Is the Star Manager Extinct?

Is the Star Manager Extinct?
To answer my own question: not completely. Jeff Gundlach was a (super)star manager until fairly recently, when he left TCW to start his own firm, DoubleLine. There are a few others, as well.

Nevertheless, there's no doubt that things have changed mightily over the past quarter-century. Back in the day, the manager was king (or occasionally, queen). Most investors, advisors, and journalists cared less about a fund's sponsoring company or even its expense ratio than they did about the reputation of its portfolio manager. Two assumptions underlay that mind-set. First, that fund managers operated in something of a vacuum; that is, if you moved a manager from one fund company to the next, things wouldn't much change. Second, that past performance records were strongly correlated with future records. Today, neither of those assumptions is widely believed.

Experience has taught that most fund managers operate within a system. Yes, they bring their own ideas, but the system molds them. Information and recommendations from internal analysts, conversations with the company's other managers, and corporate risk-management practices tend to unite a fund companies' managers. As a result, their funds usually fare similarly. They'll have relatively good years in tandem, as well as their relatively poor years. Diversifying among different managers who invest in the same broad asset class at a single company is not really diversification.

The bloom has come off the past-performance rose, as well. It's not correct that past performance has absolutely, positively no relationship to future performance, as is sometimes stated these days, but the connection is very loose. As a result, investors demand a high level of "proof" (not in the statistical sense, but in the sense that the numbers seem overwhelmingly compelling) before deciding that, yes, a manager really owns a special ability. Moderate success no longer earns assets. It takes a long string of excellence to make the short list, as demonstrated by  TCW Total Return Bond (TGLMX), with seven straight years in the top third of its category.

I don't see this trend changing. Increasingly, financial advisors are staking their reputations not on the ability to find special managers, but instead on the ability to form low-cost, diversified, and appropriate portfolios for their clients, as well as to manage risk. In such a framework, there is even less room for the star portfolio manager than now.

In 1988, the greatest mutual fund star was Peter Lynch, a hired gun. Twenty-five years later, the biggest stars are Bill Gross and Jack Bogle, two fund company founders. Today is the era of the builders.

Watch Out, Starbucks!
Vanguard has been crossing the country with its At-Cost Cafe truck, which markets Vanguard's at-cost structure by selling coffee for $0.26 per cup. It's a good shtick and a dramatic illustration of how disruptive Vanguard has been to the U.S. fund industry. Imagine the reaction at Starbucks if somebody came out with similar coffee, offered with a similar quality of service, for one eighth the price. Mortification would understate the matter.

As a side note, coffee futures have been declining in price and are now at about $1.25 per pound. Which makes me wonder ... Starbucks and the other coffee chains have in the past raised their prices in response to commodity hikes. Have they ever lowered them when commodities have become cheaper? Hmmm. Maybe Vanguard should open up a few more of those cafes. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.