The Winners’ Game

Charles D. Ellis

Financial Analysts Journal, 2011, vol. 67, issue 4, 11-17

Abstract: Practitioners of the investment management profession are underperforming for their clients and for their profession because of three errors: defining their mission as “beating the market,” allowing the values of their profession to be eclipsed by the economics of the business, and not providing much-needed investment counseling. The solution is to incorporate investment counseling into the heart of their client–manager relationship.Practitioners of the investment management profession, despite their manifest talents and notoriously hard work, risk underperforming for their clients and for themselves because of three errors—two errors of commission and one error of omission.The first error of commission is to define our professional role as beating the market. Increasingly extensive data show that markets have changed and most managers are not succeeding at this task.The second error of commission is that the values of our profession are increasingly eclipsed by the profoundly different disciplines of our business. Significantly, because investors can obtain market-matching index funds at very low fees (less than 10 bps), what investors really buy from active managers is risk-adjusted incremental returns. Therefore, we need to recognize a daunting reality: 1 percent fees as a percentage of assets equals over 10 percent of returns and 100 percent of incremental, risk-adjusted fees. This is not an easily defended position, particularly if we define our mission as “beat-the-market performance.”Our third and most important error is an error of omission. Investors make repetitive mistakes that investment professionals could easily help them avoid by providing sensible investment counseling as part—ideally the lead part—of the overall relationship.Incorporating investment counseling into the heart of the client–manager relationship greatly increases the chances for good results for the client and professional satisfaction for the manager and, therefore, longer-lasting and better business for investment managers.

Date: 2011
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DOI: 10.2469/faj.v67.n4.3

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