Here is my complete Washington Post column from last weekend:

When should you fire your mutual fund manager?

Not too long ago, a well-known mutual fund manager got into a tiff with a well-known hedge fund manager over a well-known company’s stock. The hedge fund manager thought the company had deeper problems than it was admitting to publicly and bet the stock would drop. The mutual fund manager, believing the company was undervalued, bought up nearly a third of the outstanding stock (he also became the company’s chairman).Pop quiz: Is this a mutual fund you want to own?

Need more info to help you decide? Assume both managers had outstanding long-term track records, but the debate over this one company may have become a distraction. Since getting involved with this holding, the mutual fund manager’s performance has suffered.

Do you hold onto his fund or cut it loose?

You probably have no idea what to do; I’m sorry, it’s a trick question. That’s probably because you’ve never considered the criteria for leaving any mutual fund. Most investors think long and hard about why they buy this fund or that — but they never think about when or why to sell.

They should.

This question involves huge sums of money. Ninety million individuals in the United States have $12 trillion invested in mutual funds. In terms of saving for retirement, mutual funds holdings account for 54 percent of 401(k)s and 47 percent of IRAs (in dollar terms). The 8,500 “Registered Investment Companies,” as these mutual funds are formally called, hold 27 percent of all outstanding stock of public companies in the United States.

Hence, most of your invested dollars in 401(k)s and IRAs are probably handled by a mutual fund manager. We shall leave the important question of active vs. passive investing — ETFs vs. mutual funds — for another column. (ETFs hold far less money, with less than a trillion dollars in assets).

Which brings us back to our rather interesting and oft overlooked question: When do you fire your fund manager?

When you buy a mutual fund, you are essentially hiring a manager to handle your assets. Typical investors research various fund families, use Morningstar to review history, review the fund’s top holdings, consider long-term track records. They do all of this work to answer the question, “Which fund should I buy?” But in my experience, they hardly ever consider the other side of that equation.

Most buyers of mutual funds are doing so for a variety of reasons: They want exposure to a given asset class, such as technology or small caps. They may be looking for professional assistance in stock selection. Perhaps they want to participate in a given region but lack the boots on the ground to make intelligent buys.

While there are many reasons to hire a fund manager, there are just as many reasons to fire one. Here are my main criteria:

When they suffer from style drift: This happens quite often; a manager developed an expertise in a given area but is looking beyond that. Maybe they got bored. Maybe the new cow in the pasture caught the bull’s eye. Whatever it is, they are doing less and less of why you bought them in the first place. That’s your signal that it’s time to move on.

When they become too big: Some managers find a niche that they can profitably exploit. But beyond a certain size — which can range from less than $1 billion to about $5 billion — they no longer can create alpha with that strategy. This may be true for eclectic segments such as convertible arbitrage, but I have found it is especially true for small cap and technologies, and emerging markets.

When they fight the dominant market trend: Bill Miller’s market-beating 15-year streak came to an end amid a value trap. He bought more and more of his favorite holdings — banks, GSEs and investment houses — right into the financial collapse. Doubling down again (and again) is not a valid investment strategy. Whatever advantages he had heading into 2008 disappeared.

When they seem to lose their edge: Whether it’s success or money or a loss of interest, managers sometimes lose the “fire in the belly.” Determining this is admittedly challenging. We often find out about some personal demons — divorce, alcohol, whatever — after the fact. Regardless, when whatever it was that made them a top stock picker starts to fade away, you should also.

When they become a closet indexer: When a fund owns 100, 150, 200 names, it effectively becomes a high-cost index. Even if they have the top performing stocks, it will be in such small quantities as to not move the needle. This is an easy fix — you replace them with a low-cost, passive index.

Notice that performance is not a factor in any of the points above. There are two reasons for that:

Process, not outcome: Investors ought to be focused on creating a reproducible methodology, regardless of luck or misfortune in any given quarter. Investing is a probabilistic exercise, and performance can slip for a quarter or two — even when the manager is doing everything right.

