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RP: When you buy an investment, you should hold it for the long term.
But most investors don’t. Even supposedly sophisticated institutional investors, such as pension funds, switch managers far too often.
They’re usually acting on the advice of consultants, who claim they can add value through fund selection but generally can’t.
HB: From the research that we conducted for our book, The Trust Mandate, the most consistent finding was that neither institutional investors, nor the consultants that advise them were able to demonstrate any ability to pick winning investment managers. For both groups, the returns of the recently fired managers was typically greater than those of the recently hired ones. At least in the horizon of one to two years.
RP: You could argue that the constant hiring and firing of fund managers at least keeps the industry on its toes.
But switching funds costs money, which is one of the reason why it’s so difficult to profit from it.
HB: So although on average sponsors gain no advantage from switching, the constant churn might improve the competitive marketplace. So industry returns might be higher, and costs lower than they would be in a less competitive environment. But, there is no way of measuring this. And even then, for any individual investor it would still be better to stick with the same manager, and just let everybody else take care of maintaining the competitive marketplace.
RP: What, then, can ordinary investors learn from the experience of institutional investors? First and foremost they should buy a fund and stick with it.
HB: Well, neither institutional investors, nor the consultants that advise them have proven themselves able to identify in advance which investment managers will outperform and which won’t. So you probably won’t be able to do so either. It’s probably better to stick with the same manager who keeps costs firmly under control, and then just let others take care of maintaining a competitive marketplace with their endless cycles of hiring and firing.
RP: Finally, remember the advice of Warren Buffett, the most famous investor of modern times. Both small and large investors, Buffett says, are better off with low-cost index funds.
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