They get paid either way, but...
I’ve been thinking a lot about what 'unbiased' is recently. Especially after this recent article, where I was simultaneously amused and disappointed.
It’s generally quite hard to claim 'unbiased' when you’re promoting a stand, especially one that's inaccurate and untrue.
But after the Seedly Festival, and especially after talking to the extremely motivated and intelligent folks at digital DIY platforms such as FSMOne, whose core revenue comes from Unit Trusts – I’ve begun to ask myself what exactly ‘unbiased’ is.
There isn’t a single person in the world who’s managed to make the textbook definition – but what about their own definitions?
After all, it’s not particularly wrong in today’s world for people to have a different definition – culturally, and maybe topically (such as Finance). I certainly think I’m unbiased, but that simply isn’t factually true.
It’s a big problem which requires far more thought.
But one thing I could certain address… Is the perception of a fund manager.
By definition, a fund manager is someone who manages the investment of money on someone else’s behalf (individual, institutions).
Recently, especially post-festival, fund managers have been getting quite a bit of flak, and part of the flak is the idea that fund managers aren’t reliable, or biased, because they get paid no matter how they perform.
It’s an interesting thought. How does that logic stack up?
The Origin of a Fund Manager
Let’s sidetrack a bit.
In the old days, Xiao Ming was a very good stock investor. He always made money from stocks every year. One day, his friend Richard approached him.
“Eh, Xiao Ming – you’re very good at investing. Help me leh. Brother a bit.”
Xiao Ming was a good friend, but mixing business with friendship could make things difficult.
So, he wrote up a contract with three contingencies:
1) Xiao Ming was not responsible for any loss of money that Richard had
2) Xiao Ming did not guarantee any return amount
3) Xiao Ming was to be paid a fixed salary for this labor. After all, it was his time and expertise.
Initially, Richard felt this arrangement was fair. After all, Xiao Ming was an ‘investing genius’. Leaving his money with Xiao Ming was certainly better than not leaving it with him.
But Xiao Ming is not a magician. The very first month, he experienced minor, temporary losses.
This was when Richard realized he had several problems.
1) Firstly, there was almost no accountability. He would hand Xiao Ming some money, hundreds or even thousands of dollars, and he had no idea if Xiao Ming invested it or kept it.
2) Secondly, he had no idea if Xiao Ming treated his money with the same respect that Xiao Ming treated his own money.
Maybe because Richard’s money was additional, Xiao Ming would take greater risks with it because he didn’t care so much? Or maybe because they were such close friends, Xiao Ming would be even more cautious with his money – too cautious?
3) Lastly, Richard was already giving Xiao Ming a salary. Whether it was too low or too high, he had no idea. Would Xiao Ming prioritize his needs and money?
He had no idea.
How would he overcome these problems?
‘He earns money either way’
Pushing Xiao Ming and Richard aside for a short while, the above phrase is something I’ve seen countlessly online as an argument for the biased fund manager.
The hypothesis for proponents of this argument will say the above, and the logic for it is simple. Regardless of whether your fund performs or not, your fund manager will still get paid.
In contrast, if you ‘do it yourself’ (DIY) you have some control of how much output you want in terms of fees.
Now, nobody is denying the potential benefits of DIY, not even the commission-based Money Maverick. It would be unfair to deny those facts.
But similarly, the sentence above is pretty unfair.
By occupation title, a fund manager is a job. You pick out stocks and try to make money from them, and you get paid a fee for your service. This generally makes costs more expensive than tracking an index (ETF) or trading with limits/values in mind (e.g. Value investing, Factor-based investing, etc).
With costs potentially much lower than you for the purpose of investing, as well as the ability to put together a diversified portfolio for that kind of expense - there are really only two primary reasons people still utilize fund managers:
1) Returns higher than the market (or your own stock picking)
2) Returns safer than the market
Logically speaking, without these two reasons, there isn’t a need to outsource your investing towards a fund manager, or even a Financial Advisor.
I’ve written about SPIVA – which is the Standard and Poor Indices Versus Active, the very set of case studies used to suggest that the majority of fund managers underperform the index - and my co-writer already helped me dumb it down a lot.
With the debatable argument for another time –
Let’s assume that the fund manager does do his job and achieves either point 1 or point 2, or if you’re lucky, both.
Let’s assume you’re someone like Richard and caught in a seemingly tenuous position.
What’s the easiest way to solve this problem?
The Unbiased Fund Manager(‘s Fee)
It’s pretty simple.
Rather than a salary or fee, which Xiao Ming or a fund manager would get regardless of performance, now he is only entitled to a percentage of those earnings.
Now you might be thinking – wow, I just spent 2 pages reading the same phrase presented with no explanation whatsoever.
So here it is.
The below is a numerical description of two funds. The first fund on the left is performing at a consistent rate of -10%. The second fund is performing at a consistent rate of +10% instead. Fees are being charged at 1.5% per year and subtracted at the end of the year.
What does this show?
The strong fund manager made almost 3 times the fees that a poor fund manager made across a ten year period, even with a small AUM (Assets Under Management) size of $10million dollars.
The strong fund manager’s salary increased year on year with strong performance.
In contrast, the poor fund manager’s livelihood became worse and worse.
I'm not sure about you, but I don't know if a normal person could handle a salary that gets lower per year of hard work.
Even worse, if it's completely dictated by the market and the market happens to be bad.
Your Interests are Aligned
By paying Xiao Ming a fixed percentage fee, the interests of Richard and Xiao Ming became aligned.
Xiao Ming would prioritize and respect Richard’s money as much as his own, because he is getting paid to do so.
The money that he invests and the returns they will get is the same.
Various things come into play as an AUM gets bigger (e.g. if the fund goes from $10mil to $100mil). But accountability is first and foremost, which means that Richard never has to worry about whether Xiao Ming is secretly embezzling his returns and writing it off as losses.
We’ve been told often to think and act like the rich – using a long term, growth mindset - but the ‘poor’ mindset is holding us back. Maybe something is biased, or out to cheat us at every waking corner.
But behind every company and every service, whether you choose DBS or an insurance company or a fund manager, is a person or group of people. They are not nameless, faceless corporations that are conspiring to get you and eat at your money.
Every single business and every single job exists on the premise that you can serve and will be served.
If you cannot do a job, you will lose it.
If you continue to screw over clients, your business will collapse.
A fund manager’s interests are aligned with yours because your losses are the same. You lose money, he does also. On top of that, he loses his livelihood, reputation and dignity.
Is a fund manager biased? You decide.
Incidentally, Financial Consultants also face the same problem. Are we biased, or not?
If you’re a market, passive investor who isn’t into taking risks, that’s fine. You'll never need to know.
If you enjoyed the article or have some thoughts or comments on how you can start developing your streams of income, do like - comment and subscribe!
Credits: Seedly Blog: https://blog.seedly.sg/regret-buying-investment-linked-policy-ilp/ Budget Babe: http://www.sgbudgetbabe.com/2019/02/5-investment-lessons-that-ive-learned.html