Things Money Managers Won't Tell You... Unless You Ask The Right Questions
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I assume that most of you reading this have been glued to the media coverage of our national disaster along the Gulf Coast as a result of Hurricane Katrina. The devastation is beyond description, and the loss of life -- as of yet still unknown -- will be in the thousands. The effects on the economy -- also as of yet unknown -- will not be minor. Gasoline prices have exploded with prices topping $6 in some areas.

There are many aspects of the latest national disaster which I would very much like to write about this week and in weeks to come, especially with all the finger-pointing as to who is to blame. And there is certainly enough blame to spread around at the federal, state and local levels. Everyone knew this could (would) happen one day.

There will also be the debate over whether to rebuild New Orleans, especially the lower areas. There is the question of whether most of the people now in shelters around the country will ever come back. I predict that most will not. Thus, the question of whether, or how, or who will pay to rebuild New Orleans will generate a serious debate.

For a week now, we have had wall-to-wall, 24/7 coverage of the hurricane disaster. Dozens upon dozens of editorials and articles have been written on just about every aspect of this tragedy. While I would love to share some of my own opinions in the pages that follow, maybe it's best if I stick to my business -- investing and making money.

In SPECIAL ARTICLES below, I have included several of the most interesting and most thought-provoking articles I have read in the last week regarding the Gulf Coast disaster.

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Even before Hurricane Katrina hit the Gulf Coast, we were already seeing an increase in the number of new investment schemes from self-proclaimed "experts" in our mailboxes, e-mail folders and on the airwaves, with promises of making you rich. This will only increase in the weeks ahead due to the spike in oil and gasoline prices.

It seems that every time a major world event takes place, there are a number of promoters that burst onto the scene as overnight experts who are now more than willing to share their supposed wealth of knowledge with you -- for the right price. These fly-by-night hucksters come out of the woodwork when our national emotions and fears are elevated, and they hope to profit from the misery of others.

Expect to see more schemes to make you rich by trading in oil, gasoline, heating oil and other energy-related futures and options markets. Remember this: buying options on futures contracts is one of the worst investments you can make! It is estimated that around 90% of all futures options contracts expire worthless, meaning the purchaser lost all of the money he/she paid for the options. Just say no. It's too late to jump on the oil bandwagon.

Schemes to profit from soaring energy prices will be just one example. There are and will be many others. Remember, if it sounds too good to be true. . .

Skyrocketing oil and gasoline prices are bad news for the stock markets. While the equity markets held up amazingly well in the days just after the hurricane, if gasoline prices remain above $3 per gallon (and much higher in some places) for an extended period, I expect equity prices to begin to trend lower. This will be a problem for most investors.

Now more than ever, I believe you should consider professional money managers for a significant portion of your investment portfolio. Evaluating money managers is not an easy task. I've been doing it for over 25 years, and it is a continuing learning process, even today. In this week's E-Letter, I'll share some of the basics of evaluating and selecting professional money managers.

The "Due Diligence" Process On Money Managers

T here are countless articles, studies and entire books on the subject of selecting money managers. Yet because there are so many different types of money managers, and so many different styles of money management, there are many additional tips and nuances that are not even discussed in these books and articles. While these sources are certainly helpful, there is no substitute for decades of experience in hands-on analysis of money managers, also known as "due diligence."

At times, interviewing money managers is like giving your teenage kids the third degree after they stayed out until 3:00 in the morning. They won't necessarily lie to you, but you have to ask the right questions to get the whole truth. I have made a business out of asking the tough questions and getting the answers from money managers.

It is a mistake to assume that money managers, or mutual funds for that matter, will provide you all of their pertinent information voluntarily, especially if some of that information is negative. You have to know how to dig for the pertinent information, how to ask the right questions and press until you get the real answers.

Please note that the comments below relate mostly to independent professional money managers, but the principles can be used for virtually any type of investment offering. Be aware that these guidelines and tips won't necessarily help with evaluating online investment advice or investment newsletters that do not actually manage money. These services offer advice, but are usually not licensed as Investment Advisors and do not manage client assets. As a result, they generally are not covered by regulations governing appropriate performance reporting, etc. and you should be very careful when evaluating their performance claims.

