Investment firms are typically heavily incentivised to grow assets under management and star managers work extremely well from a marketing perspective. Investors want to know their savings are in safe hands and it is easier to gain comfort when the manager is an individual with a glittering resume and track record, particularly if they are also photogenic.
While investing with a star manager is reassuring, it might not be best for long-term returns. Like sports stars, some star managers endure while others flame out suddenly. As in sports, it can be hard to predict when a winning streak will run dry or sharply reverse course. Star managers’ success also often acts against them. Investors flock to managers who have achieved great recent returns, but large inflows leave high-performing managers with two bad options.
The first is to recommend more stocks, either by stretching their research efforts or lowering the bar for investment. The second is to keep the number of stocks steady, but only invest in larger ones that can accommodate more capital. That handicaps the manager’s ability to move the portfolio to the areas of greatest opportunity, which can be costly. After all, market inefficiencies are rare and difficult to uncover, while the pockets of relative value can change considerably over time.
Then there is the issue of longevity. The average fund manager is approximately 45 years old. At that point they are half way through their career, whereas an investor in their 20s is only just starting to invest, with their retirement more than 40 years away. That means no star fund manager is going to be a one-stop solution.
A good succession plan can work in theory, but nurturing an heir is no easy task. The star may appoint a successor, but that person can go untested because – by definition – a star system means there is only one decisionmaker directing client capital.
- Investing with a star manager might not be good for long-term returns.
- Identifying investments requires specialisation.
- Blending the stock picks of a small number of individuals into a single portfolio is one way of stock-picking.
Using a sporting analogy, footballer Luis Suarez’s 31 goals in 33 league games propelled Liverpool FC to within two points of clinching the Premier League title in 2014. He left for Barcelona the next season, but Liverpool appeared to be in good hands, as its young English talent, Daniel Sturridge, scored 21 goals in 29 games. Since Suarez’ departure though, Sturridge has notched a mere 16 goals in 58 games. Liverpool finished sixth the next season and dropped to eighth the following. Reds fans learned the hard way how disruptive a star’s departure can be.
So, what is the solution? When it comes to investing, it is not as simple as putting a few stars together around a table. The key benefit of investing globally is that it provides more opportunities to find cheap stocks.
But capitalising on that breadth of opportunity can be difficult because identifying great investments requires specialisation. After all, it takes time to understand and evaluate a business and the best investors do so with a detailed insight into the key challenges facing the company and the industry in which it operates. Honing that deep knowledge allows them to evaluate how attractive a stock is compared to other opportunities available.