How do I tell good managed funds from bad ones?

[Julia]

From yesterday's Business section in "The Australian":

One of Australia's most prominent private equity figures, Carnegie Wylie cofounder Mark Carnegie, has hit out at the excessive fees and lack of transparency within his own industry, urging superannuation investors to do more to hold it accountable.

The financier has called for the alternative asset classes - including private equity, venture capital, hedge funds and infrastructure - to be subject to the same rules and regulations as public companies managing super funds, including the requirement to disclose links between performance and executive pay.

Speaking at a SuperRatings conference in Malbourne yesterday, Mr Carnegie said he was aware of investment managers who could afford luxury beach houses on the back of their million dollar management fees alone, despite their failure to outperform the market.

"When you look at some of these base fees, they're absolutely obscene," he said. "There isn't enough pressure for people to disclose this. I know people who'd be shocked in any other industry."

 

[doctorj]

Sorry if I was unnecessarily vehement in my support of Sir O's remarks, but it's something about which I feel strongly. I'm just tired of hearing people say how much they are down in their Super and other managed funds since the GFC.

It’s unfortunate that people lose money. What’s even more unfortunate is that people have become particularly accustomed to the idea that losing money is the exception, rather than a real possibility. For a long time, the markets have only gone one way, but it’s the exception, rather than the rule. There is no return, without risk. Many people were more than happy to book exceptional returns (15-20% or even higher) and in fact have benefited greatly from it and now they’re suffering the other side of the coin.

With a managed fund, you invest in a strategy and the fund manager has to invest within those rules. They’re not a promise of return and they’re not a guarantee that a particular product is good for you (it’s probably a different story with financial advisors and superfunds as you’ve mentioned, but the subject is managed funds…)

No, perhaps not, but many simply are too lazy or uninterested to educate themselves financially.

I'm not sure how you'd know that 'many people investing in managed funds are a lot more successful than any of us here?
You've chided me for rhetoric, and I will do the same in return over this statement.

Fair play. My logic behind this statement is that globally, there are very large amounts of money under management – much more than can be accounted for by retail investors (which most are here at ASF). A lot of this money comes from pension funds and insurers, but it also comes from wealthy individuals. Anyhow, I agree it’s only relevant in trying to illustrate the argument (and the only argument that I’m trying to make) is that there are good managed funds, good fund managers and depending on an individual’s circumstances and objectives, they may benefit from investing in them.

Agree that the principle of ensuring people put money aside for the future is absolutely necessary. What I'm questioning is that professional fund managers necessarily do better than individual investors who take the trouble to educate themselves and then devote reasonable time to looking after their investments.

Of course, it’s entirely possible that an experienced retail investor with a modest sized portfolio could outperform a fund in any given period. That’s why everyone is at ASF – they desire to be in that position and their dedication is to be admired (and hopefully one day rewarded). The problem is that there are only 24 hours in a day and people’s time may be better spent doing other things. There’s quite a difference in the time taken to dd on a set of managed funds vs becoming a consistently competent trader/solo investor. Aside from time, there are also other reasons an individual might be interested in a managed fund – diversification, access to different asset classes, international exposure, leverage others expertise etc.

Well, that's a matter of opinion. Diversification doesn't necessarily reap better rewards. Personally, I'd rather put more into a sector that's running well, go with that trend, and then exit when it falls from favour.

As you said, each to their own.

From yesterday's Business section in "The Australian":

So does that make him a good fund manager or a bad one?

 

[Julia]

So does that make him a good fund manager or a bad one?

I don't suppose it makes clear whether he is himself good or bad.

I just posted it because I found it interesting that an 'insider' in the industry could so slam the performance of many of the contributors to that industry.

Your points about the usefulness of managed funds are well made, doctorj, and I quite understand what you're saying.

From time to time I just get a bit irritated by all the people who are so critical of how their Super and other managed funds have lost money, but who are not prepared to take some responsibility for their own outcomes, even if this just means understanding the options they might have within the various types of managed/super funds.

Anyway, thanks for the civilised discussion.

 

[basilio]

This is a very useful thread and certainly brings up many of the issues that many longer term investors or "observant" observers would have noticeed about the funds industry.

I thought Julia's quote from Mark Carnegie who noted how well investment mangers were doing while their clients received little was the most telling. Inside that picture there should also be the realisation that the nominal increases in market indexes have fundamental flaws which systematically overstate the increases in share value. The problem lies in that the index is always changing as companies fall and are replaced with better performers. That will tend to keep the index higher than the actual investment funds which continue to take the losses from the failed companies.