Typical promotions by these services include boasts of phenomenal gains. However, what they may not be telling you is that they had phenomenal losses as well. Any time you are tempted to subscribe to a newsletter or online E-letter, you should insist on a complete record of all of the prior recommendations over the past 5 years. Or better yet, check them out in Hulbert Financial Digest, an impartial rating service for investment newsletters.

Now let's begin the steps of a typical due diligence process.

1. Is The Performance Record For Real?

Assuming the Investment Advisor you are considering actually manages money, the firm will have a performance record of some sort. The first thing to determine is whether the performance is "actual" or " hypothetical" with numbers derived from a practice called " back-testing" or a combination of both. Obviously, an actual track record (that really happened with real money) is preferable to anything hypothetical (a simulation that didn't really happen with real money).
In over 25 years, I have never seen a hypothetical track record that didn't look phenomenal, outstanding, etc. Why? Who would advertise a bad one? No one. Yet very few hypothetical track records actually succeed in real time.

For starters, there are some in the investment world who will simply make up a completely bogus hypothetical performance record and try to pass it off as real, hoping to fool unsophisticated investors. Fortunately, this practice is on the decline.

Now, let's go back to the more recent practice of 'back-testing' as noted above. Back-testing is a process whereby an Advisor takes its actual strategy and resulting recommendations and applies those signals to past market data before it began to manage real money in real market conditions. The obvious weakness to back-testing is that it implies that future market conditions will be similar to the past. We all know that future market conditions are unpredictable.

But it gets worse, unfortunately. While the practice of back-testing is meant to provide a confirmation that the strategy works, we often find that the Advisor has - consciously or unconsciously - tweaked the system to fit the historical data. With the benefit of hindsight, the Advisor may see that one or more minor modifications to its strategy would have produced greatly enhanced returns in the past. How convenient! But it is in the past.

Don't get me wrong. Back-tested results can be very useful in certain situations, especially when you have a well established, highly successful Advisor who, for example, is using back-testing to test a new program it wants to introduce. Just know that this practice can be badly abused.


Since most Registered Investment Advisors (RIAs) are not subject to the rigid performance reporting criteria applicable to mutual funds, a careful review (or 'audit' as we call it) of the performance numbers given by the Advisor is imperative. In recent years, many successful RIAs have already taken that step and spent the money to have their performance record audited annually by independent accounting firms.

Where an independent audit is not available, there are other alternatives. One such resource is the CFA Institute, formerly known as the Association for Investment Management and Research (AIMR). Advisors whose performance is "AIMR compliant" can represent that they adhere to the high ethical standards for creating performance information that ensure fair and accurate representation as well as full disclosure. Over the last few years, AIMR compliant performance reporting has become an industry standard.

While my company knows how to verify if an Advisor's performance is AIMR compliant or not, most investors do not know how to confirm this. Recent studies have shown that some advisory firms are claiming to be AIMR compliant when in fact they are not. This presents just one more disclosure hurdle that most investors are not prepared to verify.

In cases when there is no independent audit and no AIMR compliant reporting, my company requires the Advisor to provide detailed records of actual customer accounts, randomly selected, usually in the form of monthly brokerage or mutual fund statements. We compare the actual results in the customers' accounts to see if they match the performance record provided by the Advisor. Believe me, they don't always match!

On more than one occasion, we have visited Advisors that advertised outstanding results, but when we looked at the actual account statements, we found that the real performance was very disappointing. If so, we pack up and leave, right then and there.

It is important to note that individual investors may find it difficult or impossible to get this kind of information from an Advisor. While Advisors regularly provide such detailed information to another RIA like my company, which represents thousands of investors, many are hesitant to make detailed client information available to a single prospective client, unless it is a very large investment.

One last point on the performance record issue. Often in the past, I have had Advisors tell me that they could not show me their customer account statements for confidentiality reasons. Let me tell you, that's a crock! The routine practice is to "white-out" the names on the customer account statements. If an Advisor tells you he can't do this, consider that a big red flag!

2. What Is The Money Manager's "Methodology"?

Once you have verified that the performance advertised by the Advisor is for real, the next step is to understand generally how the Advisor's investment system works. There are many different types of investing and trading systems. Some are fundamentally based; some are technically based; some are discretionary; and many are a combination of these approaches. Likewise, the use of computers and software varies widely.

Most successful money managers have a well-developed "methodology" that drives their systems. While successful Advisors tend to protect their "secrets" to success (ie -- certain information is proprietary), they should be willing to explain generally to you how their systems work.

