Another week sees another monster fine levied against a bank for rigging the markets – in this case Deutsche Bank has had to stump up $2.5bn for manipulating Libor, the rate at which the major banks lend to each other.
The scale of banks’ malfeasance over recent years has really been remarkable, to such an extent that new evidence of their fraudulence now raises little more than an eyebrow on the part of investors. We are all suffering from “deception exhaustion”. Since we now expect banks to behave badly, being shown evidence that they continually do no longer surprises us.
The journalist Michael Lewis makes an excellent point about the danger of regulators being somewhat late to the party: “Financial regulators, like editorial writers, are at best the markets’ last line of defence; they are less inclined to join any battle than they are to wander in afterward and shoot the wounded.”
But while the banks are currently the most prominent lightning rod for regulatory zeal, one wonders whether fund managers might be the next in line for a visit from the boys in blue?
Certainly, nobody could accuse the fund managers of being under-nourished. There are more than 250,000 actively managed funds on Bloomberg’s database of managers. But they are all prone to conflicts of interest. So how can you sort the wheat from the chaff? The good guys from the greedy? How can anybody possibly filter a universe of that size down to something more manageable? Here are some of the characteristics I look for when considering allocating money to a third-party specialist manager.
Has the manager invested his own money? If he’s not willing to eat his own cooking, why should you? Meaningful personal investment is no guarantee of outperformance, but all things being equal, it at least aligns the interests of manager and investor.
Independent administration: nobody wants to fall victim to the next Bernie Madoff. Ensuringthat funds’ custody and audit functions are performed by entities at least one step removed from the fund manager is simple common sense.
Appropriate size: the tree cannot grow to the sky. But try telling that to fund-management groups. Since the managers’ pay is normally directly linked to the size of assets under management, the bigger the fund, the better paid the manager. It takes guts (or at least principles) to turn money away. But that’s precisely what many smaller investment boutiques do on a regular basis.
Independence and owner-management: David Swensen, chief investment officer of the Yale Endowment, says he prefers smaller, private partnerships to larger, publicly-listed subsidiaries of full-service investment firms (notably insurers and banks).
The larger fund-management groups employ a higher number of staff who sit between you and your money. The more mouths that need to be fed by your fees, the lower your returns. All things being equal, the smaller boutiques are more likely to deliver the sort ofafter-fee returns that you seek.
A genuine competitive advantage: there are lots of funds managers around, plenty of them “me too” players who bring very little real differentiation or value to the party. What investors want is to allocate their capital to someone with a definite “edge”, rather than a quasi-index tracker with messianic delusions of relevance. And although the regulator frowns on the emphasis of past performance, what else is there to go on in assessing managers?
Asset managers, not asset gatherers: this gets to the heart of the challenge facing fund investors today. The investment world is polarised between asset managers, who focus their energies on delivering the best possible performance for their clients; and asset gatherers, who just want to maximise their number of clients.
How can you distinguish between the two? It’s not easy, but tuning out the more ubiquitous advertising and marketing messages is unlikely to hurt. Try to find fund managers like the celebrated investor Jean-Marie Eveillard who once remarked: “I would rather lose half of my shareholders than half of my shareholders’ money.”
The fund marketplace is clearly larger than it need be. It is oversupplied and there is insufficient “talent” to support the sheer number of funds out there. Asset-management groups might wish to cut their fund ranges before the regulators force them to.
• Tim is director of investment at PFP Wealth Management. He also writes The Price Report newsletter with Doug Pritchard.
Category: Market updates