Star Managers

Don't pay for stars. You don't know who they are.

Investment is, or ought to be, a highly skilled activity. We ought to be prepared to pay a premium for proven good performers.

But there is a problem.....

.... and it is this. Not one of the many studies of fund performance has managed to establish a link between past performance and future success. In other words, the past is no guide to the future. See Pick on Performance.

The regulator has recognised this by banning the use of past performance statistics in fund advertising. So even if there are stars out there (and there is no evidence that there are) how are we going to pick them?

..and they'll cost more

Another thought, possibly unworthy, is that stars are going to charge more than your average trundler. So they will be taking a bigger slug out of our returns. This may be less than the value of their expertise. But we have no way of telling.

.....and they move around

You invest in a fund. The fund employs the manager. One third of managers move jobs every year. If you want to follow the manager, selling his old fund and buying the new one is expensive.

......and maybe all they do is take high risks and get lucky

You wouldn't take high risks with your own money. But what if it was someone else's money (ie you are a fund manager)? If it goes right, you are a star. If it goes wrong - you can fold the fund or merge it into another one. People have short memories. You can start another fund later.

Of course, this is an unfair over-simplification of a much more subtle process. But two things are true:

  • Cautious, safe managers will never be stars.
  • Average managers can achieve stardom by taking high risks and praying.

....and a warning about leverage

You can increase risk and prospective returns by leveraging, so you should be particularly careful with funds that permit it. It's a legitimate weapon in the hands of good managers, but, as always, it's hard to tell good from bad.