1. “You may have more investing experience than I do.”
The first step when selecting a money manager is reviewing his or her track record, which provides information about past performance and returns as well as investment style. A manager without a track record should raise a red flag, especially for an investor who’s looking to place money in experienced hands.
“If they don’t have a track record, there’s no real compelling reason to take a risk,” says Gary Schatsky, an attorney and fee-only financial advisor in New York.
Often, investors are concerned about ending up with a young money manager, but age shouldn’t be the focus of their search because it does not always speak to experience, he says. Instead, investors should look at how long the people they’re considering have worked as money managers and check how their performance compares to investing benchmarks like bond funds or the S&P 500.
Currently, 546 out of the 2,729 domestic equity funds have managers with an average tenure of two years or less, according to Morningstar. And more than half (280) performed worse than the S&P 500’s 12-month return ending July 31 of 13.84%.
2. “I’ll beat the market—someday.”
It’s not easy to find a money manager who consistently beats the market. That’s not so bad when the market is up and your fund is up a little less; it’s worse when the market is down and you’re down more.
Lagging returns have been a common problem since the recession that began in December 2007.
“When virtually all indices are dropping the best you can hope for are comparatively better returns, which in many cases are negative just with a lower rate,” in the same asset class, says Schatsky. “But it takes a rare client to embrace that and recognize comparative value.”
Investors who are shopping for a money manager should focus on their past performance not just over the one-, three- or 10-year periods but specifically during bear markets to have a better understanding of how they adjust their investing tactics and how they react to market losses. Compare their performance to similar funds and, if applicable, to the index itself, says Schtasky. “You want to see that they have performed well to the benchmark,” he says.
3. “Hedge funds aren’t what they used to be.”
Once reserved for the super-rich, hedge funds today are quite common and accessible to the average investor. Assets in hedge funds climbed 10% during the second half of 2009 to finish the year at $1.82 trillion, according to HedgeFund Intelligence. However, they haven’t been immune to the market downturn. That bump followed an 18-month period during which the hedge fund industry contracted by more than 30% and fell off its 2007 peak of $2.7 trillion in assets.
The funds’ recent, relatively poor performance has caused some high-profile hedge fund managers to close up shop. In August, fund manager Stanley Druckenmiller, whose firm Duquesne Capital Management holds about $12 billion in assets under management and has averaged gains of about 30% over the past two decades, announced he would be closing the fund, citing disappointing returns.
Most hedge funds charge a management fee of around 2% of assets, and they charge a performance fee, which is often around 20% of portfolio gains. The performance fee doesn’t necessarily kick in right away; typically, the contract an investor signs with a hedge fund states that the fund must meet a certain level of performance first.
Updated and adapted from the book “1,001 Things They Won’t Tell You: An Insider’s Guide to Spending, Saving, and Living Wisely,” by Jonathan Dahl and the editors of SmartMoney.
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