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Financial Advisors and Active Fund Managers

Updated: Sep 9, 2023


Active vs Passive


The “Active vs Passive” debate was settled long ago - passive is better in the long run mathematically and empirically, e.g. SPIVA. Investing is a “solved” game!


However, there's a never-ending stream of financial professionals* trying to lure the average investors into active funds instead - of course their heart is pure and there's no other motives, right?


At the very top of the active fund managers food chain lies the "hedge funds" managers with many collecting >$100M in fees (top 8 got $1B+ last year, even when the market is down and the funds may have lost billions!


Two questions always spring to my mind:

  1. Why the hell are people giving so much of their money to these hedge fund managers who are only great at turning everyone's money into THEIR money while producing returns far inferior to index funds? (Standard fees of 2% & 20% is ~3% AUM)

  2. Where do they invest their money?


I remember reading an article on a very successful hedge fund manager (earning $100M+ annually). When asked where he invested his money, he simply laughed and said "I put it all in one product - the Vanguard Lifestrategy fund".


So, it was no surprise when I read the recent article by Robin Powell that discusses my second question.


Many comments by active fund managers were incredible. Two that stands out for me are:


“All my own money is in index funds”

And

“I wouldn’t invest in my own fund.”


It’s quite unsettling to think that fund managers and financial advisors are purposely putting investors’ money into inferior/junk/active investments to maximize their earnings. On the surface, this all seems nefarious but you are wrong!



Hanlon’s Razor



It turns out that MOST financial advisors lack understanding of basic investment principles, proper portfolio constructions, or the power of indexing! This came from a study that analyzed the portfolio of the fund managers themselves – ie, looking at how when and where they put their money. Their portfolio lacked diversity and lopsided while their investment timing shows clear signs of behavioral biases like “performance chasing” and “panic selling


It may surprise you but MOST financial advisors do not know about or understand index funds. The fund managers/advisors that know the superiority of index funds literally have billions of reasons to not recommend index funds.


"It is difficult to get a man to understand something, when his salary depends on his not understanding it." -Upton Sinclair


It turns out that most funds/portfolio managers pushing investors into active funds are simply incompetent while the rest are doing so to maximize their pay. A very small percentage (I estimate <1%) of financial advisors and fund managers are fiduciary, knowledgeable, and making extensive use of passive index funds. Good luck finding them! By the time investors are able to identify the good managers/advisors, they should have enough knowledge to not need one!


It’s no wonder passive index funds are growing so fast as groups like the Boggleheads and SimplyFI (for expats) who are shining a light on the industry, pushing back against the bad actors in the industry and educating people on sound investing principles and how to do it themselves.


This problem is magnified in the UAE where weak regulations have allowed bad actors in the industry to run rampant, destroying the financial lives of countless expats, with impunity. Insurance brokers have been masquerading as financial advisors while selling overpriced life insurance policies that they pretend are financial investments. All before they disappear with all the client’s money. I will be writing more on this in future posts.


Active Management and Hedge Funds


To be fair there are some reasons why people would choose to predominantly invest in active/hedge funds.

Some of these include:


  1. Potential for Higher Returns: Active or hedge fund managers aim to outperform the market or achieve above-average returns through their investment strategies and expertise.

  2. Active Management and Expertise: Active and hedge fund managers typically have extensive market knowledge, research capabilities, and specialized expertise in specific investment areas or strategies.

  3. Risk Management and Hedging Strategies: Hedge funds often employ risk management techniques and hedging strategies to mitigate potential losses or provide downside protection during market downturns.

  4. Diversification and Alternative Investments: Hedge funds often have the flexibility to invest in a wide range of assets beyond traditional stocks and bonds, such as commodities, currencies, real estate, private equity, or venture capital.

  5. Access to Exclusive Opportunities: Hedge funds may provide access to investment opportunities that are not easily available to individual investors or offered through traditional investment vehicles: e.g. private placements, pre-IPO investments, distressed assets, etc.

  6. Personalized and Tailored Approach: Active or hedge funds often offer personalized investment approaches, allowing investors to align their portfolios with specific goals, risk tolerances, or investment preferences.


However, when you examine the data on the claimed benefits against the final results, it simply doesn’t add up - index investing proves to be a superior strategy over any location, time period or market conditions.


In my opinion, there’s two reasons, mainly psychological, why so much money is still being poured into active/hedge funds.

  1. Lack of knowledge – People who have money to invest (HNWI)tend to be older and may lack the knowledge of and understanding of indexing which has exploded in recent times.

  2. Special connections – Being part of some active/hedge funds is a very exclusive club that provides financial, business and political connections that money can’t buy.


Index Investing is the Future


Over time, more money will shift to index funds as active funds continue to underperform. Retail and institutional investors will recognize the futility of having most of their money in active/hedge funds.


We are already seeing this as index funds finally caught up to active in 2022 and extending the lead further in 2023 as more and more people understand index investing.

Should You Fire Your Financial Advisor? Index Funds Overtake Actively Managed Funds
More and more people are opting out of financial advisors

If you’re already in index funds, you can rest assured that you are ahead of the curve and your money is working hard to achieve your financial goals.


If you want help getting started with index investing, book a free 15 minute call now.



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* In this post, I consider fund managers, financial advisors, hedge fund & portfolio managers to be in the same boat as they are all pushing retail investors into active funds for their personal benefit.


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