Why I Won’t Own an Index Fund or ETF
Skilled Fund Managers
Many investors are skeptical that there exist fund managers who have skill and who can beat the index over the long-term. Other investors believe that there are fund managers who have skill, but that it’s impossible to identify them ahead of time.
There are skilled fund managers that can be identified ahead of time. I know quite a few of them. You just have to look using the right criteria.
When looking at funds, many investors take an objective approach and study recent returns, look at ratings or statistics, or try to forecast which sectors will perform well.
Other kinds of skill evaluations are more subjective and rely on insider judgments, e.g., doctors assessing other doctors, or even actors judging performances of their peers.
The evaluation of a fund manager falls somewhere in between those two approaches, the objective and the subjective. I believe that, to find the best fund managers, you have to study them, not the fund.
Start by finding fund managers that have beaten their index over their career or long periods of time. This could be in more than one fund. They do not need to beat the index every year – just over time. Then study them to find out how they do it. Is it because of stock-picking skill?
Outperforming the appropriate indexes is just one factor in the criteria. Top fund managers are usually not trying to secretly follow the index–they’re more likely to have an effective style (like value investing), and have high “active share,” which means that they’re investing in a way that differs from the index; they also often have great experience and have their own money invested in the funds that they manage, i.e. “skin in the game”.
My All-Star Fund Managers
One of my special skills is identifying all-star fund managers — it’s essentially my main focus related to investments. I’ve found around 50 fund managers over the years who I would characterize as having superior skill, and all of them have beaten their index over long periods of time.
Most of those 50 managers are on my “watch list”. I own only a handful of those funds. Although I’m resistant to the idea of sharing statistics about my own personal investments, mostly because my investment style may not be suitable for every investor, I want to emphasize that it’s possible to identify skilled fund managers early and ahead of time.
Why I Will Never Own an ETF or Index Fund
I won’t ever own an ETF or an index fund because I’m not happy with below-index returns. I choose investments based on the fund managers–I want to invest with the Albert Einstein of investors, the absolute best. ETFs and index funds don’t have fund managers, so I’m not interested. The goal of investing is to obtain the highest long-term return after fees, and a skilled fund manager provides enough value to pay for those fees and more.
There are really two options when you’re pursuing above-index returns: one, you can find yourself an all-star fund manager, or, second, you can choose a portfolio manager who’s paid by performance fee. When portfolio managers are paid by performance fee, they’re motivated to beat their index. If they don’t beat the index, the fees are similar to ETFs. If they do beat the index, the fee pays for itself.
Getting above-index returns is all about finding skill.