It’s a common principle of investment that returns have to come at a cost – whether it’s having your money locked in for a period of time or risking a loss. Due to many economic forces any investments that have a good chance of producing higher returns without more risk, work, or inconvenience typically don’t last long enough for the average person or even someone who manages billions to get access to them.

It’s even difficult to pay someone else to do this, given the poor performance of money managers at all levels. Diversification is often brought up as the only way you can get higher returns without more risk. Like it or not, this means that most investors who don’t want to dedicate a large part of their life to managing their investments can’t expect to do better than the market average for their chosen asset classes.

However, a possible exception to this recently came to mind. I receive emails periodically from an investment management company that serves institutional investors. Just for fun I signed up for their regular long-term asset class forecasts, which never fail to indicate how much they expect to outperform the index in each class through active management. I can’t take the index forecasts or the active management expectations too seriously, but after receiving the lastest one I started thinking about it.

It’s virtually impossible to find a money manager guaranteed to beat an index by a significant amount consistently. It seems that no salary can buy better talent – someone always has to lose if there is to be a winner, and it changes every year. So what’s the back door? Career risk – which is discussed frequently in the emails I get.

Blindly following the market wherever it goes and taking extra risks along the way is the surest strategy to lose money, so to get above-average returns consistently you need to do things that virtually everyone disagrees with at times. For an individual investor this can be frightening and it’s difficult to hold your position when you constantly act against conventional wisdom.

For an institutional investor it’s far worse however. If you follow the market (find a hot asset, borrow everything you can, and buy in!) and get bad results you can at least say that you couldn’t forsee problems. If you go against conventional wisdom and don’t do well you’ll never get a second chance. This is the core of career risk. Whether it’s for job security or emotional security the majority of people would prefer to do poorly than to act on their own investment decisions and have better chances.

The great thing is that if there are money managers or mutual funds that consistently act against the current market “wisdom”, career risk will keep many investors away from them and leave the opportunity open to those who can see it. They are in fact risking their own careers by doing this. If they don’t perform they have no excuses.

Of course if they demonstrate exceptional returns over a long period of time people will eventually start to listen to them. Past performance seems to drive a lot more investment decisions than reasonable expectations of future performance. But until that happens, career risk may be the only way besides luck to have your money managed by the best before they’re “discovered”. That is if you can stand everyone you know thinking you’ll wind up broke for a decade or two.

Even mutual funds that attract large numbers of performance chasers can follow a cycle after they’re discovered – new money floods in, returns diminish or the strategy produces a couple of bad years, and the fund returns to its original size. Simply holding such a fund for a long period would give you much better results than the average fund flipper.

I still plan to be 100% indexed for the forseeable future, but this seems like one of the ways I may eventually be able to find a truly competent manager to increase my returns.

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