Why don't more winning funds stay winners ??? The better a fund performs , the more obstacles its investor face :
MIGRATING MANAGERS :
When a stock picker seems to have the Midas touch , everyone wants him including rival fund companies . This is very big problem .
ASSET ELEPHANTIASIS :
When a fund earns high returns , investors notice - often pouring in hundreds of millions of money in a matter of weeks . That leaves the fund manager with few choices - all of them bad . He can keep that money safe for a rainy day , but then the low returns on cash will crimp the fund's results if stocks keep going up . He can put the new money into the stocks he already owns which have probably gone up since he first bought them and will become dangerously overvalued if he pumps in millions of money and more . Or he can buy new stocks he didn't like well enough to own already but he will have to research them from scratch and keep an eye on far more companies than he is used to following .
NO MORE FANCY FOOTWORK :
Some companies specialize in incubating their funds-test-driving them privately before selling them publicly . Typically , the only shareholders are employees and affiliates of the fund company itself . By keeping them tiny , the sponsor can use these incubated funds as guinea pigs for risky strategies that work best with small sums of money , like buying truly tiny stocks or rapid-fire trading of initial public offerings . If its strategy succeeds the fund can lure public investors en masse by publicizing its private returns . In other cases , the fund manager waives or skips charging management fees , raising the net return then slaps the fees on later after the high returns attract plenty of customers . Almost without exception , the returns of incubated and free waived funds have faded into mediocrity after outside investors poured millions of money into them .
RISING EXPENSES :
It often costs more to trade stocks in very large blocks than in small ones with fewer buyers and sellers , it's hard to make a match . The typical fund holds on to its stocks for only 11 months at a time , so trading costs eat away at returns like a corrosive acid .
SHEEPISH BEHAVIOR :
Finally , once a fund becomes successful , its managers tend to become timid and imitative . As a fund grows , its fees become more lucrative - making its managers reluctant to rock the boat . The very risks that the managers took to generate their initial high returns could now drive investors away and jeopardize all that fat fee income . So the biggest funds resemble a herd of identical and overfed sheep , all moving in sluggish lockstep , all saying "baaaa" at the same time . This behavior is so prevalent that finance scholars simply call it herding . But by protecting their own fee income , fund managers compromise their ability to produce superior returns for their outside investors .
Some companies specialize in incubating their funds-test-driving them privately before selling them publicly . Typically , the only shareholders are employees and affiliates of the fund company itself . By keeping them tiny , the sponsor can use these incubated funds as guinea pigs for risky strategies that work best with small sums of money , like buying truly tiny stocks or rapid-fire trading of initial public offerings . If its strategy succeeds the fund can lure public investors en masse by publicizing its private returns . In other cases , the fund manager waives or skips charging management fees , raising the net return then slaps the fees on later after the high returns attract plenty of customers . Almost without exception , the returns of incubated and free waived funds have faded into mediocrity after outside investors poured millions of money into them .
RISING EXPENSES :
It often costs more to trade stocks in very large blocks than in small ones with fewer buyers and sellers , it's hard to make a match . The typical fund holds on to its stocks for only 11 months at a time , so trading costs eat away at returns like a corrosive acid .
SHEEPISH BEHAVIOR :
Finally , once a fund becomes successful , its managers tend to become timid and imitative . As a fund grows , its fees become more lucrative - making its managers reluctant to rock the boat . The very risks that the managers took to generate their initial high returns could now drive investors away and jeopardize all that fat fee income . So the biggest funds resemble a herd of identical and overfed sheep , all moving in sluggish lockstep , all saying "baaaa" at the same time . This behavior is so prevalent that finance scholars simply call it herding . But by protecting their own fee income , fund managers compromise their ability to produce superior returns for their outside investors .
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