There was a time when the term “fund manager” made bankers tremble, and request a quick change of pants. From the 70’s to the 90’s these were the GODS of the financial world. They could make fortunes by sneezing too hard. Then the impossible happened: The Gods fell. In this article, we find out why fund managers have gone from Alpha dog to starving mongrel:
What is a Fund Manager?
A fund manager is someone paid to manage a portfolio (bonds, stocks, etc.). They might work alone, in pairs, or as a whole team. But their job’s always the same: To take control of a portfolio, and grow its value.
We also call them investment managers, or active managers.
Now, in return for growing a portfolio, fund managers take a cut. This is usually a percentage of the total value of assets managed. So if their management fee’s 1% per year, and they handle a portfolio with $5,000,000 worth of assets, they’d get $50,000.
“But so what?” we used to think, “These guys will make us rich.”
Up till a decade ago, we believed fund managers had super-powers. That they could time the market like a Swiss watch, and spin gold from spit.
Then one day, people like Fred Schwed Jr. asked: “Wait a second. Where are the customers’ yachts?”
And that’s when we realized fund managers were rich…but their clients sure as hell weren’t. We also noticed a bunch of other problems:
- It’s hard to pick a good fund manager
- Fund managers are expensive
- Market timing is a questionable tactic
- It’s impossible for every fund manager to deliver on their claims
1. It’s Hard to Pick a Good Fund Manager
Fund managers differ in terms of skill. The fund manager you engage could be the next Anthony Bolton. He could also be a complete smurf, with a streak of cluelessness that’d span the causeway to Johor.
Considering the ratio of Anthony Boltons (one) to crap fund managers (several thousand), what do you suppose your chances are?
Sure, you could look at a fund’s history. But remember that, over 20 years, a fund could have been in the hands of three, five, maybe ten different fund managers. You have no way of knowing if the current one’s good.
Also, it’s not easy to evaluate a fund manager. You have to be able to look at reels of statistics and performance data, and work out whether he’s worth hiring. That’s something even finance experts struggle with, let alone lay investors.
That’s why Singaporeans back away from fund managers: Because we don’t know who the hell we’re hiring. We know there are some good managers out there, but (1) they’re rarer than unicorns, and (2) we can’t tell who they are.
2. Fund Managers are Expensive
I’ve explained management fees before, but that’s not the end of it. There are plenty of fees in active management. There are fees for shuffling stocks around, administrative fees, sometimes even fees for advertising the fund.
(Yeah, that’s right. Buy into an actively managed fund, and you could be paying for those ads in the MRT. Enjoy.)
By the time we stack up all the fees, you’ll realize actively managed fund costs way more than the manager’s 1%. Let’s just say you need to work out the TER (Total Expense Ratio). That’s the total fund costs divided by the total assets.
You’ll find the expense ratio is significantly higher than the management fee; numbers like 4% or 5% are not uncommon. You need to deduct the TER from your returns, to determine how much you’ve made from a fund. So if you get 9% returns, but the TER is 4%, you’ve only really made 5%.
Now imagine if the fund manager doesn’t do too well. He generates returns of 3%. With a TER of 4%…well, you do the maths. And I don’t need to remind you how Singaporean kiasu-ism reacts to steep fees.
3. Market Timing is a Questionable Tactic
Market timing is the art of buying low, and selling high. Fund managers “time” the market, so they buy stocks when they’re cheap, and sell them once the stock prices rise.
Is such a thing possible?
I don’t know. Do you believe in Tarot cards and Bigfoot? Because that’s the level of question we’re dealing with here.
I give fund managers the benefit of the doubt. I believe that, with skill, it’s possible to time the market better than the average person. That’s why I claimed in point 1 that there’s still good fund managers. But I’d be arguing against a Nobel Prize Winner, and Princeton Professor Burton Malkiel.
Malkiel claims that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts“.
To think fund managers accuse me of being rude.
4. It’s Impossible for Every Fund Manager to Deliver on Their Claims
As many Singaporeans have learned, fund managers often can’t deliver on their promises. Here’s why:
Say we have a tiny market, where the total gains for the year are just $5 million. In this market, there are just five fund managers. Each fund manager has promised above average returns.
Now, the five million in total gains is going to be divided amongst them. It’s not possible that each one gets exactly one million; we know markets don’t even out that way. What’s realistic is that one or two fund managers will come out on top, whilst the others are at the bottom:
Fund Manager A: $3 million
Fund Manager B: $1 million
Fund Manager C: $0.5 million
And so forth.
The point is that only one or two of the fund managers can meet their claims of “above average returns”. The others sink to the bottom. It’s impossible for every fund manager to have above average returns, because for every such winner, there has to be losers.
So what you’re really doing when you hire a fund manager…is betting that yours is a winner. Not too different from race horses. We’ll be going more into advice on how you can handle investments yourself, so follow us on Facebook and stay tuned!
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