"Punch or May Day" by Benjamin Robert Hayden, 1829
Can a financial adviser manage a portfolio of active funds and consistently select above-average managers for their clients in advance?
That's definitely possible, but highly unlikely. Trillions of dollars come from actively managed funds and have gone into systematic strategies, rule-based strategies and index strategies. Costs are part of the story, but also endurance.
Persistence does not exist. Financial advisors are periodically asked to defend their asset allocation decisions to clients who have entrusted their money. In the past, financial advisers have been able to select active fund managers and either defend the underperformers or make them a great success by demonstrating their added value to the client by making manager changes.
It does not work and not because active managers can not beat the market or their competitors. Every year, there are above-average managers. Every year, there are funds that outshine their benchmarks and those of their competitors.
That is not the problem. This is:
In 2010, five US equity fund managers were named fund managers of the decade. Do you know how many have surpassed this decade?
The average underperformance of the five nominees was 5 percentage points per year.
And the winner? 8 percentage points underperformance per year.
– Meb Faber (@MebFaber) October 29, 2019
You can not use previous performance records to identify the winning or losing managers for the next time period. There are no performance-related data points to help you as a financial adviser. Morningstar can not do that. Lipper can not do that.
We all would like to believe that a fund that has just separated itself from its competitors for five years is more likely to do so over the next five years, but statistically this is simply not the case.
Ten years ago, based on a review of the entire database, Morningstar said that the fund's most predictive attribute of future fund performance is lower compared to its peers. Performance, brand, pedigree, employee size, etc. in the past were not key drivers of outperformance. A consultant who carefully examined these qualitative aspects of a fund did her job safely, but did not help clients beat the market go-forward base.
Worse yet, the financial advisers found that the fund selection game was asymmetrical for them. If they chose a great manager who outperformed, they did not receive much recognition as the client expected it. "Wow, you did your job." However, if they chose a below-average manager and then had to build up a defense of their choice, they were blamed far more than credited for all their other good decisions. Counselors began to question the wisdom, make those assumptions, and put their own neck in that noose. Then they stopped.
A decade ago, there were many financial advisors to major banks and brokerage firms who told their clients they were managers of managers. They tested the funds for them and monitored them every year. There are currently fewer financial advisors who present themselves to their clients in this way, as the above facts have become more understandable and the economic incentives of the advisory business model have changed.
I spend a lot of time thinking about what could suddenly change and getting things back the way they were – higher interest rates? An accident? A bear market? A new fund incentive structure? A regulatory shift? A wave of young rock star managers?
After considering these possibilities and their potential impact on the behavior of consultants or clients, I only think that the current trend will not reverse.
However, this reality does not encourage consultants to explain their portfolio choices. Instead, the review of asset allocation decisions focuses more on geographical or sectoral weighting, tactical measures and / or timing adjustments, the total cost of fund spending, the commission cost of trading, the tax implications of any measures and even the social, environmental and governance aspects underlying investments. And this is In front You have to defend yourself whether a portfolio is still suitable for the personal plan and the situation of each household or not.
The advisors will continue to provide clients on a daily, weekly, monthly, quarterly and yearly basis to make their selections. That will not change. But they try to answer for things that are more in their own control. Executives who essentially predict the success or failure of another were increasingly excluded from the entire company.
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