Why you may not get the best returns from the professional money managers?

December 20th, 2006

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The vast majority of the money sloshing around and influencing the movements in the market today is from managed funds (e.g. superannuation, life insurance, hedge funds, etc) and the ?professional? money managers. Individual private investors and traders usually do not have enough weight of money to move or affect the markets in a big way.

One of the pressures that fund managers often face is the unrelenting judgment on their performance. Their performances are usually measured against their competitors? performance and against the market average. To compound their pressures, their performance is often measured on a quarterly or annual basis, which in our view is woefully too short a time-frame to form an opinion on a money manager?s skill. Thus, if they under-perform their peers in the short-term, they risk losing their lucrative jobs. As a result, many fund managers have to focus on chasing short-term gains to grab an edge from their peers even though their performance, in absolute terms are unimpressive. For example, if they lose 20% in a year, they will be considered doing well if their peers perform worse and the market average is not any better.

Where is the source of such pressure?

Many managed funds seek their business among the mass retail consumers. Most of these retail investors are insufficiently educated in the art of investing. That means the only way these investors can judge the quality of fund managers is through their performances, which are measured in ridiculously short time-frames of a few months to a year. Some of these retail investors are quick to switch their wealth to another managed fund the moment they perceive that their fund manager is ?under-performing.? As we said before in How do you define risk?, one?s perception of risk will depend on whether one is investing from the retail level or among the legendary investors of excellence. Since most people investing in managed funds are investing from the retail level, managed funds have to cater to their needs by using such simplified but inadequate and misleading metrics as quality measures.

Now, our question to you is, do you want to be just an average investor or do you want to run along with the best in investing? If you decide to choose the latter, it will certainly demand a lot of commitment to acquire the necessary skills, knowledge, wisdom and patience. Many of the most lucrative returns involve taking contrarian positions, which require patience to see them bear fruit. In the meantime, short-term relative performances are irrelevant.

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