Lars Kroijer is one of the most intriguing – and intelligent – hedge fund managers you could ever wish to meet. A Harvard-educated Dane, he used to run his own hedge fund in London and still serves on the board of several others. Although, as you’d expect, he believes it is possible to beat the market, he says it’s extremely hard and that the average investor is far better off not even trying. His strong recommendation is that they should invest instead in low-cost index funds.
In this fascinating interview, Lars explains why, ultimately, it all comes down to cost.. and why fund managers are far more likely to drive Porsches than their clients.
EBI: Although you’ve spent your entire career in the hedge fund industry, you’re probably better known as the author of two notable books. Tell us about those.
LK: I ran a hedge fund for many years and wrote a book about that called Money Mavericks. I felt there was a story to be told. Clearly the world of hedge funds has this undertone of everyone making a lot of money, and all these success stories, and a little bit of (a sense that) everyone can do it. My personal view is very, very different, namely that it is incredibly hard for an average investor to outperform the financial markets. It’s almost impossible. My book Investing Demystified is about that — whether you have an edge, the overwhelming likelihood that you don’t, and then what you should do on the basis of that premise.
EBI: That’s an extraordinary thing for a fund manager to say. Some might accuse you of being inconsistent, even hypocritical?
LK: That’s an interesting one. I’m not saying edge doesn’t exist. I’m not saying that no one in the world has the ability to outperform financial markets. I’m not quite that big a hypocrite! What I am saying is that most people don’t and that it’s super-important for the individual to make up their minds whether they do or not. If you say, as an individual person, Can I outperform the markets?, I’m arguing that the overwhelming likely answer is that you cannot. That doesn’t mean that others can’t. There’s no inconsistency in my view there.
EBI: Central to your argument for why most investors should use index funds is cost. Why is that?
LK: It’s very, very hard to exaggerate the importance of cost, especially in the long run. If you take the example of someone who drives a train on the London Underground, that person will make perhaps £50k in annual income. Say they take 10% of their income and put it in equities every year. Let’s say they do that between the ages of 26 and 65, and that in that time the markets perform as they have historically. On that person’s 67th birthday the difference in their life savings between having invested in an index tracker and an active manager would amount to the same cost as roughly seven Porsche cars. In today’s money that difference is almost £300,000. This is someone who will never drive a Porsche, yet that’s the staggering difference in cost. It’s about 1.75% a year.
EBI: Of course many investors say, I don’t pay 1.75% a year. And yet there are expenses that aren’t included in the headline charge. Give examples of those extra fees?
LK: Very often there’ll be load fees, or fees for some sort of intermediary. There will be a far greater level of trading (compared to index funds), and there are costs associated with that, like commission costs and the bid offer spread. On top of that, bigger funds incur much greater administrative costs that you, as an investor, indirectly incur. It all adds up on average to 1.75% a year. Over time, that adds up to a lot of money. So expenses are unbelievably important, and if you get that right, you’ve come a long way.
EBI: You also say that investors should become much more discerning consumers of fund industry advertising. What do you mean by that?
LK: There will be an active fund for everything, because something is always in vogue. There are thousands of these things. The very large investment houses, like Fidelity for example, will have literally hundreds of funds, and when they market themselves, there will always be one of their funds that’s number one in its category. It’s a very astute marketing ploy to make you think that everything Fidelity does is number one. I wouldn’t say that they’re misleading, but people forget to fully appreciate what the ads say sometimes.
EBI: A manager who frequently appears in fund ads in the UK is Neil Woodford, and he does have a good record. Is there a case for investing with a successful manager like that?
LK: Let me be clear what I mean by saying that most people don’t have an edge. You can’t yourself through active selection of securities outperform the market. Even more important, I’m also saying that you can’t pick the managers who can do it for you.
There I’ll take a step back. Suppose I present you with a hundred people who look like Neil Woodford and have an equally impressive track record and sales pitch. When I also tell you that, statistically, there is no correlation between past and future performance, that argument falls down. Neil Woodford has done phenomenally well over the last ten years. There were also, ten years ago, another 100 people starting out alongside Woodford who we’re not talking about today. If you flip a coin ten times, someone in every thousand is going to come up with ten tails in a row. There is a huge selection bias in the edge that we think these people have. We think about them after they have done really well, and there is no indication, statistically speaking, that they are going to continue doing well going forward.
So I don’t think you should give your money to the most successful hedge fund or mutual fund manager, unless you decide, as an investor, that you have some specific reason to know that that person or fund will outperform in the future. That’s as valuable as being Warren Buffett yourself. I know a lot of people who would love to talk to you if you genuinely have that skill. If you don’t, don’t pay the fees.