“You might think the fund manager’s job is to beat the market.” Says Zweig. “But, in fact, the fund manager’s job is to keep his job. Zweig then introduces an adapted version of Mark Kritzman’s “matrix” and he elaborates, “A fund manager who is right along with most of his peers — whose portfolio resembles that of the market as a whole — will earn acceptable results with minimal risk of being deserted by investors. The upper right quadrant is the safest place for a portfolio manager to live.
One whose stock picks pay off when he goes against the crowd will stand out for high returns; but being right and alone is risky, since being proven right can take time. An upper left quadrant is a perilous place for a fund manager to inhabit.Meanwhile, a manager who is wrong along with everybody else suffers no significant penalty; his portfolio stinks, but everyone else’s does too, so investors aren’t likely to demand their money back from him in particular. The lower right quadrant is bad for a fund’s investors, but not so bad for its manager.
Finally, a manager who is wrong and alone will stick out so badly that the flypaper effect won’t even hold anymore; investors will yank their money out. The lower left quadrant is the zone of death for fund managers.
By closet indexing, managers position themselves squarely in the right two quadrants. Making only half-hearted stock picks relative to an index, portfolio managers can ensure that they won’t ever look badly wrong relative to the market — and that investors will be less likely to pull out their money.”
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