Tuesday, 10th December 2019
Why money managers don’t swim against the tide….
As a private investor with money to put into the market, there are basically two choices on how to proceed….
One, you can trust to your own powers of analysis, do your own due diligence, come to your own conclusions and allocate your own capital into the vehicles, instruments or stocks you determine to be appropriate for your needs….
Or two, you can trust to the ‘experts’ – professional brokers, analysts and money-managers who get paid to put your money to work for you….
There’s a whole multi-billion-pound international industry built on the idea – and constantly promoting the argument – that trusting to the ‘experts’ is the way to go….
After all, the ‘experts’ have the skills, the knowledge, the experience, the know-how, the savvy, the contacts, the inside-information, the data, the tools, the resources and the technical proficiency to get the job done more effectively – with measurably better outcomes – than poor old individuals like you and I could ever hope to achieve under our own steam….
At least that’s what ‘they’ say….
…. the self-same professional brokers, analysts and money-managers who rely on the commissions paid by private investors like you and I to put bread on the table and petrol in the Ferrari….
But there might not be as much truth in that idea as ‘they’ would have you believe….
- No better at prediction than anybody else….
The idea that the professional experts are better at predicting the movements of share prices might be more illusion than fact….
Research published earlier this year by Vanguard concludes that stockbrokers’ analysts are no better than anybody else when it comes to predicting what will happen to the prices of individual stocks….
Vanguard looked at the ‘buy’, ‘hold’ and ‘sell’ recommendations provided by brokers over a period of time stretching all the way back to the early 1990s….
What they found was that the brokers tended to recommend that private investors ‘buy’ specific stocks when they were close to or at their peak prices and to ‘sell’ specific stocks when they were close to or at their bottom prices….
Buy-low, sell-high is the formula for success in the markets….
Buy-high, sell-low is just about the worst (and most unprofitable) scenario you could envisage….
But that’s the scenario the professional brokers delivered….
- Why don’t the experts perform better?
If you’re paying somebody hefty commissions for access to their expertise, it is reasonable to expect them to perform better than you could without their help….
You know they can’t see over the horizon. You know they can’t see round corners. You know they are not clairvoyants. You know they cannot and will not predict the future correctly 100% of the time….
But it is reasonable to expect the self-professed ‘experts’ to make a better fist of the predictive job than you can. But the Vanguard research clearly serves to highlight that they don’t….
I don’t know about you, but I reckon I can find plenty of buy-high and sell-low investment opportunities that lose money or miss profits off my own bat. I think I can handle that on my own and save the commission payments….
But why is it that the so-called ‘experts’ don’t perform any better than the rest of us?
How is it that all their experience and knowledge – they do work in the industry day-on-day and it is reasonable to expect them to know more than the average private investor on the street – does not translate into results better than the rest of us could achieve on our own?
It’s an interesting question. I’ve given it some thought over the weekend. And I think I have an answer….
- The difference between say and do….
Every fund manager interviewed in a newspaper or a magazine will tell you he’s a contrarian – that his fund makes a point of not running with the herd and of seeking out the gem-encrusted investments that other funds and their managers are missing….
That’s good material. It plays well to the cheap seats. It’s what the prospective clients in the audience want to hear….
After all, nobody wants to place his capital with some money-manager whose daft enough to come out and say that he just does the same thing everybody else does….
But that’s probably the reality….
Our money manager might call himself a contrarian. He might even believe he is one. But when push comes to shove, he will do what everybody else does….
That’s how money-management really works. That’s where the incentives lead….
I think that’s what the Vanguard research results are really telling us….
Despite all the knowledge, experience, resources and expertise at work in money management, the experts still manage to consistently advise clients to buy-high and sell-low because they work in an environment where going against the grain (actually walking the contrarian walk rather than just talking about it) is not only frowned on but is bad for business and bad for the individual money-manager’s career prospects….
- The real incentives at work….
Look at it this way….
When the market or an individual stock is soaring and everybody is making money, it would take a brave (or foolish) money-manager to go against the grain and to quit buying and to forego banking profit on the next round of rises….
Even if he is right to do so, he is unlikely to time his call to perfection. It is highly unlikely he will make his contrarian call on Tuesday afternoon before the market turns on Wednesday morning….
Much more likely is that there will be a period – maybe a long period – when the market continues to rise and to defy his contrarian instincts….
Long-term, the contrarian call might be the correct one. Short and mid-term, the money-manager will be under pressure to do what everybody else is doing – and most will buckle to it….
Our money-manager’s decisions and actions will be called into question – perhaps by his superiors, perhaps by his investors and maybe both….
Why are you not making money for your investors in this market (or on that stock) when everybody else is making hay? What are we paying you for?
Why are you sitting on my money when other asset managers are neck-deep in this market and piling pounds onto the bottom line? Why the hell am I paying you to sit on your hands whilst profit opportunities come and go – all unacted upon by you?
In a market going the other way, it would be a case of why are you hanging onto these worthless shares when everybody else is dumping them and cutting their losses?
The money-manager might be right to hang onto that stock – to wait for it to bounce back. But in the hothouse environment of money-management, he might not be able to hang onto them without damaging his career prospects or losing funds under management – or both….
The over-riding incentive for the professional money-manager is not to do the best job possible for the investor but to stay in a job, to enhance career- and earning-prospects and to maximize funds under management (on which commissions and bonuses are paid)….
So, what you end up with is a money-management environment where instead of contrarianism you find conformity – money-managers, brokers and analysts giving buy signals at the top of the market and sell signals at the bottom, just as the Vanguard research project found….
- Go your own way….
Private investors can manage their own investments or put the ‘experts’ to work….
Given what the Vanguard research tells us, it might be better to trust yourself rather than pay some guy who is ultimately incentivized to conform and to do what everybody else is doing….
Being a contrarian gives you an edge in the market. It gives you the opportunity to buy-low and sell-high….
If you want that edge working for you, it is better to go DIY than to trust to the ‘experts’….
That’s the truth of it as we see it….
All the best,