Why most money managers cannot beat the market, Part ONE

Some years ago, in 1988, I was asked by my friend Paul Singer of Elliot Associates, to represent the convertible arbitrage practitioners at an annual Convertible Securities conference in New York. Paul had been the speaker the year before and advised me to keep the dialogue going with the large convertible fund managers such as the many mutual funds that had increased as convertible securities became popular as a separate asset class. Paul and I had spoken many times as Cohen Feit and Elliot were one of the few funds that specialized in convertible arbitrage. We met often at lunch’s sponsored by investment bankers to promote new issues of convertible securities.

At the conference, I spoke about my firm, Cohen Feit and how we allocated capital between the various strategies we employed. I then delved into one of my pet peeves about the new, non-traditional convertible issues that were being promoted by the various bankers on behalf of their clients, the corporate issuers. I was very much against the issues that were oftentimes so complex that I just stopped looking at them at all. I complained to the audience that perhaps they should do the same. Just say NO. Hands raised and I called on one of the largest mutual funds managers in attendance. His response was echoed by many others. He had to buy almost anything that came out because his fund was growing and, wait for it… he had to almost fully invested at all times. He did not have my luxury of just saying no. He would have been penalized by his parent managing company for not being at last 95% invested at all times in various convertible securities. All of the other funds in the parent companies’ family of funds had the same requirement. Full investment. Never mind the market condition, stay invested.

The result, when the crash occurred the previous year, they had to lose. They had forgotten Warren Buffett’s famous saying: “Only when the tide goes out do you discover who’s been swimming naked.”

So, reason one on why most if not all managers cannot beat the market: They have to be fully invested. Even the index funds contain the good, the bad and the ugly.