If the Advisor cannot explain to us generally how the system works, that raises several questions for us: 1) Is there really a methodology and a system at all, or does the Advisor simply trade "by the seat of his pants"?; and 2) Is the system so complicated that maybe even the Advisor himself doesn't fully understand it?

The point is, you need to have at least a general understanding of how the Advisor's system works, how decisions are made, how it gets in and out, etc.

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3. Is There A Strong "Back-Office" To Handle Administrative Issues?

Successful Advisors must have a good performance record -- that's a given. But that's just where it starts. Once an Advisor generates a signal to buy or sell, the administrative staff must be sufficient to implement the trades, see that they are executed properly and make sure they are allocated in the correct amounts to all the Advisor's various clients. This operation is commonly referred to as the "back-office." In addition to the back-office, there must be adequate administrative staff to be able to interface with clients and firms, like my company, that recommend the Advisor's investment programs.

The best way to determine the sufficiency of the back-office operation is to conduct an on-site visit to the Advisors offices. In such a visit, many facets of the administrative side of the business are reviewed. This includes everything from how the system works, to trade execution to client statement generation, and all other elements of the business.

In particular, it is important to determine that the Advisor's staff is equipped to handle not only the current assets under management, but even more. Remember, if an Advisor continues to be successful, it will almost certainly accumulate a larger number of accounts and more assets under management. Ideally, the Advisor will have a long-term growth plan for adding administrative personnel at successive levels of increased assets under management. We also like to see that the Advisor has a serious commitment to the latest computer hardware, software, technology and the personnel to run it.

This is not to say that an Advisor must have a large number of employees to be considered successful. Many Advisors have outsourced administrative tasks to independent custodians such as trust companies, brokerage firms and even mutual fund families. The on-site due diligence review helps to confirm that these resources, coupled with the Advisor's internal staff, can handle significant growth in assets under management that we or others may bring about.

The on-site visit has another beneficial outcome. It allows us to meet and talk with all of the principals and staff, and get a good feel for the organization as a whole.

4. Regulatory Skeletons In The Closet?

Most professional money managers are registered with the Securities & Exchange Commission as Registered Investment Advisors. The SEC has strict regulations that must be complied with in order to avoid regulatory problems. Not all firms are compliant. You want a money manager that is serious about compliance with all applicable rules and regulations.

Appropriate due diligence requires that the regulatory history of the Advisor be examined to see if there have been any compliance problems in the past. Key personnel of the Advisor should be checked out as well. This is accomplished through review of required disclosure information, a search of the SEC regulatory database, background checks and a review of any reports from on-site SEC examinations.

It is important to realize that many Advisors also have affiliated companies that may be registered under other regulatory bodies such as the National Association of Securities Dealers (NASD), etc. The due diligence process should include a review of the regulatory histories of all such related entities.

In addition to regulatory background checks, the principal traders should also be questioned about any significant personal situations that may have occurred in the recent past. An Advisor's performance can be affected by a significant personal event, such as the death of a loved one, marriage, divorce or geographical move. All of these factors are also taken into consideration while doing a background check of the Advisor.

5. Does The Manager Have A Backup Plan In Case Of Emergency?

Ideally, an Advisor will have a back-up plan in case of emergency. This could mean anything from a medical emergency or death, to an extended vacation, or even a power outage. We want to see that trading can continue and that client accounts will continue to be serviced. Some Advisors are "one-man shops" with no such backup, so they are generally overlooked when considering potential Advisors for our clients.

Even if an Advisor has a sufficient administrative staff or has outsourced back-office operations, this is no guarantee that someone could trade effectively in the absence of one or more of the Advisor's principals. The optimum situation is that the Advisor has at least two or more individuals who are familiar with the trading methodology and the system and can continue the investment programs in the absence of the primary trader.

As a bare minimum, an Advisor should have someone designated who could unwind existing trades and take the program to cash, especially in the situation where the Advisor has died or will be out of the office for an extended period of time. This gives investors more assurance that their accounts will not be locked into a trade during unfavorable market conditions because of the Advisor's absence.

The recent news about Hurricane Katrina also brings about another point: What happens if an Investment Advisor can no longer access his or her office and systems? The SEC now requires all Investment Advisors to have a Business Continuation Plan. A review of this plan is an important part of all due diligence reviews that we perform, and it should be on your list of questions to ask as well.

