When I manage money for my clients, my own money is on the line along with them.? That’s the way it should be.? I try to give clients a clone of my portfolios whether on bonds or stocks.? This aligns my interests with theirs, because I want to make money over the long run on my assets.
This post is spurred by a post at the Wealthfront Blog, where he cites a Morningstar study where only 40% of mutual fund managers invest alongside their investors. Now, some of that is explainable because the asset class of their funds would not be a complete asset management strategy.? But it does not explain why they don’t have any significant amount invested there.
At one firm that I worked for, there was a rule: you could buy anything so long as the firm had first dibs on buying what you wanted to buy.? Once the firm was done buying, you could buy your idea.? Same thing for selling.? The firm must sell first, and only after that could any employee sell.? If you are not trading in lockstep with your clients, you must trade behind them.? No front-running.
But personally, I prefer managers that have the same incentive as investors.? Why? It makes them manage to normal risk levels.? Hedge fund incentives, unless there is some clawback for bad future performance, or that performance fees must be reinvested in the fund for a number of years, incent hedge fund managers to swing for the fences.? You can make a lot in a really good year, and receive your ordinary fees in bad years, without taking any losses.
My experience was when I was one who hired equity managers that the value shops tended to have large amounts of their personal wealth invested in their funds.? Why?? One, they believed in what they were doing.? Two, value investing tends to self-correct over time.? Three, value investors don’t trade as much.? They are typically holding investments they would be comfortable holding for a long time.? Four, there was an ethical idea of “we eat our own cooking.”? They wanted incentives aligned 1:1.? I win, you win.? You lose, I also lose.
This article is dated, but most of those that eat their own cooking are value-oriented managers.? This article is another example, but note that the excellent Vanguard does not require managers to invest in their own funds.? Part of that is the bond complex, and also that some of their equity funds are multiple manager funds.
As for me, I have over 60% of my net worth invested in my strategies, and over 80% of my liquid net worth.? I believe in what I do.? Granted, value investing has not been rewarded recently, but over the long haul, it is usually more than adequately compensated.
I can see valid exceptions to this though. For example, for myself I have separate “investment” and “trading/speculation” accounts. The vast majority of my money is in my “trading/speculation” account because I think I can do much better there long-term with a tolerance for much higher drawdowns that 99.99% of outside clients couldn’t tolerate. How many people could stomach 40-50% drawdowns in exchange for the possibility of 30-50% CAGR. Not to mention the operational logistics of implementing a super-active trading approach (hundreds of trades annually) would be a nightmare across a large number of separate accounts (if you didn’t run a single fund structure where all accounts were commingled).
On a different note, long ago we discussed technical analysis/chart patterns, the implementation, etc. Here is a blog you might find of academic interest and his long-term performance numbers are there as well:
http://peterlbrandt.com/
http://peterlbrandt.com/performance-2/
My investing is primarily fundamentals and valuation oriented. My trading is primarily chart/TA oriented. My trading is substantially outperforming my investing.
I would have one question for Mr. Brandt — did you keep compounding your gains in your trading, or did you pull money out to keep your size small?
I see your point, but I am suggesting the those who manage the money of *others* have incentives closely aligned with others, which would be true of a trader or an investor.
Yes, incentives should be aligned. I’m just suggesting that someone who manages money for others might choose to manage their own personal money more aggressively which doesn’t invalidate how they are managing client money.
For example, someone doing pure stockpicking might diversify more for client accounts but run some of his own money in his top 3-5 ideas.
It’s been my experience, and I’d be interested to get your take on this, but most people can’t really handle more then about a 20-25% drawdown. I had some clients get really panicky in 2008/2009 who thought they could handle being 100% in risk assets. Some long-term allocations got changed to include a heavy dose of bonds and conservative bond funds, and a good number of my accounts are 50/50 along a traditional balanced pension fund allocation.
Me…I can look in the mirror and know I can handle a 50% drawdown if I really believe the process is going to deliver superior returns long-term. My desire to be more aggressive and shoot for higher long-term returns shouldn’t be chained in my the average person’s risk tolerance.
Your question is an interesting one because I think I know what you might be getting at. Not all approaches are scalable to large amounts of money and therefore you couldn’t compound at those high rates with much higher capital. That said, most futures markets are pretty deep so I don’t think you’d run into issues of liquidity until tens of millions. And I would add his record doesn’t “prove” chart-reading anymore then Buffett’s record “proves” you can be be a biilionaire through value investing.
Hope you got your power back.