Thursday, August 28, 2008

Are Modern Conditions Tougher for Money Managers?

Some commentators say that while professional money managers used to provide value because stock markets were inefficient, modern markets are too efficient for money managers to make up for the fees they charge. I agree with the latter part of this claim, but I haven’t thought much about the former part.

The idea is that in the “old days” there was little information available to the little guy, and professionals supposedly had a huge advantage. But, with the instantaneous spread of information on the internet, professionals no longer have an edge.

For the claim about the past to be true, money managers had to be buying when stock prices were low, and selling when they were high. After all, the only way to outperform in the stock market is to sell stock for more than you pay for it.

I came across a 30-year old quote from Warren Buffet showing that money managers in the past weren’t doing their job very well for at least one time period:
“An irresistible footnote: in 1971, pension fund managers invested a record 122% of net funds available in equities – at full prices they couldn’t buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks.”
These pension fund managers made a huge error of record buying at high prices followed by record selling at low prices. Buffett continues:
“In 1978 pension managers, a group that logically should maintain the longest of investment perspectives, put only 9% of net available funds into equities – breaking the record low figure set in 1974 and tied in 1977.”
The evidence says that during this period, pension fund managers behaved like momentum investors following the herd. So, I’m sceptical that professional money managers as a group ever provided value.


  1. "So, I’m skeptical that professional money managers as a group ever provided value."

    What they did provide was a highly paid sales force that rammed mutual funds down the throats of individual investors.

  2. I agree, and at the same time, I don't envy the fund manager's job (their salaries *are* enviable, though). Even if they are able to add value through expertise, the advantage is likely to be negated by fees and by size. I would be a worse investor if I had to invest $100 million, though that would have its advantages too. Hmm... "how to make $8 million a year without really trying".

    Then there's the whole competitive nature of the business. Who wants to stray from the herd and risk under-performing by 10% when you can mimic the market (closet index) and make a great living.

    Don't they say, it's better to lose money on IBM along with everyone else, than make a little on some stock no one has heard of?

    Fund managers also have to contend with fluxes in capital. A bear market is a great time to be adding to positions. However, it's also the time that your unit holders are likely to get scared and pull out their money.

  3. Mark: Your comments are harsh, but they are consistent with my personal experience.

    Gene: I once heard an investor express the social nature of investing quite clearly. It went something like "I'd rather lose money at the same time as my friends than make money sitting alone." I don't share this feeling, but I guess I understand it.