Thursday, September 17, 2009

"The Case Against Professional Money Managers - Why They Are Ruining You" by Fred Carach

Not so long ago there was a golden age of professional money managers when giants like Sir John Templeton and Peter Lynch delivered superior performance year after year to investors IRA and other retirement accounts. This golden age is now over with and the question is why?

Investors today are paying for performances that they are no longer receiving. You are essentially paying these people to duplicate the market averages. The overwhelming majority of investors today would be better off if they fired their professional money managers and invested in an S&P 500 index fund. The question that has to be answered is what went wrong? Why are today's money managers unable to duplicate the superior market beating performance that they used to be able to produce in the past?

The short answer is that the rules have been changed. Not so long ago it was possible for superior money managers like Templeton and Lynch to march to their own drummer. They were given the freedom to make long-term bets and pick out of favor and non-index stocks. They were given the time to invest in contrarian plays that might not work out for a year or two. They could actually invest real capital in small-cap and micro-cap stocks instead of the Godzilla nifty-fifty blue-chip stocks.

The horror of it:

In those days managers would be given X million dollars and two or three years to show what they could do. In today's brave new world the report card comes due every 90 days, Not in two or three years. The benchmark that your performance is always measured against is the S&P 500. Failure to duplicate or exceed that average for even a couple of quarters can end your career. The only way a manager can be certain that he will duplicate or exceed the S&P 500 is to own the iron core of that index, the nifty-fifty. These fifty blue-chip giants, IBM, General Electric and Microsoft etc. dominate the S&P 500 to an extent that is hard to imagine. He then cleverly encases the nifty-fifty hard core with careful collection of promising non-index stocks that are designed to give the impression that he is clued in and is not operating a closet index fund in drag. The weighting however, is such that the fund will always mimic the index. In other words truly superior performance is highly unlikely unless the non-index stocks put in a spectacular performance.

Strangely enough it is hard to blame these frauds. You can almost say that investors deserve to be cheated. Imagine a superior money manager today with the courage to invest in non-index stocks and to take long-term bets. Who then delivers a return 20% better than the index for four straight years and on the fifth year delivers a performance 15% worse than the index. That superior manger would be thrown out into the street like a dog. While Joe-average manager who always buys index stocks and has performed in line with the index because he owns the index will never be fired.

In other words our current system guarantees mediocrity. It is hard for people to believe this but today's managers make no real attempt to beat the averages. Their only concern is to guarantee that they never do worse than the averages. Which they know only too well could be a career ending experience. In other words, superior performance is only rewarded temporarily.
While inferior performance is punished permanently.

It is indeed fortunate that I was never a money manager. With my contempt for nifty-fifty stocks and my passion for small-cap and micro-cap stocks, I would not have lasted very long. But I digress. The issue is what is today's investor to do? The first thing thing you can do is to dump your "alleged" professional money manager. You can get the same performance simply by buying an S&P index fund.

The next thing to understand is that you can't get superior performance by investing in nifty-fifty dinosaurs. Their day is done. Their superior performance is in the past it cannot be in the future. How much bigger can a dinosaur get?

Recently, I was listening to a finance program on the radio as I was driving my car. An investor called the program bemoaning the recent rotten performance of General Electric. He could not understand how such a splendid company could be doing so poorly. The answer you fool I screamed at the radio is because General Electric is the economy and the economy struggles to grow at 3% a year.

Of course if you are really daring, you can enter my world. The world of the small-cap and the micro-cap investor where superior performance is truly possible. A world where you can make a fortune on a chump-change investment.

I wrote my book because I wanted people to know that there is an affordable alternative to buying blue-chip stocks at $40-$60 a share. A price that renders many blue-chip stocks unaffordable. Most of us cannot afford to buy these stocks in sufficient amounts to ever make us financially secure.

In my book I put in my email address so that readers could contact me. The first reader to contact me was Bill from Buffalo. Bill told me that he was forty years old and had a wife and two children. He owned a modest home and had $8,000 in life savings. He told me that he knew what his future was and it terrified him. He was going to be working at a fast food place when he was 69 years old. That was his future. He didn't have enough time or money to buy enough blue-chip stocks. Stocks that he knew could be expected to go up 10% in an average year to enable him to retire at 65.

My way provided him with an answer. He could easily afford to buy my low priced, unknown stocks in amounts big enough to make a difference. In addition my smallcap and microcap unknown stocks had better growth prospects than the old, tired blue-chip dinosaurs that everyone else is forever touting. I don't do guarantees. If you want guarantees go to the bank and see if you can get rich on the miserable returns that they offer. If you want opportunities then I am your man. I offer my readers a chance to make serious money on a chump-change investment.

Fred Carach is the author of " FortyYears A Speculator."

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