When I read this story I thought he was right. If we think of fish as rates of return, we would assume that the novice fisherman is the better fisherman or fund manager because he caught more fish.
The anecdote also made me think of the mutual funds that have performed well during the 2020-2022 COVID lockdowns. Were they good because they had capable investment managers? Or just because the pond they were fishing in has been refilled? How many investors do you think have seen these great returns from the tech-heavy growth funds and switched to these funds?
Why returns tracking doesn’t always work
Wiggins gives three reasons to explain why chasing yields is a bad idea.
- Mean reversal: This is the likelihood that an outperforming fund will underperform in order to return to long-term average returns.
- Investor Sentiment: Outperforming funds can attract new investors and drive valuations higher, but when sentiment shifts, investors can flee the fund just as quickly.
- Reviews: As the individual securities held in a fund increase in value, expected future returns decrease.
Complicated fund? There’s a selling point for that
Later in the book, I chuckled when Wiggins provided an outline of a sales pitch for complicated funds, and I’ll add alternatives because I’ve seen that presentation many times.
- «We have a product that can generate returns that are both better and different than what you’re currently investing in.»
- «You can only get that from us.»
- «You won’t be able to understand.» And if you could, everyone would.
- «We are very smart.» We get it.
I find that investors are now getting more and more complicated investment products at their disposal. So take a moment to think when you hear this selling point. Do you only buy the fund because of strong past returns or do you know the fund well?
Wiggins explains that it’s impossible for investors to make informed decisions about funds they don’t understand and can’t understand. He likens it to an act of magic where investors just wait for the rabbit (yield) to be pulled out of the hat.
Fees that are just as complex as the investments themselves
Often associated with complicated investment products are incentive fees that can be attractively presented.
There is a base fee, and if the fund is doing well, the fund manager charges more. However, as Wiggins points out, they don’t reduce the base fee if the fund is doing poorly. This can lead to a higher than average fee in the long term.