And of course any increase in market indexes isn't adjusted for inflation or the ongoing management costs of investment bodies. As mentioned a few times these fees are taken at many levels and through good times and bad which magnifies the costs.

On a personal note I can offer the experience of knowing one particularly ethical and effective financial planner who was very good and attempted to look after his clients. The problem? By being so professional and careful with his clients interest his employers were not making enough money... That had it's inevitable consequences and that probably says it all.

 

[doctorj]

From time to time I just get a bit irritated by all the people who are so critical of how their Super and other managed funds have lost money, but who are not prepared to take some responsibility for their own outcomes, even if this just means understanding the options they might have within the various types of managed/super funds.

Agree here. Whether it’s a fund or the latest hot spec stock, there is only one rule - caveat emptor. By taking shortcuts, you only risk your own coin.

Anyway, thanks for the civilised discussion.

It’s been fun. Apologies if I got a bit agitated, but I felt that people were encouraging the OP to write off an option without due consideration for his or her circumstance.

 

[Sir Osisofliver]

OK, fair enough. I doubt that we’re ever going to agree on this – you believe that it’s always best to invest in assets directly and I believe that funds (private equity, index funds, hedge funds etc etc) offer some advantages that may benefit individuals, depending on their circumstances.

For the record, I invest professionally, but hold my personal holdings directly. Each has its own benefits. Why don’t I invest personally in the funds we invest? Mainly because I can’t – we manage our own funds.

OK we can agree to disagree if you would like, I take the view that the results are the most important factor here...having said that...

I know plenty of funds that make their investors plenty of money, but anecdotal evidence or specific examples won’t really prove anything. Here’s a paper written by University of Chicago’s Booth School of Business that shows that fund managers can/do have a statistical edge over the markets. There are other similar reports I can share from MIT etc, but I don’t have them to hand.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1477586

From your above link..... We find overwhelming evidence that the hedge fund managers in our sample have stock-picking skills. The average one-, two-, and three-year raw returns of long recommendations submitted to the site over the January, 1 2000 to December 31, 2008 period are 17.11%, 45.02%, and 74.39%, respectively. After controlling for market risk, size risk, book-to-market exposure, and momentum risk, via a control portfolio, we find excess one-, two-, and three-year returns of 9.52%, 19.03%, and 23.60%, respectively. These results are all highly statistically significant and are well in excess of any management and performance fees these managers charge their investors.

I'm sure you've heard the statement, there are lies, damned lies and statistics right? What exactly do you think the bolded line above means? I'll tell you what it means to me. They have removed MARKET RISK from their comparisons. So I will say it again in a different way. Hedging is the only way to remove market risk. Whilst managed funds do perform hedging, they are generally hedging specific types of risk (eg Currency) rather than whole market risk. Managed Funds on the whole are unable to hedge in this way because it has considerable expense to do so, and doing so locks the value of the fund. So the investors only option to remove Market risk is to remove their funds from the product (paying any exit fees applicable).

Comments?

I was referring to a Morningstar report published around the time of my post – I don’t have it to hand, but you should be able to find it on their website.

Can't be stuffed looking for as I simply cannot spare the time. If you link it I'll gladly look at it.

Investors are not fortune tellers. Without risk there is no profit. Many funds did make profit (or at least lose less than the market) at the height of the crisis – the obvious example here is Taleb who made a stack for his fund. Other funds did lose money, but most have also recovered exceptionally well. One of the largest asset managers in the world (can’t say who, but they manage several billion) had their best month on record in September and are well up on the year, despite global markets being relatively flat.

Wow that's a great chestnut. We aren't fortune tellers, we can't tell the future. (It sound suspiciously like a black swan event kind of comment.) No profit without risk. Great! lets disavow all responsibility towards the people who entrust their life savings to us.... and hey it's not our money so lets not have any risk protection in place either.

So in August 2007 when BNP Paribus said it couldn't value the assets in two of it's funds because of a "complete evaporation of liquidity" in the market, or when the European Central Bank pumped 63 billion euros to try an improve liquidity and then added another 108 billion when that was enough a week later; Or when the Federal reserve cut interest rates and warned that the credit crunch "could be a risk to economic growth"..... how much of a fortune teller did you need to be to put risk protection in place?

