The Intelligent Fund Investor

There are many mistakes we can make when investing in mutual funds or exchange-traded funds.  Joe Wiggins discusses these mistakes from a unique perspective in his book The Intelligent Fund Investor.  He covers some familiar territory, but in a way that is different from what I’ve seen before.  Although most of the examples in the book are from the UK, the points of discussion are relevant to investors from anywhere.

Each of the first nine chapters cover one topic area where fund investors often make poor choices.  Here I will discuss some of the points that stood out to me.

“Don’t invest in star fund managers.”  There are many reasons to avoid star fund managers, but I never thought of lack of oversight by the fund company being one of them.  “Individuals working in risk and compliance have little hope of exerting any control – they are likely to be relatively junior and considered expendable.  If they go into battle against a star fund manager, there is only one winner.”

Wiggins claims that index funds perform best during periods when large stocks perform well, but that active funds are better when large stocks falter.  This first appeared to be an attempt to support expensive stock-picking fund managers, but late in this chapter he explained that by “active” funds he means “alternative index funds” such as smart beta or “funds tracking equally weighted indices.”  As for the problem of knowing whether large stocks are going to perform well or not, the author suggests mild shifts in index fund allocation based on the valuations of large stocks.

Investors like steady predictable returns, but “smooth fund performance conceals risk.”  The reported price of most funds is “marked to market,” meaning that the fund price is based on the current trading price of its holdings.  However, for funds holding illiquid investments, we usually don’t know what the current price would be if the holdings were traded.  In this case, the holdings are often “marked to model,” meaning that there is some price model that the holdings are assumed to follow, and these models tend to give smooth results.  “Private equity is another asset class that enjoys the benefits of mark to model pricing.”  “Unfortunately, both the return and risk measures commonly used are illusory.”

Simple investment approaches tend to give better results than complex strategies, but that doesn’t stop investors from seeking complexity.  We like to feel sophisticated.  “We don’t just buy complex funds because we believe they might give us better outcomes; we buy them because they make us look better.  The asset management industry is a more than willing seller.”  Wiggins gives two examples of complex funds: XIV and LTCM.  While they are examples of complex funds that cratered, they seem more directly to be warnings about using excessive leverage.

“Great stories make for awful investments.”  At some point, “a certain narrow area of the market will generate strong performance.  This attracts the attention of investors and the media.”  Then fund managers “launch concentrated funds tapping directly into this area.”  Such “thematic funds are perfect for asset managers as they come with built-in marketing.”  Some thematic funds “will wither and die, while others will raise assets and continue to outperform for a time.  There is no need to worry too much about the investors left experiencing losses or stumbling from one story to the next.”

In a chapter where the author argues convincingly that “investment risk is not volatility,” but “is the chance that we will fail to meet our objectives,” he makes a strange assertion.  “Most of us will have to draw on our investments at some juncture.  We should aim to make withdrawals as small and as late as possible.”  Making withdrawals at some point is the purpose of investing.  The goal shouldn't be to die with the largest possible portfolio.  There is nothing wrong with living well, as long as it doesn’t force us to scrimp late in life.

A lesson I learned the hard way was that “past performance is a terrible way to select a fund.”  Sadly, this is exactly how a high proportion of investors choose their investments.

The interests of the asset management industry are very poorly aligned with the interests of investors.  Wiggins does an excellent job of explaining this problem in both the cases with and without performance fees.  He even takes a run at explaining the problems with having a fund manager invest his or her own money in the fund alongside investor assets.  I found this argument much less compelling than the discussion of the other conflicts of interest.

In a discussion about focusing on the long term and not abandoning funds too quickly, the advice seemed to be to be patient, but not too patient if it turns out that the fund is being poorly run.  I found the whole discussion to be a strong argument for using simple index funds and not worrying about other types of funds.

In the last chapter before the conclusion, Wiggins explains the good and bad of investing in ESG (Environmental, Social, and Governance) funds.  Investors who want to just buy ESG funds to feel good about themselves might not be happy with what they learn in this chapter.

Overall, this is a thoughtful book about investing in funds intelligently.  Investors who choose their own funds will likely find useful discussion here.