Mutual Funds for the Utterly Confused: The Manager’s Delimma
And there is no shortage of critics. MarketSci believes in what is known as the quantative approach. Subscribers call themselves quants. He believes that by locking those of his ilk in a room would help them think outside the box. Step in the box to think outside of it. Curious.
(Before we move on, a quant or quantitative analyst, as described by Wikipedia is a “person who works in finance using numerical or quantitative techniques. Similar work is done in most other modern industries, but the work is not called quantitative analysis. In the investment industry, people who perform quantitative analysis are frequently called quants. Although the original quants were concerned with risk management and derivatives pricing, the meaning of the term has expanded over time to include those individuals involved in almost any application of mathematics in finance.” For those of you who are still confused. most mathematicians as these quants tend to be, can’t figure out simple math - the kind we live with everyday.)
Cam Hui at the DailyMarkets thinks a little differently but not by much. He poses the question: “would you buy sushi from a pizza joint?”, a suggestion that you, the fund investor are perhaps looking for something you thought might exist in a place where it clearly doesn’t.
Although Mr. Hui, your defense of mutual fund managers brings up a lot of arguably good points, the failure of fund managers lies with the next level of manager in the chain, the fund family. Not the fund investor as you would suggest.
Mutual fund managers now are even with the rest of us. Quants or not, subscribers to modern portfolio theory or not, stockpickers or not, they are forced to do two things that open their profession up to the foibles of behavioral investing.
First, they must perform. Performance is key to attracting shareholders and keeping the folks that are still on board invested. This is tricky business with or without a successful investment model.
Second they must perform for shareholders of the public company that many mutual funds are. These shareholders are concerned with profits, not the underlying models that attain those profits or the people that run the individual funds.
This puts all investors in a precarious situation. Who is the master? The mutual fund shareholder? The shareholder in the company that manages the mutual fund?
This problem, in almost every situation forces the mutual fund manager to adopt a “style drift”, an action that undermines the chartered focus of the fund and leaves investors underdiversified as fund managers try to mimic the gains (or recently, the losses) of a similar index fund. A drift can result in more narrow losses - if you have failed to use funds as a building block as you suggest. You, on the other hand suggest drift as a result of under-capitalization when many funds are forced to keep an inordinate amount of cash on hand for redemptions.
But in the current environment, when ten-year performance numbers are at or below zero, when many large-caps are now mid-caps, mid-caps are small, this is difficult to avoid. Investors, those that have avoided the temptation to slip into a target-dated funds (something I have little regard for) are left with a manager who is struggling to comprehend the market just like the rest of us. Oh the humanity!
Simple observations such as 60% stocks, 40% bonds are no longer applicable. What is applicable and has yet to be offered is increased transparency, an admittance that these “traders” were not as superhuman as we all believed and a promise to re-examine how they approach the market place.
Unfortunately, as long as the pressure comes from the top down, fund managers will continue to do everything they can to satisfy the wrong master. We may not go to a pizza shop to order sushi, but we expect an incredible pizza when we do. And fund managers have not been able to deliver this with any consistency. True skill is present when things are bad and this is sadly missing.
They control the markets. What worries me is who controls them.