How about September, when Northern Rock had to apply for Emergency financial support from the Bank of England as lender of last resort causing the biggest run on a Bank seen in a century... Did we still need to be fortune tellers to put risk protection in place?

Perhaps October when UBS announced losses of 3.4 Billion dollars from sub-prime related investments...did we need to be fortune tellers then to protect the assets?

When exactly during the storm of negative overseas announcements over the next three months would it have been appropriate as an Australian Fund manager to protect the assets under their control?

Yet how many did so? Your comment about unable to predict the future - when the issue is one of risk management at an appropriate time frame
sounds to me like a control statement.

Not sure about this example – banks make money on the buy side, on the sell side, for advisory etc etc. But I thought we were discussing fund managers anyway? Yes, fund managers will go bust if they can’t raise monies for new funds, but funds tend to be 3-5 years or longer, so not investing the funds at their disposal in the short term won’t put them out of a job. The main thing that will impact their ability to raise funds in the future is the returns of their previous funds.

Yeah regardless of the time period that the 3-5 years crosses in terms of economic cycles. Since the average length of an economic cycle (In Australia at least) is 6.8 years, shouldn't that mean there is a window of opportunity that is ideal for construction of a buy and hold portfolio? What do funds do during the other 60% of the time when the market is not in its ideal buying window or falling? Oh yeah they are strutting around in thinking they are the smartest guys in the room as the markets are going up.

How can an individual hedge better than a fund? I guess what you’re asking is can a fund generate alpha returns – there’s plenty of research both ways on this, but take a look at : http://www.create-research.co.uk/pubRes/exploituncert/downloadreport.html

I think I have already answered this above.

In relation to your post immediately above.... I absolutely encourage everyone who thinks that managed funds are an appropriate investment for them to look very very carefully at what they are buying.

Cheers

Sir O

 

[roland]

I haven't really read much of this thread, but having been in a few managed funds, with my super, my wife's super and her investments still sitting with Colonial First State, I would suggest that the management of the funds is not dynamic enough.

Why there are not stop losses in place to avoid things like the GFC killing all the funds is beyond me. With Colonial I believe that the funds are reviewed every 6 months and rebalanced according to this schedule. So if a portion of the fund tanks within this time frame, then tough luck.

Of course you could rebalance the funds yourself, but lose out on entry and exit margins.

Having said all that, there is still a place for managed funds - for non active investors - but without the risk management that we are all used to with trading, then they don't produce the returns they should.

I sent an email to Colonial about stop loss strategies on the managed funds and was totally ignored...

 

[Julia]

Why there are not stop losses in place to avoid things like the GFC killing all the funds is beyond me.

Perhaps because to have moved to cash when the GFC threatened would have cut off the commissions received by the fund managers.

 

[Tukker]

Perhaps because to have moved to cash when the GFC threatened would have cut off the commissions received by the fund managers.

A senior portfolio manager in the east told me exactly the same thing over a beer.

To add my own belief however, couldn't the massive shift from equities to cash be one of the main contributing factors of the GFC? The result of said dodgy fund managers/advisers signaling a financial event horizon, compounding the spiral of doom?

If sophisticates control 90% of the stock market's trend, isn't it fair to assume that if they all dumped at the same time then there would be no significant market to trade?

Imo its a game of follow the leader really.

 

[Dona Ferentes]

here's a really good one NOT

Mike Hill’s Bombora Investment Management, attributed market cap of $125 million, froze redemptions from its main fund last year, as funding markets remained shut for pre-IPO companies and its listed holdings underperformed.

Investors in the Bombora Special Investments Growth Fund were told they couldn’t make withdrawals in September, with the change applied retrospectively. Bombora plans to review the arrangements in March, but the freeze is expected to stay in place until June or a total of 12 months.

The fund has 20 investments, including at least six float candidates in edtech Pathify, accounting software firm Ezy Collect, gaming simulator Orbx, video content technology play 90 Seconds, Aussie Plant Based Food and LVX Global.

In addition to pre-IPO names, there’s a 20 per cent allocation to listed names like pet care marketplace Mad Paws (down 42 per cent in 12 months), edtech Janison (down 53.57 per cent), healthcare software player Beamtree Holdings (down 29 per cent) and customer engagement software business Gratifii ( down 60 per cent)..

.. geez, and fees?