Are fund managers wearing halos?

Are fund managers wearing halos?

Do fund managers really deserve the "star" status we give them? There's a phenomenon psychologists call the halo effect: our tendency to take one piece of evidence about someone and use it to form an overall impression of them. It's extraordinarily common in the fund industry, where a manager who performs well, even over a short period, is assumed to be someone who will keep on outperforming in future. History suggests that assumption is often badly misplaced.

In this video, investment analyst Abraham Okusanya explains how the halo effect distorts the way we judge fund managers, using two well-known examples. The first is Bill Gross, the celebrated "Bond King," whose success owed much to a particular set of economic conditions that happened to suit his investment style. When those conditions changed, and after he moved firms, he was unable to sustain that outperformance. The second is Neil Woodford, once hailed as "Britain's Warren Buffett," who seemed able to do no wrong.

You'll learn why Woodford's reputation rested on surprisingly thin foundations. His career was essentially built on a single well-timed decision: avoiding technology and large growth stocks during the late-1990s tech bubble. Strip out that one call, Okusanya explains, and his subsequent results were actually rather mediocre. Yet that didn't stop the media, private investors, institutions and advisers from continuing to hold him in the highest regard, right up until he launched his own firm, which collapsed spectacularly and cost investors large sums. And what happened next? Attention simply shifted to anointing the next "star."

The video also explains why this cycle keeps repeating. At its heart, Okusanya argues, investment management is a marketing business with an enormous budget, and it's prepared to spend heavily to persuade investors, advisers and journalists to focus on the hype rather than the evidence. What actually works over the long term is far less exciting: invest for the long run, stay invested, and diversify broadly. It's been likened to watching paint dry, which is precisely why it makes for such poor headlines.

The takeaway: there are many lessons to draw from the Woodford experience, but perhaps the most important is simple. Fund managers are only human. They don't wear halos. Don't be swayed by media hype, and keep your focus on the evidence rather than the story.

Chapters / Key points

• What the halo effect is and why it matters in investing
• Why one good run makes us assume future outperformance
• Bill Gross, the "Bond King," and the conditions behind his success
• Neil Woodford and the "Britain's Warren Buffett" label
• Why Woodford's record rested on a single well-timed decision
• How his firm collapsed and cost investors dearly
• Why attention simply moves to the next "star" manager
• Why investment management is really a marketing business
• Why boring, evidence-based investing works over the long term

Transcript

Are fund managers wearing halos?

RP: There's a phenomenon psychologists describe as the halo effect. It refers to our tendency to use one piece of evidence about someone to form an overall impression of them. It's very common in the fund industry. When a manager performs well, even over a short period of time, we assume they will carry on outperforming in the future.

AO: The legendary Bond King Bill Gross is an example of that, where he was very well regarded for being a successful bond fund manager because a certain set of economic scenarios presented themselves and they happened to have favoured his particular investment style, and then of course that dispensation came to an end, a different environment presented itself, and he wasn't able to replicate or maintain that level of outperformance, and then he moved to another firm, that didn't help.

RP: Another example of the halo effect is the way that a fund manager called Neil Woodford was hailed as "Britain's Warren Buffett." It seemed he could do no wrong.

AO: Neil Woodford essentially made his career by avoiding the so-called tech bubble in the late 1990s. If you took out that single decision, i.e. avoiding large growth stocks or tech stocks during that particular market condition, his subsequent results were actually incredibly mediocre. But it didn't stop the media, investors, private investors, institutional investors and indeed advisers from continuing to give him the regard that he had earned as a result of that.

RP: Unfortunately, it didn't end well. Woodford set up his own fund management business and flopped spectacularly. His investors lost large sums of money. But what happened then? Attention turned towards the next "star" manager to anoint.

AO: The investment management business is really, at the heart of it, a marketing business. The investment management industry has a huge, huge budget. And they are prepared to spend that money to persuade ordinary investors, financial advisers, and indeed the media, to not look at the evidence but to focus on the hype. What we know works in the long term as far as investing is concerned is really simple: invest in the long run, stay invested, diversify broadly. It's been described as "watching paint dry," right? As a journalist, you can't really write about that all the time.

RP: There are many lessons to learn from the Woodford experience. One of them is to remember that fund managers are only human. They don't wear halos. So don't be swayed by the media hype.