Professional Fund Managers: Are They Worth It?

I had a very interesting conversation with a friend of mine today about how to go about choosing a professional fund manager to manage your money.  Anand, my good friend and CFP, manages investments for some of his clients.  He doesn't have a huge number of clients and most of them are his close friends and family.  Our conversation first started out with gripes about how incredibly wrong some professional traders, analysts and fund managers have been about the direction of the stock market since late March.  Yet, despite the reversal of the market, many of these professionals continued to double-down on their bear market thesis.  This caused many pros, including some very famous ones (such as Warren Buffet and Mohammed El-Erian) to admit that they missed out on the market rebound that started in April and has continued to this day.

We both agreed that it's OK to be wrong but a good fund manager should be able to adapt very quickly to changing stock market dynamics.  Instead of double-down on a wrong assumption, they quickly adjust their positions by analyzing market dynamics and try to make money for their clients even in highly turbulent and volatile environments.  No one said making money in the stock market was going to be easy -- especially if you're managing millions or even billions of dollars for your clients.  

One metric that fund managers are often held by is the S&P 500.  You'll often hear some fund managers boasting about how their funds beat the S&P 500 but what will surprise you is how few fund managers actually beat the S&P 500.  According to this CNBC article from last year:

• For the ninth consecutive year, the majority (64.49 percent) of large-cap funds lagged the S&P 500 last year.
• After 10 years, 85 percent of large cap funds underperformed the S&P 500, and after 15 years, nearly 92 percent are trailing the index.

With stats like these, it makes you wonder if you really should entrust your money to professional fund managers.  Would you really be willing to pay them a fee to under perform the S&P 500?  Wouldn't you be better off just buying the SPY?  You'll save yourself the fund's management fee and also make more money.  

I brought up an interesting point to Anand during our conversation.   Trading stocks in volatile and uncertain times is no easy feat.  It's stressful.  It's a lot of work.  However, you still need to perform.  One can't simply say "I'm sitting in cash" until the smoke clears.  That is not an investment strategy.  Well, I guess it is a strategy -- just a really lazy and ineffective one.  If the S&P 500 is up 25% this year and you've only made 1% for your client by parking your funds money in money market and treasury bonds -- then you've failed miserably at your job.  Sure, you didn't lose money for your clients.   But you couldn't even beat the S&P 500...so that makes you pretty useless as a fund manager.

By far the biggest gripe that Anand and I had on was the inability of professional traders to adapt to changing environments.  In late March, I saw so many instances of popular authors on Seeking Alpha telling their readers and paying subscribers to run for the hills using 1930's Great Depression references to scare them.  I wanted to scream at those authors -- "Dude, that was almost 100 years ago.  A lot has changed in 100 years."  Again, there's nothing wrong with being wrong.  It's the inability to recognize your mistake and adapt to changing patterns in the stock market that completely cause me to lose faith in those "stock market professionals."  Not only do many of these professional traders fail to make course corrections, but they often double-down on their original "wrong thesis" causing their readers and subscribers to lose (or miss out on) even more money.   That's just inexcusable.

So that leads me to a few interesting observations:

1) Just because you have a ton of clients, a large audience or a recognizable name doesn't automatically make you a good fund manager.  Having a gazillion twitter followers or your own CNBC TV Show doesn't automatically make you a good fund manager.  Jim Cramer, one of the most popular stock market "gurus", has vastly underperformed the S&P 500 for many years now.  

2) The best fund managers are often ones you've never heard of.  I went to TipRanks and looked at their list of the top 25 fund managers by performance and I've literally never heard of any of them.  I'm not saying they don't have a following or that they aren't recognized names.  But I'm pretty sure they're not household names like Warren Buffet or Jim Cramer.

3) Don't just let anyone manage your money.  Make them earn it.  Make them prove to you that they can at least beat the S&P 500.  If not, then you're much better off just buying the SPY and saving yourself their management fees and their inferior performance.

Conclusion

I firmly believe that the buy-it-and-forget-it strategy doesn't work anymore.  It may have worked for Warren Buffet back in the 50's and 60's.  But it's 2020 -- times have changed.  The stock market is so volatile now and the constant barrage of political and market news bombard market sentiment in very unpredictable ways.  A good fund manager will help you navigate these dangerous waters and protect your nest egg. They will also be nimble and adapt quickly to changing investment environments while striking an important balance between diversification and risk management.  But finding the right fund or fund manager to invest in is no easy feat.  Be patient, be cautious and educate yourself.