How do you know if your investment manager is doing a good job? Large institutional investors assign their investment manager with a benchmark and then compare investment performance with the benchmark. (The S&P 500 is the most common benchmark.)
The latest study shows that four out five managers failed this test both last year and this year. So, how do you measure your investment manager?
Some years ago, I had lunch with two security analysts. They were both extremely bright, highly educated, and both were assigned to "Big Pharma" or drug stocks. Yet, they disagreed over whether Pfizer or Merck was the better stock. Like all males, they started competing -- on who had read the most footnotes in the financial statements.
There was a time when superior financial information in the hands of superior intelligence was likely to produce superior investment returns. That is much less common today. One reason is that superior information is hard to find, because information is everywhere. (Sometimes, superior information can even be illegal.) Today, we often find that superior political information is more important than superior financial information.
According to CNBC, many advisors have concluded there is no advantage in studying large companies and are using index funds or ETFs for exposure to that asset group. This is called "passive investing." At the same time, they are using mutual funds for smaller companies, where information is more difficult to find and evaluate. This is called "active" investing. Individual stock purchases are limited to those companies where the advisor has strong convictions. Additionally, advisors are increasing cash levels during times of increasing uncertainty, partially discarding the "buy and hold" faith of our fathers.
I think that should, in fact, be the definition of a good investment advisor. He/she is more interested in minimizing risk than maximizing investment returns. Being measured against some arbitrary benchmark never made any sense.
So, how do you know if your investment manager is doing a good job? There are some "risk-adjusted" investment measures available, but they also contain some troubling assumptions and should be viewed with caution.
So, how do you know if your investment manager is doing a good job? How do you know if your spouse is doing a good job? How do you know if your best friend is doing a good job? How do you know if your lawyer or your CPA is doing a good job?
You just know!
The latest study shows that four out five managers failed this test both last year and this year. So, how do you measure your investment manager?
Some years ago, I had lunch with two security analysts. They were both extremely bright, highly educated, and both were assigned to "Big Pharma" or drug stocks. Yet, they disagreed over whether Pfizer or Merck was the better stock. Like all males, they started competing -- on who had read the most footnotes in the financial statements.
There was a time when superior financial information in the hands of superior intelligence was likely to produce superior investment returns. That is much less common today. One reason is that superior information is hard to find, because information is everywhere. (Sometimes, superior information can even be illegal.) Today, we often find that superior political information is more important than superior financial information.
According to CNBC, many advisors have concluded there is no advantage in studying large companies and are using index funds or ETFs for exposure to that asset group. This is called "passive investing." At the same time, they are using mutual funds for smaller companies, where information is more difficult to find and evaluate. This is called "active" investing. Individual stock purchases are limited to those companies where the advisor has strong convictions. Additionally, advisors are increasing cash levels during times of increasing uncertainty, partially discarding the "buy and hold" faith of our fathers.
I think that should, in fact, be the definition of a good investment advisor. He/she is more interested in minimizing risk than maximizing investment returns. Being measured against some arbitrary benchmark never made any sense.
So, how do you know if your investment manager is doing a good job? There are some "risk-adjusted" investment measures available, but they also contain some troubling assumptions and should be viewed with caution.
So, how do you know if your investment manager is doing a good job? How do you know if your spouse is doing a good job? How do you know if your best friend is doing a good job? How do you know if your lawyer or your CPA is doing a good job?
You just know!
