I sometimes ponder how brokers and advisors choose this fund over that one.
After all, economic theory suggests that they all tend to perform in tandem with others investing in the same asset class. In such a case, the lion’s share of performance variation will be attributable to how much is charged to run the fund. Absent the advisor’s own pecuniary interests, I wonder if the choice isn’t totally arbitrary. Sort of akin to reaching into a barrel of monkeys and pulling out the first one you grab hold of.
This week, a new client came to our offices. As if often the case, he arrived with a stack of papers telling the story of his prior investments. In this instance, those were chosen by a broker-dealer representative working for one of the megabanks.
My business partner saw the portfolio first and described it to me as “a pile of garbage.” By this she meant ridiculously high internal operating fees. When I looked over the list, my eye was caught by one mutual fund. has a mighty fancy name. What in the world, I wondered, was this investment fund all about? Promising myself a research effort at some later date, I pushed it aside.
Then I got lucky. The lasted edition of Fortune Magazine had just arrived in my box. I decided to take a short break and relax while perusing it. An article called The Fund That Was Too Good to be True caught my attention. Here, you can read it for yourself .
As the article’s author put it, “The consensus seems to be now that much of … [the] amazing early track record was faked, either a product of a hypothetical back-test or just an outright fraud.” Happily, I wasn’t going to have to spend any valuable time trying to figure out why this guy had picked this piece of garbage.
So how do these guys make choices about individual investment funds? It is pretty clear that decision process starts with the broker/advisor’s own interests. Beyond that, though, how do they select among hundreds of alternatives all of which offer them the same inducements? The whole thing does in fact seem pretty arbitrary. Past performance is essentially without value here. And while the careful selection of asset class diversification is quite important, the individual vehicles used to achieve it are not.
Always keep in mind, the financial services industry is a “sales based” enterprise. It does not exist to offer guidance based on wisdom, science or experience. Its business is making money, and most of that money comes from the pockets of its own customers. When it comes time to make a selection among many alternatives, the driving concern is the furtherance of that goal. As a potential client, you ignore that motivation at your own risk.