How To Make a Fortune In The Investment Business

One of the worst kept secrets in the investment world is that there are a lot of mediocre performers managing huge sums of money on the backs of marketing campaigns and a constant presence on financial media. Some of the most familiar faces you see on CNBC and Bloomberg are, in fact, serial underperformers. I'm not even talking about "beating the market" as that is not necessarily an investment goal for many people. I'm talking about your money going almost nowhere.

But many of these money managers with a huge media footprint and hundreds of thousands of Twitter followers are consistently awful. But the good news is the little guy can beat the "star" advisors at little cost, if you just avoid these outsized firms.

Here's a pitch I got for a fund run by a well known investment management firm with over $500 billion (yes, that's with a "B") in assets under management.

The xxxxxxxx xxxxxxxx Real Estate Fund has delivered an annualized return of 8.56% with beta vs the S&P of 0.11 and a standard deviation of 3.40 since inception in 2014.

Not so fast. You see, they had an outsized year in 2021, when real estate swooned and then rebounded handsomely. Taking that year out, the annualized return is just 4.16% over the previous seven years. Once again, another firm that would have gotten beaten by a random portfolio of GinnieMae paper. But note the fund composition. Back in the '90s, they called this a "fund of funds," but that very costly structure got a bad name for itself. So today, they call it "asset allocation." The same money sucking fee structure is still in place.

Note the front end load of 5.75%, so right away, you get a year's worth of annualized gains erased with your first deposit. Then there is a management fee for keeping track of less than three dozen funds, and some sundry fees which bring it up to almost 2% in addition to the load. This is where money goes to die, and there's over five billion of dead dollar bills stuffed in this thing.

But wait, there's more!

As per the prospectus, "...certain conflicts of interest may arise in connection with a Portfolio Manager’s management of a fund’s investments… Other potential conflicts might include conflicts created by specific Portfolio Manager compensation arrangements, and conflicts relating to selection of brokers or dealers to execute Fund portfolio trades and/or specific uses of commissions from Fund portfolio trades (for example, research, or “soft dollars,” if any). The Adviser has adopted policies and procedures and has structured its Portfolio Managers’ compensation in a manner reasonably designed to safeguard the Fund from being negatively affected as a result of any such potential conflicts."

Uh-huh. So in addition to the fees charged to investors, there is also a fee structure to reward participants on the other side of the trade.

As per Investopedia:

"The investor essentially bears the costs of research and other bundled services provided in a soft-commission transaction, yet an asset manager does not disclose them. They are built into the cost of trades, which impacts the long-term performance of a fund. Some speculate that soft commissions can bump up the per-share cost of executing and clearing institutional trades by roughly 2-3%, though there is little reliable research on the matter."

Boy, did I miss the boat.

So how do they amass over $5 billion in assets in such a deadbeat enterprise? The answer is DISTRIBUTION. Thanks to the soft dollar arrangements, there are a lot of incentives to push this dog onto the investing public through huge investment firms that do things like sponsor national golf tournaments and the like.

The sad part is there are dozens of operations like this with even more assets under management than this one. Personally, I've given up looking at the track records of money managers interviewed by Tom Keene. But no one calls them out on performance on screen, and few are the wiser, except perhaps for those on social media who expose the underperformers.

At least this one example is transparent, since they have to file with the SEC and disclose just about everything. Other firms, mostly RIAs, are not required to disclose their performance or (unlike hedge funds) even disclose their holdings or recommendations. These are mostly sales organizations pretending to be investment advisory firms, who impose performance targets on their "advisor" staff and feature hefty employee turnover.

It is extremely difficult to manage billions of dollars. The investment base becomes so atomized across thousands of entities (hence the use of simply buying funds across a specific sector to diversify) performance HAS to suffer, even without the onerous fee structure.

Smaller firms like mine, where personal service and close contact with the investor is the rule, is one way to avoid the fate of placing your money in these labyrinthine behemoths.