Mutual Fun?

How do managers manipulate returns? Let me count the ways…

Global Market Update - Fudge

Source: Bear Creek Fudge Factory

Yesterday I noted how fund managers are conflicted. They want to look good so their firm can attract funds to improve their fee income. One way to look good is by gaming the system—fudging their returns. You’d think there would be rules about this sort of thing. But often, there aren’t.

One way to manipulate performance is through incubation and mergers. Several new funds are established with different strategies. Initial investments are limited; hot new IPOs get allocated. What looks like investment skill might just be the trading clout of a big firm working for a small fund. Successful funds get marketed; failures are quietly closed. Really successful funds may be merged into the firm’s flagship funds, where their enhanced performance makes the mother ship look good.

This is a kind of “bait-and-switch.” Mangers also manipulate more technical measures. Many of these metrics are designed around a theoretical normal distribution curve. But fund managers can use options and other derivatives to skew their results, giving them apparently higher scores. These strategies can be legitimate—but often are used just to look better. As the British banker Charles Goodhart once noted, “Once a measure becomes a target, it ceases to be a good measure.”

At the core of performance manipulation is a desire to look good. But the heart of money management is a desire to be right—to anticipate the market’s moves by understanding its dynamics. Investors need to know the difference.

Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
Leave a comment if you have any questions—I read them all!

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By |2017-07-17T12:23:11+00:00December 2nd, 2014|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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