Friday, January 01, 2010

The Professional Manager Dilemma

The blog posted here last month was rejected for publication in the newspaper, Viewpointe of Boca Pointe, by the management of the Boca Pointe Community Association. The rationale was that it could be interpreted, as too strong a criticism of the Wells Fargo Bank, despite the fact that every point made was accurate and verifiable.

As a result, for the February issue of Viewpointe, the article was revised, although the opening paragraphs of the revision are the same.

I would appreciate comments from the readers of this blog, as to whether you agree that there was justification for the rejection. To reread that article, click here: “Whom Can You Trust?

If you have any comments, please send them to

The Professional Manager Dilemma

“How do you turn an investment portfolio into $1 million? Start with $2 million.” That is an old stock market joke that is more formally illustrated by the following: “Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little.” That observation is from a book published in 1940 exemplifying the fact that the investment game hasn’t changed very much.

Actually, the title of that 60-year old book is perhaps even more perfectly evocative of today’s investment climate despite the fact that it too derives from a very old joke, a classic that you probably have heard before: "Once, during a stock market boom, an out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides pointed to some handsome ships riding at anchor saying ‘Look, those are the bankers' and brokers' yachts.’ ‘Very impressive” said the naïve visitor, ‘But where are the customers' yachts?’"

Fred Schwed, the author of that book, took what was essentially the punch line of that story and used it as the title for the book: “Where Are the Customers’ Yachts? Or A Good Hard Look at Wall Street.” Mr. Schwed had been a stockbroker during the 1920’s, and lost a good deal of money when the crash of 1929 occurred. The book gained popularity because it was a poke in the eye of Wall Street and the shenanigans that had become an integral part of the system, not too different from today’s environment. Mr. Schwed’s basic philosophy was that the way to get rich was to “Buy when the market is in the midst of a recession, and sell when times are booming.” Here is a more recent update on that philosophy: “Be fearful when others are greedy, and be greedy when others are fearful.” Since it is unlikely that you have ever heard of Mr. Schwed, you may not pay attention to his advice, however you might be more interested in the latter suggestion that emanated from Warren Buffett.

Wall Street Follies

Mr. Schwed’s book is now considered a classic, and despite its age, it has recently been reissued in paperback form. It has been reviewed as “humorous and entertaining,” as well as exposing the folly and hypocrisy of Wall Street while “offering a true look at the world of investing, in which brokers get rich while their customers go broke…opening the eyes of investors to the reality of Wall Street.” Can this rather jaundiced look at the core investing system as it existed some 60 years ago, be applied to today’s investment environment? The answer is a resounding “YES!”

That opinion is based on the many cautionary tales related to the recent near collapse of our entire economic structure, as well as the apparent systemic reacceptance of the Gordon Gecko manifesto (remember the movie Wall Street?) “Greed is good.” In fact, the immediacy of that movie is so consequential that a sequel, Wall Street 2, is scheduled to appear early in 2010. So, it would not be surprising if the question posed in the headline above: “Whom can you trust?” was being given more consideration than ever before by investors. A number of articles and advertisements have raised the question, “Do you need a professional money manager?” Of course, the articles and ads answer the question in a self interested affirmative.

However there are those who believe that when fees are taken into account, professional managers face insurmountable difficulties in producing portfolio performance that would equal the performance of the benchmark against which the portfolio would be measured. This thinking is typified by the following joke, one I used in a Viewpointe article many years ago:

Two men die at the same time and both approach the Pearly Gates. St. Peter asks them for their names and occupations. The first to answer proclaims proudly that he is a financial advisor. St. Peter checks the name against a list and says “You are eligible to enter into heaven. Here is your silk robe and your gold staff. The second man then describes his position as a minister of the faith and the pastor of a large church for some 40 years. St. Peter affirms the minister’s eligibility and says, “Here is your cotton robe and wooden staff.” The minister is stunned at the offer and asks, “Why is it that a financial advisor is treated better than a minister of the faith?” “Up here we evaluate human performance by results” St. Peter replies. “While you preached, your congregation slept. While he advised, his clients prayed.”

