If you’re an active money manager you have to ask yourself: “what is my competitive advantage”? What makes you so different from everyone else that you will succeed or add value where no one else can. You see, the problem with most active money managers is that they’re mostly mirroring a strategy that already exists. So you’ve got the XYZ Large Cap Value Fund which mimics the S&P 500 (essentially). Or the XYZ Small Cap Blend fund which mimics the Russell 2,000. Or the XYZ International Stock Fund which mimics the MSCI EAFE. Most of these funds have fewer holdings, higher turnover and higher expenses than their correlated index fund. You could send me just about any mutual fund in the world and I’ll show you its low fee counterpart which is likely kicking its butt.
My favorite of all-time was Bill Miller’s Value Trust. The “value trust” was, at times, a high beta growth fund. But the strangest part about Miller’s string of 15 years beating the S&P 500 was that he didn’t always outperform his higher beta correlated index (the mid-cap 400). But the journalists who covered this “incredible” feat didn’t understand how Miller was generating his returns and had no idea how to compare his fund to the right index. The S&P 500 was NOT it.
But Miller is just one case of no value add in a sea of money managers who don’t add value. It’s a widespread case of the Warren Buffett disease taking hold of Wall Street. I’ve theorized in the past that a horrible myth has overcome Wall Street. The Myth of Warren Buffett. This is the myth that you can beat the market by picking value stocks and just buying and holding. Just like old Warren does! Except, that’s not at all what Warren Buffett does. Buffett runs one of the most complex multi-strategy investment portfolios that exists in the world. It’s essentially a dynamically leveraged option writing, dollar cost averaging, active management, distressed asset approach.
Berkshire is brilliantly constructed. Buffett is the master of portfolio construction. What he’s not is the little old value stock picker from Omaha who just sips Cherry Coke and says “ohhh, that’s yummy, I think I’ll buy some of that!”. But that’s basically the pitch Wall Street has been sold and sold on to you. It’s the “we can all be like Buffett if you buy into this fund that mimics his approach – but really we can’t come close to mirroring his approach!”. The result is excessive fees and competing with an index that is a perennial ass kicker (the S&P 500 which just so happens to be a compilation of, oh, 500 of the greatest corporations the world has ever seen out of millions, mind you).
The point is, Buffett has a competitive advantage through masterful portfolio design. Most managers can’t say that. And that’s the biggest problem with Wall Street today. Too much myth chasing. Not enough real value add. It’s no wonder the ETF business is growing so quickly as investors slowly catch-on….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.