Investing with a 'star' manager

One of my favourite movies is National Lampoon's Christmas Vacation. Clark Griswold, a lovable suburban dad played by Chevy Chase, embodies the Christmas spirit in the extreme. He drives his family to the woods to pick their own Christmas tree, choosing one that is taller than most homes. He puts so many Christmas lights on his roof that his neighbours are blinded. He invites his extended family (and the in-laws too!) in hopes of creating the perfect holiday. His wife Ellen warns him against such excess, reminding him of all the times when his plans didn't live up to his inflated expectations. Christmas did end up all right in the end, but only after disastrously bad family dinner, a tree up in smoke, and a dead cat, among other maladies.

As it happens, the advice Ellen gave Clark isn't just appropriate for overzealous dads. Even if you don't hype holidays beyond all proportion, your expectations for your investments might be so overheated that no manager, no matter how talented, could possibly fulfill them. Too often, investors--and their accomplices in the media--transform managers with brilliant records into stars. Success attracts investors' cash and inspires the media to track the star managers' every move. After building up the manager to star status, these same people tear them down when they falter. And then it's on to the next can't-miss manager with a great record. To be fair, we too have played a part in pushing some managers to stardom, though we've cautioned investors against getting too caught up in the hype. And when these managers underperform, we're telling them to stay the course.

If you choose to follow one--and it's an open question whether you should in the first place--you should do so without Clark Griswold-esque expectations. Here are a few things you should keep in mind.

Know what you're getting into
Too often investors' research starts and stops with a look at a fund's record. A fund's record tells you little about what sort of strategy the manager employs or the risks the fund takes. Knowing a fund's strategy well should help you set your expectations in check. If your manager is willing to move way out of step with the market, you should expect performance to diverge too--for both good and, on occasion, for worse. If your manager is looking for the next hot sector, there are going to be times where they'll fall flat.

Don't assume past is prologue
One reason investors have been disappointed in the past is that they have made the all-too-common mistake of extrapolating past returns into the future, but few worthwhile investments rise uninterrupted. This is a lesson you should keep in mind if you're thinking about (or already own) funds led by managers new to stardom that have yet to stumble. To reap the full rewards of a fund, you may have to be willing to endure stretches of underperformance. You also don't want to own them in isolation. If you have a diversified portfolio, you'll be less likely to overreact if one of your star managers underperforms. By the same token, resist the urge to take money from other holdings when a 'star fund' looks like it's on a roll. You may be adding when the fund is most overheated.

Consider the supporting cast
Few Hollywood stars make it entirely on their own. They have agents, makeup artists, publicists, acting coaches, and directors guiding them. Certainly there are some talented fund managers who have succeeded as one-man operations, but there are some advantages to having a supporting cast of analysts and comanagers that can help them research stocks and help run their portfolios.

The reality is that many funds that have been closely identified with one well-known manager have been group efforts. In addition, investing where there's a strong supporting cast can also help blunt the impact of a star manager's departure.

You don't need a star to succeed
I've had some great experiences in restaurants run by famous chefs, but I'd say some of the best meals I've eaten have been at places that are out of the limelight. Similarly, you can have a terrific investing experience at funds whose managers aren't on magazine covers or frequent guests on CNBC. Unfortunately, much of the modern media favour the loudest or most controversial voices, not necessarily the wisest or smartest. That's not to say you'll never see a great fund manager on CNBC, but keep in mind that fame doesn't necessarily require talent. Moreover, the time managers spend as a media darling could detract from their money management duties. You'd probably rather have your fund manager focused on running money rather than putting himself in the spotlight in an effort to gather assets.