Thursday, October 20, 2005

Unavailable Talent?

I haven't studied hedge funds enough to have an opinion on whether they should be more regulated than they are now. I always thought that only accredited investors (worth over $1 million in ivestable assets and with incomes over $200k/annum) could invest in them. In any case, David Swensen, esteemed steward of Yale University's endowment, seems to think they need more regulation. In making his arguement, however, Swensen says some questionable things.

Swensen argues that "[t]he best money managers seldom operate in a mutual fund format, preferring to manage money for sophisticated institutional investors."

First, although I've seen many individual investors blow themselves up, I think institutional investors are no less fickle than retail investors. Retail investors tend to damage themselves by loading up on a hot category, buying after the category has surged and selling after it has tanked. Institutional investors mostly avoid that problem. They tend to keep themselves more diversified, but they become frustrated with individual managers much too quickly. So if their "small value" manager isn't keeping up with the category over six months, they dump him for another one. So, in a way, institutional investors buy high and sell low too; they just tend not to do it on the catastrophic level that retail investors do it on. Actually, sometimes their mismanagement or unrealistic expectations does lead to significant problems. How many pension fund managers, drunk with the stock market returns of the late 1990s, anticipated permanently high stock market returns (15-20%/annum), thereby mismanaging allocations and encouraging companies not to fund their employee pensions as extensively as they should have?

Second, many of the best money managers are available to retail investors and manage mutual funds. In equities, Bill Miller has beaten the S&P 500 Index for the past 13 calendar years; small investors can hire him by purchasing the Legg Mason Value Trust fund. Bill Nygren of Oakmark also has a sterling record. Marty Whitman, founder of the Thrid Avenue funds, and the team at Franklin Mutual Series give small investors the opportunity to participate in bankruptcies, restructurings, special situations, and even private equity deals. Other top-notch equity managers who run retail mutual funds for small investors include Madison Advisors, Robert Rodriguez, Richard Pzena, Christopher Davis, Herb Ehlers, John Rogers, Bruce Berkowitz, Sustainable Growth Advisors, Chuck Royce, Wally Weitz, David Winters, and Tom Marsico. And this is just a quick list off the top of my head. I'm sure I could think of others that any institution would be happy to hire -- and many institutions have hired these mutual fund managers who also run institutional money along with their mutual funds. In bonds, retail investors can hire the two best managers in the business, Bill Gross and Dan Fuss.

Harvard University just hired Mohamed El-Erian from the firm that Gross put on the map, PIMCO, to manage its endowment. Mr. El-Erian ran the PIMCO Emerging Markets bond fund, but it's not clear that his departure confirms Swensen's thesis since the Harvard job is such an unusual one. I can't say that I don't understand why El-Erian left PIMCO for Harvard; but at the same time, if I were a bond manager, I really couldn't think of a more stimulating place to ply my trade than PIMCO. The point is that, despite the defects of the mutual fund industry and the fickleness of retail investors, some of the best asset managers in the world run widely available mutual funds.


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