Fund Manager Transparency And Unintended Consequences

Aiming for Transparency by David Merkel, CFA of AlephBlog 

Here’s another letter from a reader:

David,

I’m starting this fund, and I wanted to get your opinion.

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The markets have largely recovered since the March selloff, but most would agree we're not out of the woods yet. The COVID-19 pandemic isn't close to being over, so it seems that volatility is here to stay, at least until the pandemic becomes less severe. Q2 2020 hedge fund letters, conferences and more At the Read More


 It is best explained on YouTube in 55 seconds: let me know what you think https://www.youtube.com/watch?v=frwOrQd3f6w. It (hopefully) will provide incentive for transparency in funds.

 Thank you!

Okay, I can’t embed the short video, so click on the link above and watch it — it is less than a minute, and well-done.

To the writer:

I admire your efforts at providing transparency here, but let me tell you where I think this may have unintended negative consequences.

Anytime you provide total transparency, you invite front-running, if the manager is any good.  New ideas are often most potent at their beginning, and given the delay between notifying mutual fund shareholders, voting and implementation, critical time is sacrificed, and some of your shareholders may front-run you.

Imagine a person investing the minimum in your fund so that he could front-run your picks with a greater amount of money.  But even if front-running does not happen, it is generally wise to move rapidly once the manager has come to a decision.  The delay from having shareholders vote on it is likely a money-loser.  Also during times of crisis, the manager may have some of his best ideas, but when average people are scared, will they be willing to pull the trigger?  I have my doubts.

In general, I favor investment methods where decision-making is done by individuals.  If I were running a hedge fund, or a large mutual fund, I would delegate all decisions to the sector/industry analysts.  Let sharp opinions prevail.  I’ve worked in areas where groupthink muddies investment decisions — it does not lead to outperformance.

Transparency

You don’t need to have shareholders vote on investments to have transparency.  You could do what I do, because all of my investors have full transparency.

I manage separate accounts using Interactive Brokers.  We buy and sell as a group.  We all get the same buy and sell prices.  I don’t trade often, but any investor can monitor his/her account all day long.  They can set up a daily download so that they can see what actions have been taken, if any.  There is total transparency, to the degree that my investors want to make the effort.  And remember, making investors go through a lot of effort is a negative.

If I Were in Your Shoes

If I wanted to give your investors transparency, I would give them access to a website showing the portfolio in real time, set up in such a way that only they could see it.  I would not let them vote on investments.  If you are hiring a manager, let him manage.  Second-guessing and delay are a waste of time and money.

Now those are my thoughts, and maybe your views on running a democratic fund are important to you.  Do what you think is best — just remember that democracy is not the same as transparency, and to achieve transparency, democracy is not needed.  Information is power, and you want to be careful in how you share it.

All that said, I hope you succeed, and that it works out well for you and your shareholders!

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.