Who's the smartest money manager?

Kelly Rodgers, MoneySense March/April 2000

Test your mutual fund's IQ with these questions

If you're like most of the investors I know, you've probably spent more than a few hours looking at the latest hot mutual fund and wondering whether you should buy in. My advice? Relax.

You're wasting your energy because no one can predict with any confidence how any fund will perform over the next couple of years. All the statistical evidence indicates that top-performing funds tend to fall back to earth, while underperforming funds often stage a comeback. At the end of the day, it's impossible, even for professionals, to pick tomorrow's top funds.

I'm not suggesting that all funds are equal. But what I am saying is that most people get their investing decisions backward. They look for hot funds, then try to buy into them on the assumption that whoever is running those funds must be smart. A better strategy is to look for smart managers, then stick with them on the assumption that their performance will eventually reflect their talent.

Ultimately, the question you should be asking is whether you have a money manager who meets your needs. After all, a mutual fund is nothing but a way to deliver professional money management to people who don't have huge amounts of capital. Your priority as an investor shouldn't be to pick an individual fund, but to pick a management team you can settle down with for the long term.

The nice thing about this approach is that it relieves you from worrying about short-term performance. While a fund's results may vary a lot from year to year, chances are that the quality of its management will be relatively stable. If you pick the right mutual fund company to oversee your core holdings, you're not going to have to revamp your portfolio every few months. You can invest most of your money with this company and feel assured that it will be well looked after.

So how do you pick the right mutual fund company? The standard advice is to look for a combination of low fees and strong performance over the past three to five years. While I agree those factors are important, I think they may be overemphasized.

When I'm advising institutional or wealthy clients on how to select a money manager, I tell them that recent performance should count for no more than 25% of the final decision. What's equally important is how that performance was achieved. I want to see steady, reliable gains, not wild fluctuations between huge losses and big wins.

I also look closely at the people who run the firm. I want to see a team that has worked together for at least five years, and I want to see a senior management team that owns a significant stake in the company, so their own money is on the line.

The next thing I look at are the members of the investing team. I want to see a lot of depth to ensure continuity. A strong team will have portfolio managers and analysts who range in age from their late 20s to their late 50s.

What I'm typically searching for in a core manager is somebody who doesn't take a lot of risk and who consistently delivers consistently good performance. In evaluating how he or she manages money, I always ask, "What if that person is wrong?" because I know that every money manager is going to make at least one big mistake in the course of a career.

One warning sign of a high-risk manager is too much concentration on a few companies. A portfolio or fund that holds only 20 securities is more aggressive-hence riskierthan one holding 40 securities. The research shows that to be adequately diversified an equity fund should hold a minimum of 40 stocks.

Another sign of a high-risk manager is big swings in the asset mix. If you see a manager who holds 50% bonds and 50% stocks in January, then shifts to 70% stocks and 30% bonds in June, you know that manager is trying to time the market. He's taking risks, and while those risks may pay off, they may also result in disaster.

I always look closely at how much trading goes on in the portfolio. Some managers love to buy and sell stocks; others practise a buy-and-hold strategy. My experience is that portfolios that turn over 25% to 50% of their stocks in the course of a year seem to be the ones with consistently good performance. They won't shoot the lights out in good times, but they won't blow up in poor markets. If a manager is turning over more than half of his portfolio every year, he or she is courting a lot of extra risk.

All of this information about management team, asset mix, turnover, etc., may sound like a tall order but, in fact, it should be relatively easy to obtain. If you're using a financial adviser, that person should have all this information at his or her fingertips. (After all, that's precisely why you're paying your adviser a significant chunk of money.) If you're interested in a no-load fund company, you should be able to dial a toll-free number and speak directly to a client service representative. If the representative can't provide the infor mation, you should shop elsewhere.

What are my own favorite mutual fund companies? In the no-load sector, I recommend Phillips, Hager & North, Mawer Leith Wheeler, Maclean Budden, MD Management and CIBC. I'm not a big fan of companies that charge loads, or fee for buying into a fund. If you want to invest with any of those firms, you should insist that your financial adviser demonstrate how they compare favorably with the no-load companies I've listed above.