In the world of investment, nothing is black and white. There are very few absolutes left in this game. ‘Never’ is such a very long time, and ‘Always’ sounds dangerously like commitment.
Of course we have our processes and philosophies, all investors do, some better expressed or adhered to than others, but most of these involve conditionality and compromise.
I love asking fund managers whether they believe everything has a price at which it becomes attractive – people tie themselves in knots over that one: ‘Yeah, but no, but yeah, but no…’
In fund selection, the most common entries in the ‘Always’ column are probably to meet the manager before investing and to read the small print (but how many of you allow some flexibility on one or both of these?).
The most common ‘Nevers’ are buying last year’s best-performing fund and paying full fees. Once we get beyond these basics, we get into the grey areas.
What's the ideal fund?
Ask five fund selectors to describe their ideal fund and you’ll get at least six different answers – we’re a fickle bunch. In short, the perfect fund does not exist – we therefore have to make compromises in our processes.
The main trade-offs we make as fund selectors are largely informed by why we are selecting funds in the first place. If we are investors, the compromises will be surrounding the economic exposures achieved – what you want versus what you get.
If we are selecting funds for onward distribution, the compromises are more likely to be those involving perceptions – what will sell rather than what should be bought, and what will add to the shelf rather than confuse the client with subtle distinction.
I sometimes imagine the problem as being like a DJ’s control panel, with multiple sliders and faders (classier columnists might use the conductor-orchestra analogy here) used to vary the volume and tempo of the underlying beats and melodies. Striking the right balance is a constantlyevolving challenge.
We suffer from over-complexity driven by widening choices, multi-million dollar marketing and uncertain, or changing, targets.
The paradox of choice
We have more options available today than ever before, so the task of selecting a small number is even more daunting. Unless we accept that knowing every fund in great detail is simply impossible, we can work 24/7 and still never come to a decision.
I’ve seen the manifestation of analysis paralysis way too often: seeing differences when none exists and wasting time on irrelevant nuances at the expense of comprehending the wider picture.
The rise of the marketeer
Fund management firms have huge distribution machines – everyone in our industry understands that solving the investment equation is only half the battle – if nobody buys your fund, the game is over.
Fund marketing has evolved along with, or ahead of, fund selection techniques – the aim is to play on our doubt, to exploit our necessity to compromise and to make it hard for us to say ‘no’. Many marketers have realised that we employ a process of iterative elimination (more on this later) and that staying alive to fight the next battle is more important than winning the early rounds.
Jumpers for goalposts
Selecting funds in a rapidly changing economic environment can also lead to compromises. We do not know what will happen in the world and so we pick what we hope will be a strong fund in the environment we think most likely to unfold.
As a terrible golfer, I was once advised to take each hole in stages – just focus on hitting the fairway off the tee, then just get it onto the green, and then worry about where the hole is. In other words, keep the target as big as possible for as long as possible, rather than hoping to do it all in one big step.
This brings us back to this being a process of iterative elimination. It is always easier to find small crosses than big ticks, and the typical fund selector’s process goes something like this:
- Decide what you don’t want, screen that out – this normally gets rid of 75% of the universe if you calibrate the screens strongly enough.
- Scan what’s left, looking for easy things to kick out for whatever reason. This can get rid of another 10-15% of the original starting list.
- Dig deeper on the remaining options, staying tough on what you want to avoid.
- Finally, you’re down to the last handful of funds, and splitting hairs to find distinctions between them. Individual biases and preferences make the difference here – by the time you have just four of five left, often you are essentially ambivalent between those.
Despite the first two steps having the biggest impact in terms of numbers of funds eliminated, we all spend a lot more time on steps 3 and 4, particularly step 4. Ironically, that’s the step where a toss of the coin or roll of the die would be equally effective.
It’s right that we always have nagging doubts and are never fully satisfied with any fund. We can find drawbacks in everything – a decent fund selector can probably also create justification for buying almost any fund. When it goes well, we feel justified for taking the risk and when it goes wrong we kick ourselves.
The biggest compromise facing any investor is often between head and heart. It can take balls to put your neck on the line. Such is the broad spectrum of funds out there, we are perhaps needed more than ever before to bring focus and make sense of it for our clients and bosses. Ultimately, it’s our job to cut through the marketing and put the best fund forward own terms.
Scott Lothian has held senior roles within both consulting and fund selection.
This article originally appeared in the December 2012 edition of Citywire Global magazine.