When I read that story, I thought he is right. If we think of the fish as rates of return, we’d assume the beginner fisherman is the better fisherman or fund manager because they caught more fish.
The anecdote also made me think of the investment funds that did well from 2020 to 2022, during the COVID lockdowns. Did they do well because they had skilled investment managers? Or just because the pond they were fishing in was restocked? How many investors do you suppose saw those great returns by the tech-heavy growth funds and switched into those funds?
Why going after returns doesn’t always work
Wiggins gives three reasons to explain why chasing returns is a bad idea.
- Mean reversion: This is the likelihood of an overperforming fund underperforming to return to long-term average returns.
- Investor sentiment: Outperforming funds may attract new investors, pushing up valuations, but if the mood changes, investors may flee the fund just as fast.
- Valuations: As the individual securities held in a fund increase in value, the future expected returns are reduced.
Complicated fund? There’s a sales pitch for that
Later in the book, I chuckled when Wiggins provided the outline of a sales pitch for complicated funds, and I’ll add alternatives, because I have seen this presentation many times.
- “We have a product that can produce returns that are both better and different than what you currently invest in.”
- “You can only get it from us.”
- “You won’t be able to understand it.” And if you could, then everyone would be doing it.
- “We are very clever.” We understand it.
I’m noticing there are now more and more complicated investment products available to investors. So, when you hear this sales pitch, take a moment to reflect. Are you only purchasing the fund because of strong past returns, or do you have a good understanding of the fund?
Wiggins states that it’s impossible for investors to make informed decisions about funds they don’t and cannot understand. He likens it to a magic act, where investors are just waiting for the rabbit (returns) to be pulled from the hat.
Fees that are just as complex as the investments themselves
Often associated with complicated investment products are incentive fees, which can be presented in a way to make them look good.
There is a base fee, and if the fund is doing well, the fund manager will charge more. However, as Wiggins points out, they don’t reduce the base fee when the fund is doing poorly. This can lead to a higher-than-average fee over the long run.