Friday, September 18, 2009

Portfolio Managers versus Money Managers

In my opinion there is an enormous amount of confusion about who the players are in the investment industry so here is my particular take on the subject. I define portfolio managers as investors who have the freedom to invest in multiple asset classes. Their portfolios are typically constructed with investments in U.S. and international stocks, U.S. and international bonds, U.S. and international real estate, commodities, and other exotic asset classes like managed futures, hedge funds, private equity, etc. While they have the freedom to invest in any mix of these assets that they like, in the traditional world of buy and hold strategic asset allocation virtually all portfolio managers subscribe to Modern Portfolio Theory to come up with the single best or most “efficient” mix of asset classes. The end result for portfolio managers is that the mix of the asset classes they choose never needs to be changed because markets are presumed to be efficient and investors are presumed to be rationale. In short, traditional buy and hold portfolio managers buy and hold asset classes in a fixed mix that changes very little over time while they patiently wait for the past performance of each asset class to materialize.

Portfolio managers invest with money managers like mutual fund managers or separate account managers to invest each asset class in the portfolio. A money manager usually is an expert in managing assets in one asset class, and his or her portfolio performance is compared to a one asset class benchmark. You can find money managers specializing in virtually any asset class, including all of the ones mentioned above. These are the managers who buy and sell individual stocks and bonds as institutional investors, and these are the managers you see on TV who comment on the current state of the markets. They have an immediate and vested interest in the financial news of the day as they actively manage their portfolios to try and beat their one style constrained performance benchmark. For example, a large cap value mutual fund manager who is trying to outperform the S&P 500 Index.

For most retail investors, their financial advisor acts as a portfolio manager. They invest in money managers in the form of mutual funds and separate accounts in order to own multiple asset classes in their client’s portfolio. If they are a traditional buy and hold advisor, once they buy these funds, there is little to do but explain how they perform to clients, check their relative performance once a year or so, and remind their clients to be patient until expected returns arrive, presumably some time in the future. Do not confuse these two types of managers. A portfolio manager who passively invests in money managers is not practicing “active” management. In contrast, Pinnacle Advisory Group actively manages portfolios at the asset class level. There is a huge difference between actively changing the asset allocation of a portfolio management versus passively owning active money managers in a portfolio. Don’t confuse the two.