibility with a manager.  

• If personal rapport with a financial professional is lacking, the relationship will not last.  
• Similarly, if there is not a level of comfort with the particular investment approach, the choice of manager is a poor one.  
• A conservative investor may not feel comfortable with a professional short-seller no matter how favorable the results, by contrast, an aggressive investor may not be compatible with a manager who buys securities and holds them.

Once a money manager has been hired, clients must monitor his or her behavior and results on an ongoing basis.  The issues that were addressed in hiring manger are the same ones to consider after you have hired one.

How the role of fund manager differs from a planner

11 JUL, 2011, 01.30AM IST, UMA SHASHIKANT,
How the role of fund manager differs from a planner

The investors who have been worried about the lacklustre performance of equity markets are beginning to ask a simple question. If fund managers are experts in investment, shouldn't they have seen this coming and protected their portfolios?

After all, most people invest in mutual funds so that their money remains protected from uncertainty. This may be a common expectation from mutual funds, but it is completely wrong. Fund managers cannot directly manage risks for investors; they are not even privy to it. The confusion stems from the fact that the roles of a fund manager and financial adviser are often mixed.

Mutual fund products are not tailored to the needs of a specific investor. They are created to mimic an asset class. So a large-cap fund is expected to invest in a portfolio of large stocks and enable an investor to gain exposure to this asset class. What an active fund manager does is to try and perform better than a large-cap market index such as the Nifty.

An investor has the cheaper option of buying a passive index fund to get the same exposure. An active fund manager takes a higher fee to alter weightages in sectors and stocks in the large-cap universe to better the benchmark index. However, if this fund liquidates the equity portfolio and holds cash because the fund manager thinks that the market is due for a correction, the portfolio would actually move away from its mandate.

First, it will underperform the index if the cash call turns out to be wrong and the market moves up. Second, there is no reason for someone to pay a fee of 2.5% for holding cash when he can put it in a liquid fund at a cost of 0.35%.

It is the job of a financial adviser to review the investors' exposure to large-cap equity, take on board the downside risks at the time, consider the risk appetite of the investor, and recommend a tactical change in weightage. It is the adviser who is privy to the investor's return targets and risk preference, who should seek liquidation of the portfolio and advise the investor to hold cash. If the adviser has already done so, the fund manager's action is superfluous and can reduce exposure to equity more than is necessary.

The fund manager's specialisation is the bottom-up research in companies and sectors, as well as the selection, timing, assigning of weightages and rotation of stocks and sectors that he holds. The specialisation of the adviser is top-down research, which should indicate how asset classes will behave and, therefore, decide the weightage in an investor's portfolio. If the fund manager's job is to deliver relative performance, it is the work of the adviser to deliver absolute performance in line with the investor's needs.

http://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/how-the-role-of-fund-manager-differs-from-a-planner/articleshow/9162198.cms

It's time for active fund managers to prove their worth

Market volatility should be an opportunity for active fund managers to prove their worth.

Market volatility should be an opportunity for active fund managers to prove their worth. Photo: Howard McWilliam

By Paul Farrow

10:00AM GMT 28 Nov 2011

3 Comments

When I worked at Money Marketing, the leading newspaper for financial advisers, in the late 1990s the City was abuzz: the stockmarket was riding high and investors were making lots of money.

At the time, fund managers tried to put me off the scent of index tracker funds.Their argument was that so-called passive funds that simply track a stockmarket could not add extra value – only managers who were selecting their own stocks could.

The active fund managers' argument would have been sound had it not been for one point I have come to realise over time – that many active fund managers consistently fail to add value. And they still do, as our front page report highlights.

Our article comes just a week or so after it emerged that sales of index tracker funds are at record levels. One factor that explains their popularity is fees, because tracker funds are far cheaper than actively managed ones. The stockmarket turmoil has put increasing focus on fees, which eat into returns. For obvious reasons, fees are under bigger scrutiny when returns are poor – few investors would give two hoots about fees if they were getting bumper returns year in, year out.

Vocal city stalwart Terry Smith has added his voice to the passive funds debate, even though he is an active manager. He argues that investing has become too complicated for savers, and that most investors would be better off buying cheap tracker funds.

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When I suggested to him earlier this year that such a comment would irritate active managers, he retorted: "I don't care if they argue that trackers will underperform. Most active fund managers underperform, and by a far greater margin, because of higher charges."

This is not to say that you should dismiss active fund managers. I readily admit that if you can find a decent one they will serve you better than a tracker fund, which will always underperform the index because of the impact of fees. As I highlighted last week, the Virgin UK Tracker has underperformed the FTSE All-Share by 50 percentage points over the past 15 years.

There are nearly 2,000 funds on the market, and an awful lot fail to make the grade – but they charge annual fees as though they do. This is why you need to ensure that your financial adviser (IFA) is earning his or her crust. There are enough decent fund managers out there, and if you or your IFA discover them, you will be chuffed to bits over the longterm.

Market volatility should be an opportunity for active fund managers to prove their worth. Yet it would seem, however, that many simply aren't up to the job.

http://www.telegraph.co.uk/finance/personalfinance/comment/8919419/Its-time-for-active-fund-managers-to-prove-their-worth.html