Obviously, investors would prefer not to rely on prayers to insure a decent performance for their portfolio. Yet, the above joke is more realistic than most investors realize. The assumption that an investor, seeking professional money management advice, can just stroll into the corner bank or other neighborhood financial institution and discover the portfolio manager of his dreams, is more than naïve, it would be beyond belief. Turning ones money over to a relative stranger without thoroughly investigating and scrutinizing every aspect of the professional, and yes, even personal, life of the prospective manager would be the height of folly. Yet, many investors spend more time searching for a car than for a financial advisor.

Before considering the services of outside money management, another option could be a “do-it-yourself” approach. While this may seem incredibly complex, there are some distinct advantages over paying, sometimes overpaying, for professional management. One, as mentioned above, is the difficulty in discovering the ideal service provider. Another should be the fact that advisory costs and fees detract from portfolio performance. A third is that on average, at least two-thirds (at times even fewer) of the highly paid (million dollars and up) mutual fund managers fail to outperform the market indices over the long term. What are the odds that the individual money manager you select can do better than the supposed cream of the crop of high paid mutual fund, money management professionals?

The DIY Alternative

Under the headline Do It Yourself Investing, an article in the December 14th issue of, an organization well known for its ties to the financial markets and commitments to the concept of capitalism, provided this unusual (for Forbes) revelation: “ The problem with paying top dollar to money managers is that not everyone can beat the market. Pay ten stock pickers 1.3% of your assets a year, the average for equity mutual funds, and over the long haul you're likely to lag the market by a similar amount. That 1.3% sounds small, but compounded over 30 years it'll eat up 32% of your wealth. Why do people strive after hot performance?”

That the average committed investor can successfully manage his or her own portfolio is especially doable if an investment strategy is applied using a well diversified mix of low expense index mutual funds and exchange traded index funds (ETF’s) based on a pre-determined, goal oriented, asset allocation strategy. Academic research has continually proven that the single most influential determinant of portfolio performance is asset allocation, not the selection of individual stocks and bonds. An asset allocation consisting of mutual index funds and/or exchange traded index funds would pre-determine the percentage mix of stocks, fixed income, cash, and international, perhaps emerging markets, and could throw in some alternative investments such as commodities and real estate.

The Core-Satellite Revolution

Although around for more than ten years, there is an investment strategic methodology using asset allocation as a foundation that has been gaining popularity at an amazingly fast level, especially with large institutional investment organizations. Considered almost revolutionary in nature by some, it is perfect for use by the do-it–yourself investor. It is called a core-satellite, or core-explorer investment strategy, and is readily available at almost any institution you choose to deal with. ( has an excellent and informative brochure you can access on-line). Although you may question the morality and activities of Goldman Sachs during the recent economic meltdown, it is still considered the smartest and best run investment bank in the business. Here is what Goldman says about the core-satellite concept:

We believe one of the most effective ways to build portfolios is through Core and Satellite portfolio construction. Core investments provide a broad foundation comprising U.S. stocks, large cap international stocks and global investment grade fixed income, while Satellite investments such as emerging markets equity, and high yield debt provide diversification and the potential for higher return. Using a Core and Satellite approach, investors can:

  • Add return generating opportunities to a portfolio
  • Reduce the potential for volatility through greater diversification
  • Increase the likelihood of meeting their specific financial goals

The object is to achieve index type returns using passive investment vehicles such as exchange traded index funds, or mutual index funds for the core portion of the Portfolio (probably the major part), and actively managed funds or individual stocks for the smaller, higher risk satellite segment. The core section thus provides minimal expenses as well as assured market index return performance (low risk) –– the smaller satellite portion, although higher risk, also provides opportunity for outperformance of the entire portfolio.

In the event you still require the services of a financial professional, seek one out who has earned a professional designation such as Certified Financial Planner (CFP), or Chartered Financial Analyst (CFA). Still, make as your mantra Ronald Reagan’s famous warning: “Trust But Verify”.


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