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Fund managers turned advisers may be good for investors

Fund managers turned advisers may be good for investors

October 9, 2014

Investors should re-evaluate their use of mutual fund managers who actively manage their portfolios. One industry expert says the days of stock picking are over.

This was reported in the August 22, 2014 issue of the Wall Street Journal in an article titled “The Decline and Fall of Fund Managers”.

This is the opinion of Charles Ellis who is referred to as the dean of the investment-management industry. Ellis founded a financial consulting firm, is the author of 16 books and is the former chairman of Yale University’s investment committee.

Ellis said “with rare exceptions, active management is no longer able to earn its keep.”

One of the reasons for the decline in the use of active managers is their strength at what they have done in the past. This has been possible because of access to strong analytical tools, electronic trading and instant access to news.

The market is more efficient and the outperformance of active managers has assured their demise. It is virtually impossible for a manager to add value by beating the market. The easy days are gone.

Competition is too fierce. If thousands of managers are looking for bargains, then all of those bargains will be taken. There is not enough to go around.

So in a world where active managers do not add value, what happens next? Now the fee conversation will heat up. If an active manager cannot beat the market, they can therefore no longer justify their high fees.

Fees have historically not been as big an issue. The client was not as concerned with investment fees in past days of better investment returns.

Now in a world of lower inflation that has lower expected returns, the fee issue is a topic that should and will be discussed. Fees as a percentage of the return on investment are high.

Investment management fees will decline and these management firms’ profits will shrink. The financial pressure will see the consolidation of investment firms and the reduction of excess staff including money managers.

There will be a surplus of unemployed ex-investment managers. The question is what will they do; and this is where it becomes interesting.

Ellis predicts that one logical path is for those former investment managers to become financial planners. There is a strong and growing demand for good financial planners.

They will be knowledgeable about investing and they can coach their clients on the difficulties of outperforming the underlying market. In many cases they will be more knowledgeable than existing financial planners.

The education, qualifications and general skills required to be a money manager are higher than those needed to be a financial planner. Having money managers joining the ranks of financial planning would be a good outcome.

Presumably their recommendation will be to attempt to capture market returns at the lowest possible cost. Having been money managers, their clients will have confidence in their recommendations.

Active management will not fade away completely because it is human nature to try for superior returns. However, there is enough evidence on the benefit of lower cost investment alternatives where the shift to these investments is in progress.

The future of the investment business looks promising for investors. Lower cost investment options should produce better longer term investment returns.