Merryn Somerset Webb: Focus on your target, aim and fire
Published: December 5 2008 18:40 | Last updated: December 5 2008 18:40
Three years ago, Albert Edwards and James Montier, then of Dresdner Kleinwort Wasserstein, published a fabulous report called ?Seven Sins of Fund Managers?. It explained how a variety of ?behavioural weakness?, all ?inherent in the average investment process?, caused average fund managers to make endless mistakes. The sins? First, using forecasts as the centrepiece of analysis in spite of reams of evidence proving that ?investors are generally hopeless at forecasting?. Second, being ?obsessed? with gathering detailed information instead of looking at important things such as earnings quality. Third, wasting hours having love-ins with company managements. Fourth, trying to ?beat the gun? by being overprecise in timing market entry and exit points. Fifth, making investment into speculation by overtrading. Sixth, ?getting sucked? into believing interesting but often ?hollow ? stories. And finally, interacting too much in a group and so investing in exactly the same way as the rest of the group.
Rereading it today, you can see how a manager who had even skimmed it might have been able to avoid the worst of the bear market. Sadly, it seems very few managers did: they are still making the same mistakes. Take a press release sent out by one fund manager, with a masters in investment analysis, just after the announcement of the 1 percentage point rate cut. He was pleased with the cut because ?the fund has exposure to a number of housebuilders retailers and pub chains? all of which would do well out of ?increased consumer spending and lower interest charges?. His investors could be forgiven for wondering why, when the writing has been on the wall for anything consumer-related for well over a year, he ?has exposure? to them in the first place. Rather than fussing about interest charges on builders? books (sin number two), might he not have been better off noting a year ago that the housing crash was going to pretty much wipe them all out?
Then take a fund manager who told me earlier this year that his fund hadn?t done as badly as the index because he?d seen trouble coming and was under- weight in financials. Yes, instead of having 25 point something per cent of his fund stuffed into the collapsing banking sector he had only 23 point something per cent worth of exposure to it. An example of clinging to a group consensus or benchmark (an element of sin number seven) at its most nonsensical.
The result? Practically no UK funds have made it through this year in positive territory and most have underperformed the index they are supposed to aim to beat. This isn?t unusual. S&P finds that, in general, a good 70 per cent of actively- managed funds under- perform the market while a study by T Bailey Asset Management found that between 2000 and 2007, an index tracker fund would have beaten 95 per cent of the active funds in the UK All Companies Sector. This is in spite of Montier finding that 75 per cent of fund managers in 2005 considered themselves to be ?above average? at their jobs.
So how did all these nitwits get to be in charge of your money? Easy ? bubbles reward stupidity. Buying what everyone else is buying; believing every story you are told about the likes of Asian decoupling; and focusing on pointless detail at the expense of an overview is the way to make money. If you were the kind of person who didn?t do all these things ? i.e. you stopped to think ? you might find yourself questioning the basis for the bubble. And that way underperformance lies. What all this tells us is simple. If you want to be in the market, be it a bull or a bear, either pick stocks yourself (odds are you won?t be any worse at it); buy exchange traded funds (at least that way you won?t underperform the market); or buy funds that aim for absolute returns. Given how easy (and satisfying) it is to sneer at hedge funds these days you might think the absolute returns concept has had its day. It hasn?t. The idea that anyone with a vague claim to investment management skills can claim the ability to make absolute returns and then charge insanely high fees for not doing so might have had its day. But the core idea ? that an actively- managed fund should have as its benchmark not an index but a return above that offered by a savings account ? is, I think, only just beginning to get the attention it deserves. Note that while the average UK fund is down more than 14 per cent over the last three years, according to Trustnet, the UK absolute return sector (not hedge funds as a whole, just UK funds aiming for an absolute return) has returned just over 1 per cent.
Clearly, you?d have been a lot better off with a savings account. But the results do suggest that having an absolute target to beat focuses the mind more than not having one.
Merryn Somerset Webb is editor-in-chief of Money Week and previously worked as a stockbroker. The views expressed are personal.