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The 10 Biggest Mistakes Made by Fund Investors

by | Investments

The 10 Biggest Mistakes Made by Fund Investors*

* Adapted from a recent article at

1) Searching for performance consistency

There is perhaps no more damaging feature than the quest for [past] performance consistency. By this, I mean the reverence for funds / managers that deliver outperformance compared to their peers or benchmark over a variety of short time periods which can be months, quarters and even years. The problem is not that it is a bad outcome (it is clearly an incredibly positive one), but that it is used as a shorthand for skill or an indication that such patterns will persist into the future. Both notions are false.

The only consistency fund investors should worry about is consistency of expectations – “is a fund behaving in a manner that is consistent with reasonable expectations about its approach”?

2) Neglecting the circle of competence

If we are investing in an active fund, we are assuming that the manager or team possess some form of skill that allows them to outperform a passive (usually cheaper) index.

When a fund manager develops a strong track record, we often seem to be comfortable watching them creep or leap outside of their circle of competence into areas where they have no credible history or expertise.

If we are invested in active funds where skill is an expected feature, we need to be precise and explicit about what it is. If a fund manager shifts away from their core competency, we should start to worry.

3) Seeking smooth returns

The attraction of funds that move on an unperturbed path upwards is entirely understandable – drawdowns and volatility are painful and bring about poor behaviours – but it is an entirely unrealistic expectation. If we are to invest with even a modicum of risk then we will witness variability in returns. Fund investors need to accept this, rather than try to find ways to avoid it. That doesn’t mean we cannot make the journey smoother by implementing sensible investment principles such as diversification, but volatility is inevitable and indeed it is a reason why long-term equity returns are so high.

4) Ignoring the odds of the game

The first question we should ask about a fund selection decision is – what are the odds of success? But it is one that is rarely posed. If we want to know whether to participate in a game, then we should at least try to understand the odds. There is no precisely right answer, but if we are investing in an active strategy, what is the history of success for such managers?

To make informed judgements about fund selection decisions, we need to seek to understand whether an investor has skill and if they are operating in an environment where their skill gives them a material opportunity for success.

5) Being complacent on capacity

Capacity is a perennial problem for fund investors. Issues around fund size are only likely to occur in funds that are performing well (making us reluctant sellers) and the asset manager is unlikely to acknowledge that a key revenue generator should be closed to new business.

Despite a disinclination to act on capacity from either fund buyer or seller, it is inescapable that asset growth serves to constrain a fund (when above a minimum viable threshold). A rising fund size limits the investable opportunity set, restricts flexibility, and fosters liquidity risks.

Fund investors need to take ownership of the capacity question, not rely on assurances from asset managers or wait until performance deteriorates.

6) Buying thematic funds for the wrong reasons

The continued growth of thematic funds – particularly in ETF structures – is a problem masquerading as an opportunity for fund investors. The potent combination of strong (often hypothetical) past performance and a compelling narrative can be behaviourally irresistible, but frequently leads to disappointment. Thematic funds are often little more than price momentum strategies with a story attached and absent any of the rules that define traditional momentum approaches.

Thematic funds need little marketing because its sales pitch is embedded in investment philosophy. Tread carefully.

7) Forgetting we are all active investors

The binary distinction between active and passive investing is simple and effective, but it is not strictly true. All fund investors exist somewhere on a spectrum between the two extremes, no portfolio or fund decision can be considered purely passive. In fact, the decision to allocate capital to a passive as opposed to active investment is in itself and active decision!

The recent (last decade) prolonged success of US- domiciled or large-cap dominated or tech-focused portfolios, has led to the assumption that people can simply invest and forget. This is great in theory, but unrealistic in practice. What happens if US equities underperform for five years – or longer? What happens if we see a great rotation from tech to resources? How strong will the temptation be to shift to the passive manager with a greater exposure to emerging market equities or a significant non-US developed market bias?

We are all taking some level of active risk, fund investors need to acknowledge what that is and be aware of the behavioural temptations that come with it.

8) Getting lost in complexity

We should avoid investing in things that we do not understand or cannot explain.  Owning complex funds is incredibly tempting – it makes us look good (see how smart we are!) and offers the prospect for a stream of returns different from traditional funds (uncorrelated, non-directional, through all market environments etc…) Yet mixing complexity (funds) with complexity (markets) often compounds risks, rather than reduces them and in ways that can be impossible to foresee. Returns from simple investment strategies have been incredibly strong in recent years and will almost certainly be lower in the years ahead. Despite this we should remain circumspect about complex funds.

9) Starting with the assumption that a fund manager will “outperform”.

As the funds we are researching will likely have been strong performers, we typically seek to discover how they have managed to outperform and why they might continue to do so. This is the wrong starting point. Our default position should be that every active strategy is destined to underperform peers or a benchmark over varying periods – sometimes for years – even if they have performed well in the past (maybe because they have). There must be exceptional evidence to the contrary to take a different view.

Framing our shortlist of candidate funds as a group of skillful managers who are likely to outperform in the future sets the bar far too low.  We need to begin by assuming everything will underperform.

10) Having time horizons that are far too short

If there was one thing that could be done to improve the decision making of fund investors it would be to extend our time horizons. The shorter our timescale the more we are captured by chance; consistently making judgements based on random and unpredictable market movements.

The irony is that as we try to become more sophisticated and diligent investors our time horizons inevitably contract making us worse investors. We check our funds too frequently, make ‘confident’ inferences based on little but noise and overtrade. Unfortunately, it never feels or looks like this at the time. We have so much ‘information’ available to us that every choice appears reasonable and well-informed in the moment. Each switch from an underperformer to an outperformer feels good whilst we are doing it. It is only when we reflect that we are likely to observe the long-term costs.


These observations are as important to bear in mind for us as advisors, as they are for our clients.

When creating portfolios or considering any changes they should be a vital reference point to making the correct decisions for the long-term so that we increasingly tilt the odds of achieving our goals in our favour.

Often our successes will be defined less by what we get slightly right, than what we don’t get wrong.


Full article at