Humility is not one of the personal traits held by many people in the investment business. This includes everyone from portfolio managers to advisers to mutual fund wholesalers. Part of this is due to the job.
After all, many serous investment professionals need to develop and hold strong investment beliefs in their own predictions to withstand any doubts coming from the markets or other investment professionals with different opinions.
But this explanation fails to note that these same investment professionals get paid handsomely whether they make good or bad decisions. It is impolite to talk about salaries in any circles, and among investment professionals it is especially sensitive since any talk about high salaries also triggers the inevitable question about what a specific manager, adviser or salesperson actually accomplished to earn their high salary.
Investment professionals also conveniently overlook the fact that the recent deep recession publicly proved that the smartest people in the room certainly did not have all the answers. If they did, there would be more positive net portfolio returns over the last decade.
This is where the need for an attitude adjustment comes into the picture. As everyone knows, a little humility is good for anyone’s character. As St. Augustine said: “It was pride that changed angels into devils; it is humility that makes men as angels” and there certainly is no shortage of pride, much of it unwarranted, in the world of investment professionals.
But in the investment business, no one gets cut down to size after they make a huge mistake or in the case of a portfolio manager, fail to beat their own fund’s benchmark, even after they have collected a full-size salary for an entire year.
This is rare in the workplace. Workers are held accountable on a daily basis for what they produce what mistakes they make, and indirectly, even for events in which they had nothing to do with, such as the bond default in Greece, widespread mortgage fraud or a decline in sales. It is true that salespeople and RIAs are measured against sales goals, but portfolio managers work in a more rarefied workspace.
As a result, one of the few ways an average investor can register any complaint about a fund’s performance or the portfolio manager’s salary is by transferring their fund to another company. This is by design since fund companies know that most investors are very hesitant to transfer. One reason is that investors rarely want to actualize or acknowledge a loss. People seem hardwired to naively believe their account will magically retrace itself to its original value. As a result, shareholders tolerate lousy fund performance much longer than they should.
Why There Is No Humility
Since the public only has limited and controlled access to its mutual fund company, few people have any idea about the stratification which exists inside fund companies. Portfolio managers are often isolated from other departments. Their offices often are physically separate from the rest of the firm and they do not want to be contacted directly by their own salespeople and advisers.
When the do make public contact, it is through carefully edited quarterly statements that often hide behind technical, CFA jargon to disclose losses or missed opportunities. Even the language is opaque. Next time to read a quarterly manager report, look for language where the portfolio manger clearly says he or she missed an opportunity on a sector or stock. Often, the language is that the fund was “over-exposed to an under-performing sector,” or underexposed to an appreciating sector.” Rarely, will a manager plainly state that they missed an opportunity.
This helps the portfolio manager to avoid taking direct responsibility for their losses. Very rarely will a manager say they made a mistake. While this may seem semantic gymnastics, it buttresses the psychological evasion. If the manager does not have to admit a mistake, they can evade accepting responsibility. This helps foster the atmosphere of arrogance, or more politely, the absence of humility. Here, St. Augustine’s quote (“It was pride that changed angels into devils; it is humility that makes men as angels”) rings true a second time.
The portfolio managers’ other most common type of public contact are the quarterly manager presentations, which are often made to their own wholesalers. Even though these are made before the home-town crowd, these are not spontaneous events. Some presentations can jam 75 to 100 slides into a 50 minute presentation, followed by some Q&A. Pointed questions are rarely asked. There is no discussion of fees, expenses, compensation, or even fund performance, unless it is an exceptional event. These topics are never raised in public, even inside corporate meetings, so no one who works for the fund company ever becomes an advocate for shareholders, who are the fund’s own customers.
Given these corporate cultures, it is easy to see how crowd behavior, conformity, tolerating anti-shareholder practices and mediocre performance, and avoiding responsibility can foster dangerous and ineffective corporate behavior and mediocre fund performance.
This cultural conformity may also help explain why one Yale study, looking at a measurement called “Active Share,” found that about one-third of all mutual funds that claim to be actively-managed are in essence closet index funds. These are fund which are largely based on an index fund, but embroider their active management by selecting a few companies which may outperform the index, even though the core portfolio is an index. While this is happening, shareholders are paying higher fees for what they think is pure active management.
Making Portfolio Managers More Humble
But when shareholders use the power of fund redemption, that is, transferring their account to another fund company, they register their ultimate lack of confidence in their portfolio manager. This is the best way of making the portfolio manager more humble.
This is nothing personal, after all, it is the shareholder’s money, but most portfolio managers consider these funds the raw materials to use for their personally-devised strategies. When the fund loses money, the shareholder takes all the risk and the subsequent losses. The portfolio manager knows they will not suffer; after all they still get their entire salary.
So when a shareholder closes their account, can it make a portfolio manager more humble? Certainly. And if it happens enough, it can remind more portfolio managers that there are consequences for making bad decisions. It can also importantly remind managers that they are only stewards, or fiduciaries, for their investor’s money, and that they are one of the few professions, which regularly get rewarded for under performance