Mean reversion: The opposite of chasing performance (and buying high) is dumping a weak quarter (selling low) that then snaps back.

With that, you have the signals to know when it’s time to take your money and go.


When should you fire your mutual fund manager?
By Barry Ritholtz,
Washington Post May 8 2011  

Category: Investing

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

7 Responses to “When should you fire your mutual fund manager?”

  1. BR,

    this is a good Piece.. it, if anything, should get the (di-)vestor Ranks thinking about their, various, MutFund holdings..(if they have, any, extra time after completing their Fantasy Sports League updates..)

    though, out of curiosity, with this .. “…The hedge fund manager thought the company had deeper problems than it was admitting to publicly and bet the stock would drop. The mutual fund manager, believing the company was undervalued, bought up nearly a third of the outstanding stock (he also became the company’s chairman)…”

    Why not name the Actors in that, specific, Tragi-Comedy?

    for a fuller ~vetting of the MutFund ‘scene’..

    by Paul B Farrell, JD, PhD
    “They operate by casino rules that they invented and they manipulate while managing over $10 trillion of your assets. If you play by their rules, you will lose. Guaranteed. Examples: During the 2000-2002 bear market, one manager paid himself $47 million while his shareholders lost 43%. At the same time, the equity fund shareholders of Fidelity Investments lost 37% while Fidelity’s two major owners saw their net worth increase from $11.1 billion to $13.2 billion between 1999 and 2002. In 2006 they were worth $20.5 billion while their shareholders have barely broken even the past seven years. As Vanguard founder, Jack Bogle, put it in The Battle for the Soul of Capitalism: “The business and ethical standards of Corporate America, of investment America, of mutual fund America have been gravely compromised.”

    Back in 2004, just before the Senate Banking Committee killed chances of any reform legislation (in spite of a 418-2 approval in the House) I warned fund investors that special interest groups would begin an aggressive campaign to defeat fund industry reforms under consideration by Congress and the SEC. It happened. The reasons were obvious. As critics point out, special interests take tens of billions of dollars right off the top of shareholder returns every year, with virtually no disclosure requirements. So fund company owners had an enormous incentive to oppose all reforms back in 2004—in fact, they always have and do oppose all reforms, all the time, it’s a matter of self-preservation.

    Their opposition occasionally surfaces in the press, but more often than not, the press doesn’t get it, meanwhile, special interest money works behind the scenes through lobbyists and political contributions. Fund company owners are one of the major special interest groups identified. So it came as no surprise when Ned Johnson, chairman, CEO and controlling owner of Fidelity Investments, in the middle of the last major attempt at legislative reform, attacked reform legislation out in the open on the op-ed page of the Wall Street Journal—a rare event for a very private man….”

  2. socaljoe says:

    Michael Price, Bruce Berkowitz, and the managers of Longleaf Partners have shown that an activist investment style can be successful over the long run. This does not mean that every one of their stock picks will turn out to be a winner.

    You should judge a fund manager over an entire investment cycle… less than a year is not long enough.

    Style drift is only bad if you’re chosing a fund because of it’s style. If you want an “unconstrained” stock picker, style drift can be an attribute as the market evolves over a cycle.

  3. Anchard says:

    I was very happy to see that you left off “rising cash positions” as a sell trigger. The pressure on fund managers to remain fully invested is an unfortunate spillover from the 401k world, where consultants press their clients to avoid paying equity fees for cash management. That advice sounds well and good for professionally “advised” institutions, but can be an absolute disaster in down markets for individuals who don’t know the first thing about asset allocation and don’t want to know.

  4. I’d fire any manager before hiring him/her.
    Why pay management fees when there is no promise of outperformance?

    I’d rather self manage or pay very low index fund fees.

  5. Thomaspin says:

    Fine journalism. Thank you.

  6. [...] Barry: When to fire your mutual fund manager.  (TBP) [...]

  7. JohnsonSmith says:

    The suggestion sounds very good for efficiently “advised” institutions, but can be a total adversity in down markets for individuals who don’t know the first thing about asset allocation and don’t want to discern.