Pick experienced managers, and other bad (but plausible) advice

Posted by Robin Powell on October 21, 2016

 

I remember Dan Goldie, the former tennis pro turned financial adviser and investment author, telling me once that he compared belief in active management to belief in Santa Claus. That, of course is ridiculous. One of those is patently sentimental nonsense, while the other is just about credible and, in any case, provides stressed out parents with an excellent way to control their children’s behaviour as Christmas Day approaches.

Seriously, though, the case for using actively managed funds, is so darned plausible. The markets are complex, Mr or Mrs Investor, and you yourself are far too busy to pore over company accounts and the latest economic data. What you need to do is to find some very clever people who know what they’re doing to pick stocks for you, to switch into safer assets just as markets reach their peak, and back into stocks just before the next bull run starts.

That plausibility, combined with our susceptibility to the constant barrage of PR, marketing and seductive advertising the industry subjects us to, helps to explain why, around the world (including, even now, the United States), active management remains the investment option of choice.

Another example of something that sounds eminently sensible but actually doesn’t bear scrutiny is the idea that it pays to use an experienced fund manager with an established track record. We hear it all the time, and who could possibly argue with a statement like that? Of course we want an experienced fund manager. After all, you wouldn’t entrust your wealth to a fresh-faced graduate who was barely out of nappies when the dot coms crashed.

Or would you? New research from Cass Business School shows, perhaps surprisingly, and certainly counter-intuitively, that experienced fund managers are often just the managers you need to avoid. The findings come in a paper by Professor Andrew Clare entitled The performance of long-serving fund managers.

What makes this particular study so interesting is that, unlike most similar studies, which look at the performance of funds, this one analysed the returns delivered by individual managers — specifically 357 equity managers based in the US with a track record at a single fund of at least ten years, as of December 2014.

There is, of course, a huge issue here with survivorship bias. Managers who survive for ten years in the same job are those who’ve done relatively well. But don’t go thinking that the longer they remain in post the better their returns become. In fact the very opposite is true. The Cass study found that long-serving managers tended to show a “gradual deterioration” in performance over time rather than improving with experience. Indeed the excess return they produced between Years 7 and 10 were, on average, negative.

“This report,” to quote Professor Clare, “tackles a long-standing myth. Until now, the saying that ‘there is no substitute for experience’ has gone unchallenged in the world of asset management. With this analysis we can determine that this is not actually the case.”

So, what’s the explanation? One possibility is that earlier in their careers some managers are willing to take more risk, thereby increasing their chances of winning (or losing) big. Another explanation is that some managers are simply lucky to start with but eventually succumb to mean reversion.

“It’s almost as if the manager had two or three good years and then their performance trended back to the average,” said Professor Clare.

“Then essentially they’ve stayed in their post because they develop a reputation inside and outside the firm, which makes it more likely that they’re going to stay on.”

So, armed with these findings, should you deliberately seek out funds run by inexperienced fund managers? Of course not. You may be able to pick a long-term winner in advance, but the odds of doing so are heavily stacked against you. And if you seriously think you can pick a whole portfolio of future star performers, you might as well believe in flying reindeer.

 

Professor Andrew Clare: The performance of long-serving fund managers

 

ROBIN POWELL is a freelance journalist and the founding editor of The Evidence-Based Investor. Based in Birmingham, England, he founded Ember Television and Regis Media, and he specialties in helping disruptive financial firms to grow. He also campaigns for a fair, transparent and sustainable investing industry. You can follow him on Twitter at @RobinJPowell.

 

Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.

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