Flying in the face of data: What active investment management has to sell

I’ll admit it, I’ve been obsessed with investing for a long time.

My introduction to the stock market came through individual stocks, and I got lucky right off the bat. Twice in the late 1970s, I wrote an annual report for a tech company on Long Island that paid me in shares of their stock rather than cash, and the shares I received for $3 and $4 in successive years were worth $21 when the company was acquired by National Cash Register in 1980. Similarly, I bought Wang Labs when I went to work on the account at Hill Holliday in 1978, and the shares rose, if memory serves, from $6 to $42 before I unloaded them

Despite my early success (which, unfortunately, didn’t involve substantial money), I eventually came to believe that mutual funds made good sense for me, and I began to invest in them.

There were various reasons why I liked them:

  • I had confidence in their internal research capabilities, which are obviously quite extensive.
  • I valued the ready access they have to the senior management of publicly traded companies, which meant they could put questions directly to business leaders and (presumably) get straight answers.
  • Most of all, I believed that their best fund managers would have investment abilities that removed luck from the equation and made investing a matter of skill, judgment and analytics.

The question is, if I were making the same decisions today, would I be justified in putting my trust in these “active managers?”

The edge goes to the benchmarks

According to “The Dying Business of Picking Stocks,“ a recent article in The Wall Street Journal that attracted a lot of attention, there’s a very strong likelihood that the answer to the question is “no”. That’s because over the last 25 years, only about one in five active managers has outperformed the Vanguard 500 Index Fund, a proxy for the U.S. stock market that invests in the 500 stocks of the S&P 500. That’s a pretty puny number. And it gets worse more recently. In the last year an even smaller percentage of active managers – only 15.4% – have outperformed the Vanguard 500.

You’d assume this kind of performance would have consequences for active managers, and it has.

“Over the [last] three years,” the WSJ article reported, “investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds.”

How can actively managed funds be marketed?

As a marketer, I’ve done a lot of thinking about how companies whose fundamental identity is associated with active management can effectively market themselves in the face of data that would seem to contradict blanket claims they might make about superior investment management, especially when you also consider that ETFs often charge lower management fees

Here’s what I would recommend to them.

1. Focus on individual funds with dynamic managers who are or have put up good numbers

We’re all familiar with the way too many fund families go about marketing their funds in print. What I’m talking about are ads that show the names and trading symbols of a bunch of funds with Morningstar stars hovering above them and a glib headline that goes something like “The stars have aligned for us.”

This kind of marketing communications is unoriginal, undifferentiating and uninteresting.

What you don’t see is marketing that brings the managers to life. I went to a dinner hosted by Fidelity a few years ago with Rajiv Kaul, manager of their Select Biotech Fund, and I was overwhelmed by his intelligence, the depth of his understanding of diseases and the role he plays and the prominence he enjoys in the biotech industry.

I know, biotech is getting seriously clobbered this year, and yeah, Rajiv is lagging his index by several percentage points. But I believe there’s a story to be told by and about managers like him that would resonate with investors like me.

Fidelity tries to do some of this on its Asset Management website, where they publicly declare that “The goal [is to] beat the benchmark.” You can judge for yourself whether you think they’re going far enough to engage advisors and investors.

2. Deliver a deep dive on the investment methodology

Investing isn’t easy, and investors recognize it. We know it typically involves the participation and contributions of a lot of smart people, that deep analysis is required to build and manage a portfolio and that markets themselves are complex and dynamic (i.e., constantly in flux).

As an investor, I want the fund company to explain their investment process to me and what they’re doing to capture alpha on my behalf. Treat me like an intelligent consumer and provide specific details.

Hey, my money is at stake. This stuff matters to me, and I’m certainly not unusual.

3. It’s fine to be truthful

I’ve always thought it was interesting that when you read a quarterly report for a fund, you can find out not only which positions in the portfolio contributed to success, but which ones detracted from it. I find this revealing – i.e., the transparency works.

My recommendation to fund companies – in all communications, be forthright. Let investors inside the kimono.

4. Emphasize the brand

I have no doubt that all fund managers want to produce great numbers for their investors, but I also believe there are companies that make it a cultural mandate. I have this feeling, for example, about Ron Baron’s fund company and about Donald Yacktman’s (although the Yacktman website could certainly use improvement). Why larger fund companies don’t bring this same emphasis to their communications is another thing that leaves me scratching my head.

The bottom line is this. If I’m going to continue to entrust money to professional managers, I need to know they’re living, breathing people with a passion for what they do. I believe that difference – between the qualitative and the quantitative – is the best defense against strictly judging things by the numbers.

(If you want to see a company that I think is doing many of these things well, visit the MFS website and check out the content they’re making available to individual investors.)

AFTERWORD: I finished this blog on a Saturday morning. That afternoon, my copy of Barron’s arrived in my driveway with these words on the cover:

MAN BEATS MACHINE. Forget those stories saying cheap index funds are unbeatable. Since July 1, a full 60% of managers at active mutual funds have outperformed the market. Expect to see more of that.”

Well, son of a bitch. While the article acknowledges that “just 6% of active growth funds are outpacing the market year to do date,” it argues that conditions have turned in stockpickers’ favor. And it suggests that “fund investors have another step to take; they must choose the managers they consider poised to outperform.”

All the more reason, in my opinion, for fund companies to get out and tell their story.