|A fund management mantra: cull
the Dogs, advertise the Stars
What's the game?
If a manager runs a family of ten boring old funds in a boringly
average way he can expect at any time that five will be above average
and five below. With any luck one will be a Star.
How can he can use this statistical inevitability
to his advantage?
- He could advertise his whole fund family
by quoting results only for the Star.
- He could liquidate the Dog
and transfer its assets to the Star ("Our largest Fund ranks in
the top 10% of all funds")
- He could liquidate any number of below-par
funds to favourably skew the average performance of the family.
- He could keep starting funds with institutional
friends as investors, kill the losers and run the winners. The
performance of the winers can be used to pull in new investors.
....and that's why....
- Fund families tend to be so large. The more
funds you've got, the easier it is to play this game.
- Fund managers have an incentive to take big
bets, particularly in the early days of a Fund's life. If it goes
right, he's got a Star. If it goes wrong, his mistakes are buried.
Pity about the investors.
- Historical studies of performance are unreliable.
They can be favourably skewed because the Dogs have all gone.
It's called "survivorship".