The mutual fund industry needs more people in it like Bob Rodriguez — the manager of FPA Capital and FPA New Income — and his speech at the Morningstar conference last week showed why.
In his remarks, Rodriguez had sharp words for the mutual fund industry’s performance in the current credit crisis, saying that the industry’s analysts and managers failed to anticipate both the housing and credit bubbles. Even those who might have been concerned, Rodriguez noted, were unlikely to act on those concerns for fear of being wrong.
Rodriguez has always been one of the industry’s more outspoken participants, and his success as a fund manager lends a great deal of credibility to his opinions, even as his convictions have sometimes hurt his firm.
His concerns about the economy led him to raise his funds’ cash stake to as high as 45 percent in early 2008. That decision didn’t sit well with a number of his funds’ investors, who pulled upwards of $700 million out of his funds. That didn’t faze Rodriguez, who said, “I would rather lose business than lose money for my clients.”
Rodriguez was ultimately proven right, of course, but his experience — and the actions (or, more rightly, the inaction) of his peers in the industry — lend credence to John Maynard Keynes‘ famous observation about money management: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
If you make the decision to go the active management route, you want a manager like Rodriguez in your corner — someone with an ability to recognize when the market’s risk/reward ratio is getting out of whack, and, importantly, someone who has demonstrated that they possesses the courage to profitably act upon their beliefs, even if it risks both their reputation and their income.
Unfortunately, managers with this trait — not to mention a long-term track record of success — are distressingly rare in the mutual fund industry.
Instead, as Rodriguez hinted at in his speech, fund investors are sold active management in half-measures, in which the primary goal is, essentially, not to screw up too badly. Yes, a bold bet might result in whipping the market index by an impressive amount, but it could also go horribly bad.
Fear of the latter is why the mutual fund industry is dominated by actively managed funds that are closet index funds, which own portfolios that differ only nominally from the broad market index — ever-so-slightly overweighting a particular sector and underweighting another, for example. This composition guarantees that a fund’s performance will track the market quite closely over time while providing the hope that their bets on the margins will allow the fund to outperform.
Such an arrangement allows the fund manager to have it both ways. If they win, it’s of course attributable to their prescience and wisdom. If they lose, well, jeez, everyone did, and besides, we didn’t lose by very much. Even better, such an arrangement tends to allow the management company to retain the assets of investors who might be scared off by a big loss — and, of course, to hold onto the resulting fees.
Which is why Rodriguez’s approach to investing is so refreshing in an industry that’s so utterly stale. Managers such as Rodriguez are few and far between, of course, and the task of profitably investing with one is made all the more difficult by the fact that their past success in navigating the market provides no guarantee for the future.
It’s for that reason that I personally can’t imagine staking the achievement of my long-term goals on a bet that even a brilliant guy like Rodriguez will remain brilliant over the coming years. (Or even remain in his job. Rodriguez announced earlier this year that he’s taking a one-year sabbatical beginning in 2010.) But if you’re the sort of investor to whom that approach appeals, you’ll be much better served by entrusting your assets to managers like Bob Rodriquez, instead of paying active management fees to closet indexers whose approach, in the words of Teddy Roosevelt, will result in them knowing neither victory nor defeat.
