🔒 WORLDVIEW: The name games money managers play – and how they hurt investors

After his 80th birthday Warren Buffett dispensed with what for me was the best reason for that annual 26 hour trip from Johannesburg to Omaha for the Berkshire AGM. Fortunately, I still have the notebooks of those very special Sunday afternoon press conferences. Events where 30 or so fortunates had the opportunity to each pose a question to Buffett and business partner Charlie Munger. Their responses were priceless.

In between questions, Buffett loved teasing us. His favourite was that we need to tell the dirty secret about money managers. Do the homework on their returns, he urged, and you’ll be telling your readers to buy ETFs instead of falling for the hucksters of Wall Street. But I’m not holding my breath that those stories will be published, he would add, because your bosses know who has the marketing dollars.

My Biznews colleague Jackie Cameron picks up the theme in today’s contribution. She writes: “The financial services industry puts a huge collective effort into coming up with names that will entice us to buy their products. Popping words like wealth into a fund label helps drum up interest; terms like ‘alpha’ – performance above-and-beyond market returns – help sway more discerning crowds.
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Tapping into niche markets works well, too, with many a fund riding on the back of the latest investment fad. Remember all the dotcom funds before 2000, and then the biotech funds?

Product names are intended to give a flavour of the style of investing. But I was reminded recently of how misleading these can be when my husband received the grim proceeds of a ‘Sure Profits’ portfolio in his bank account.

‘Sure Profits for them,” he remarked upon receiving R19,000 from a home loan protection endowment – a blend of life insurance and a savings/investment plan – into which he had paid at least R20,000 over three decades.

The approach of using misleading monikers is not a South African phenomenon. It is common for financial services companies around the world to sell products with names that bear little to no resemblance to what goes on in the management of these offerings. So common, in fact, that academics have turned their attention to analysing links between investment names and investment returns.

There are strong indications that mislabelling is a predictor of poor investment performance. For example, in a study of about 1,800 US equity funds over 12 years to 2015, economics experts at Maastricht University in the Netherlands found that about 14% of individual funds are “significantly mislabelled”.

They calculated that in the long run misclassified funds underperform well-classified funds by 0.92% per year. That’s significant when you consider the effect of compounding. What’s more, misclassified funds appear to be younger, smaller in size and have higher expense ratios. (See the study on Investment Style Misclassification and Mutual Fund Performance.)

This is an appalling state of affairs for a number of reasons, not least that many investors choose on the basis of the investment mandate. If fund managers move away from their stated investment style, they are effectively defrauding investors – though no doubt there’ll be a caveat to avoid liability tucked away in the fine print.

Some cases of mislabelling are attributed to ‘style drift’ – the fund manager dips into stocks outside the mandate to generate short-term returns or track an index to avoid underperformance – which is a polite term for dishonest portfolio management.

Investors often structure diversified portfolios of funds based on these mandates and labels. The prevalence of mislabelling means this is very difficult to allocate funds effectively.

It’s not clear why mislabelled funds tend to be more expensive and underperform, though the Maastricht experts note that much of the mislabelling is in the ‘growth’ and ‘income’ categories of funds. There appears to be far less of this behaviour in the small cap sector.

Such is the size of the problem that the Maastricht team is pushing for a Style Concentration Index to incentivise style consistency among fund managers, as this is seen as “a crucial ingredient for achieving long term risk-adjusted performance”. In the meantime, studies like theirs serve as a reminder that the devil is in the detail with investment products and that we should all be wary of marketing smoke-and-mirrors – particularly when it comes to names.”

Great stuff Jackie. Warren Buffett would surely approve.

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