The best advice to give to a potential investor who is not financially literate is surely to invest in funds where the fund manager has invested their own wealth.  Berkshire Hathaway would be a good example, as would many of the more successful hedge funds. 

Putting the same point slightly differently, isn’t it strange that most actively-managed funds expect their clients to bear all the risks of investing, and therefore reap all the rewards (net of the fees)?  Surely, if the managers really believed in their ability to generate reasonably consistent good performance, they would want to keep most of the upside for themselves?  

Believers in efficient markets will, of course, argue that active managers cannot out-perform except by occasional luck.  The obvious counter argument, however, is that professional active managers do have skill, but that is all too often not truly reflected in their portfolio’s performance because they have not managed their risk properly (or, indeed, at all!).

This talk will argue that managers who really have confidence in their ability to outperform their benchmark, while properly managing their risk, would be much better off if they guaranteed a certain level of outperformance to their clients, and bore the investment risk themselves, keeping any excess outperformance they made.

The clients get guaranteed, collateralised out-performance (and zero fees!), while the manager reaps the rest of the rewards.  Everyone’s a winner! And just in case you think this is unrealistic, the talk will be illustrated with a real case study.