Are financial advisors serving your lunch to hedge funds?

Aug 24th, 2008 | Filed under: Academic Research, Retail Investing, Today's Post | By:
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Last week we told you about a curious market inefficiency - the fact that Asian-focused hedge funds with local offices performed significantly better than Asian-focused hedge funds with no local offices in the region.  It was curious not necessarily because you’d expect otherwise, but rather because the anomaly seems to be ongoing.  In other words, the invisible hand of the market has not arbitraged it away with its usual gusto.  We drew on Andrew Lo’s Adaptive Markets Hypothesis to account for part of this phenomenon.

Here’s another weird market anomaly that seems to be in no hurry to arbitrage itself out of existence.  Individual investors who invest in mutual funds via financial advisors do markedly worse than those who don’t.  This begs the obvious question “why do mutual fund investors even employ financial advisors?”

Professor John Haslem (see previous postings), the author of an article on this question in the upcoming edition of the Journal of Investing, doesn’t mince words.  In an earlier version of his article he writes:

“The actual returns on mutual funds earned by investors are much lower than the rational behavior paradigm of financial economics would suggest. Certainly this is evidenced in the performance of funds distributed through the advisor channel. From the evidence here and elsewhere, much (if not most) of how and where investors go about investing in funds has behavioral biases as well as other behavioral and knowledge overtones.”

We’re always interested in “behavioral biases” because when you boil it right down, they represent one of the few logical explanations for the continued existence of recurring alpha in hedge funds or traditional active funds. So we posed a few questions to Haslem, who is the author of dozens of other interesting papers on mutual funds and Professor Emeritus at the University of Maryland.  Here are his answers:

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