<<– Continued from Part 1 (Where’s Waldo? The illusion of superior professional mutual fund manager performance.)

Instead of highlighting dozens or even hundreds of perennially superior mutual fund money managers, the media conversation has become a repetitive chant about Warren Buffett.

While highly successful and very worthy of respect, it is interesting that the “Sage of Omaha” gets so much press as a successful money manager. Warren Buffett is not a traditional money manager, because he tends not to buy small positions across a large number of securities like those that a mutual fund portfolio manager does. Instead, he often buys significant minority and controlling interests in firms and directly influences their management and thus the outcome. While managers of open investment fund take in investor deposits continuously, it has been a very very long time since Berkshire Hathaway Inc. has tapped the public markets for equity capital!

Concerning Mr. Buffett’s Berkshire Hathaway conglomerate, you may find some studies of its equity holdings, as if it were managed as an entirely independent equity mutual fund. Yes, the numbers do seem to indicate that Warren Buffett and his key lieutenants have demonstrated superior stock picking skill over time. Warren Buffett has generated so much cash over the long-term that he could not just keep it all in cash under the Berkshire mattress.

Back in 2005, The Skilled Investor took an overall look of the enterprises and investment assets under Warren Buffett’s control. As of mid-2005, both Berkshire Hathaway’s cash positions and its equity positions were close to $50 billion each. In addition to that, it held substantial positions in bonds and wholly owned businesses. The overall percentage distributions were about 30% cash, 16% bonds, 29% publicly traded equities, and 25% in businesses owned outright. The equity portion was invested in about 30 firms with 10 accounting for more than 90% of the equity valuation.

Within the rules of law and its prospectus, which mutual fund would be allowed to play Warren Buffett’s game? The answer is none.

Shrewdly buy companies at bargain prices … fix them up and manage them for the long run … let them spin off barrels of cash … invest some of the cash in equities and bonds … buy more companies and fix them up … hold on to a huge amount of cash under the mattress for very long periods because bargains are cyclical and sometimes impossible to find … keep repeating the cycle…

What mutual fund could sit on as much cash as it had in equities waiting for an opportunity to buy another firm outright? They simply would not legally be allowed to do so. And, if they sat on huge cash positions, shareholders would hammer them for not deploying their money, deviating from the benchmark index, etc. Warren Buffett’s game only works when the whole picture is taken into account — successful acquisitions, majority control, investing some of the cash flow in marketable securities, keeping a large amount of dry powder (cash) for when the opportunity arises, etc. These are not the tools available to a mutual fund portfolio manager.

So, where are all the other perennially superior traditional money managers who can be hired economically to manage your money and that of thousands of others for a superior return? They are not to be found. Individual investors spend an excessive amount of time and money looking for investment mutual fund managers who will all turn out NOT to be the next Warren Buffett in the long run. Mutual fund managers simply are not allowed to play his game.

For some ideas on how individual investors might approach the investment fund selection decision more efficiently, see this category of articles on The Skilled Investor website: Selecting Investment Funds – Mutual Funds and ETFs. Also, see the articles in this category: Rating Services – Morningstar.

Individual investors chase past superior mutual fund performance in the futile hope that past investment fund performance will predict superior future mutual fund performance.

This strategy is just a mirage, but the mutual fund industry willingly reinforces it. If a mutual fund family opens and promotes enough funds, random portfolio fluctuations will allow almost any fund family to brag selectively about only those of their funds that were past winners. Simultaneously, they quietly ignore their laggard funds. After investors repeatedly search the crowd for Waldo, after they have put their money into past winners, and after time has passed, only then do a few of these investors realize that Waldo was never there to found in the first place. (See: Can you really beat the securities markets?)

Given this bleak assessment of the chances of finding affordable, risk-adjusted, and sustained mutual fund money manager performance, The Skilled Investor has concluded that all forms of active management that cannot be cost justified should be mercilessly driven out of individual investors’ investment strategies.

Individuals first need to decide on investment strategies that are risk preference appropriate. Then, they need to choose very low-cost and very low-tax investments that they can let run over time. Maintenance should always be very minimal and very low-cost, and the urge to chase performance mirages should be heavily restrained. It is just a fool’s waste of money and time.