Writing in Fortune magazine late in 1997, Joseph Nocera pointed out the obvious inconsistencies between what mutual fund managers recommend to their shareholders—"buy and hold"—and what those same managers do with their own portfolios—buy—sell, buy—sell, buy—sell. Reinforcing his personal observations of this double standard, Nocera quoted Morningstar's Don Phillips: "There is a huge disconnect between what the fund industry does and what it tells investors to do." 1
The obvious question becomes: If investors are counseled to wisely buy and hold, why do managers frenetically buy and sell stocks each year? The answer, says Nocera, "is that the internal dynamics of the fund industry make it almost impossible for fund managers to look beyond [the] short term."2 Why? Because the business of mutual funds has turned into a senseless short-term game of who has best performance, measured totally by price.
Today, there is substantial pressure on portfolio managers to generate eye-catching short-term performance numbers. These numbers attract a lot of attention. Every three months, leading publications such as the Wall Street Journal and Barron's publish quarterly performance rankings of mutual funds. The funds that have done best in the past three months move to the top of the list, are praised by financial commentators on television and in newspapers, rush to put out self-congratulatory advertising and promotion, and attract a flurry of new deposits. Investors, who have been waiting to see which fund manager has the "hot hand," pounce on these rankings. Indeed, quarterly performance rankings are increasingly used to separate the gifted managers from the mediocre.
This fixation on short-term price performance, so acutely obvious in mutual funds, is not limited to them; it dominates thinking throughout our industry. We are no longer in an environment where managers are measured over the long term. Even people who function as their own manager, as many of you may do, are infected by the unhealthy nuances of this environment. In many ways, we have become enslaved to a marketing machine that all but guarantees underperformance. Caught in a vicious circle, there appears to be no way out. But, as we have learned, there is a way to improve investment performance. The cruel irony is that the strategy most likely to provide above-average returns over time appears incompatible with how we judge performance—a mutual fund manager's or our own.
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