Saturday, September 30, 2006

Investing in a professional-managed fund

When putting money in a professional managed fund, it is important to gain an understanding into how the people behind it operate and behave. Professional managed funds includes Insurance companies, Institutions, Pension Funds, Mutual Funds or any funds that are managed by professional money managers.

As these funds are usually Other-people-money, it is wise to understand how they operate. People do not usually take as much diligence in guarding other people asset more than their own.

In the fund industry, often if not all the time, money managers follow the herd mentality. Money managers are always rated relative to how the index does. Even if a stock is extremely overvalued, for instance, Amazon during the dot-com boom at USD400 per share, many funds are buying into the stock then. If a fund manager blanched at paying $400 for a profitless bookseller, and as a result his fund returned only 15% return when all the rest who bought the stock return 20%, he could expect to lose investors, at least part of his bonus, and possibly his job. On the other hand, if he took a gamble on Amazon, along with everyone else, he would be safe. Even if the whole internet sector blew up, and he lost, say, 15% of his client’s money, he would not be blamed as long as his benchmark index lost 15% or more.

So if you are a professional portfolio manager, the best way to keep your head down is to invest with the herd. More than ever, money managers are judged and rewarded based on their relative performance – how well they did when compared to a benchmark index or to their peers. For them, the greatest risk is not losing money; the greatest risk is missing the upside if the market continued to go up.

A prudent individual investor would not eat relative performance. What matter to him is absolute performance – the dollar value of his portfolio in 5 or 10 or 15 years.

The risk for money managers is more on career risk than investment risk. What counts is the past 6 month performance. Even if they lose 15% of the client’s money when the benchmark index loses 18%, they are the seen as the star performer of the industry.

3 comments:

8percentpa said...

This explains why 80% of the fund managers underperform indices. It is not that they want to, but they are bounded by institution mentality and all that, it is hard to break away.

It is better to be wrong with the crowd as they always say. But those that manage to deviate do perform very well. Like Peter Lynch.

fishman said...

They collect lots of money from investors in the form of management fee, yet they are allowed to lose money at the same time.

The whole idea was to have a professional manager who can do a good job. If not, why let them earn the money??!! Just look at the plight of investors who were invested in Amaranth Advisors.

But then because I have no experience or knowledge at all of the stock market, I'll take a bet with the so-called gurus...untill I'm ready!

Berkshire said...

If an investor choses to join the herd where they may feel they get a little warmth, the key decision to make is where to stand in relation to the rest of the herd. The grass is always greener and much more at the edge of the herd.

For most investors, whether hedge funds investors or retail investors, the strangest thing to me is they do not seems to mind as much or feel as bad if they were to lose together. Called that crowd mentality. It is the same as you being scolded singlely by your boss versus being scolded as a group by your boss.

To invest in something you do not know how to gauge or its outcome, it is gambling where the outcome can goes either way. It is really unwise to put money into something where each outcome has an equal chance of happening. I think it is much better to remain inactive and preserve your principal in any way that is most secured, be it earning 0.5% in the saving account or FD or whatsoever. It is so much harder to earn than to loss. Lossing is easier than winning. Better to take all precautions to make it work in the safest and best way.