6. Does The Manager Continually Monitor The System & Make Adjustments?

A due diligence review of an Advisor should also determine if the Advisor is using an antiquated system that never changes, or constantly monitors and adjusts the system for current conditions. In the last few years, we have seen market conditions that have no parallel in the past. Therefore, some Advisors' trading systems were blindsided and generated large losses. Being able to adapt to ever-changing markets and market conditions is one of the most important due diligence requirements we have.

This is not to say that the Advisor should tinker with the trading system so much that the program may be significantly different from one year to the next. The types of changes I am talking about involve adjustments and refinements to the program to stay current with the ever-changing markets, technologies and information flow.

In addition, we require all recommended Advisors to notify us prior to implementing any material changes to the trading system. In addition, we monitor test accounts established with each Advisor on a daily basis in an effort to pick up on any changes in the trading methodology that the Advisor may have neglected to tell us about.

7. Do They Invest Their Own Money?

Of all of the additional due diligence requirements that I have, this is one of the most important. It needs little explanation. Simply put, if I am going to entrust my clients' money, and my own money, to an Advisor, I want to know they have a substantial percentage of their own money in their programs. If an Advisor doesn't have his own money in his program, I consider that to be a major red flag.

Interestingly, most of the successful Advisors I have met have a huge amount of their own money invested in their programs - often more than they should. I am certainly no exception to this rule as I have a substantial amount of my net worth invested in the programs we recommend. It is my money invested in every program we recommend that serves as our "test accounts" which we use to monitor the results.

Finding The Really Successful Advisors

There are thousands of Registered Investment Advisors in the US. I can tell you, there are a lot of bad ones, a lot of mediocre ones, and only a relatively small number of truly successful ones. Most RIAs don't advertise. So to find the truly successful money managers (unless you just get lucky), you must have a serious commitment of time and money to do so.

At my company, we have a serious annual budget for identifying successful money managers. We subscribe to expensive databases that include information on RIAs and other money managers. In addition, we attend conferences each year where RIAs and other money managers gather. And as discussed above, we conduct an on-site due diligence visit with the RIAs before we recommend them to our clients.

Most individual investors simply do not have the time, the experience or the money to travel the country as we do in search of truly successful money managers.

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This analysis of due diligence considerations should give you a pretty good idea of what it takes to evaluate mutual fund managers, managed account Advisors and hedge fund managers. Now all you have to do is apply these principles to the thousands of available funds and Advisors in the marketplace.

Unfortunately, most investors never take the time to ask even a fraction of the questions necessary to get the information discussed in this article. Most also have no desire to travel all over the country and conduct this type of intense due diligence. Even if they did, most investors are not equipped to evaluate the answers given to many of the questions discussed above or the operations of funds and Advisors.

This is not to say that most investors are not capable of asking the right questions and demanding honest answers. It's just a LOT of work, and a great deal of experience is necessary. I have been continuously evaluating money managers and funds for over 25 years. Today, more than ever, it is still a continuous learning experience.

As noted earlier, some Advisors will simply not make all of the information discussed above available to an individual investor, especially one who is interested in opening up only a relatively small account. As a result, individual efforts to perform effective due diligence on funds and Advisors usually ends up in only partial success.

The good news is that my company already has the staff, expertise, experience and the annual budget necessary to search for successful money managers and engage in the due diligence process on behalf of our clients. We also have the necessary hardware, software and database applications to be able to monitor performance on a daily basis as well as identify new prospective Advisors.

If you are interested in the programs I recommend, give one of our Investor Representatives a call at 800-348-3601. You may also contact us via e-mail at You can also visit our website at to learn about the kinds of investment programs we offer.

Finally, you are free to share this issue of Forecasts & Trends E-Letter with friends or relatives that you believe would find it useful. As you have read, there is a lot of good information in these pages that you are not likely to find elsewhere.

Very best regards,

Gary D. Halbert

Gary Halbert is the president and CEO of the ProFutures companies, a diversified investment advisory firm located in Austin, Texas. ProFutures offers professional financial planning services to a nationwide base of clients. Mr. Halbert's firm specializes in tactical investing, and its recommended investment programs include mutual funds, managed accounts with professional Investment Advisors and alternative investments. For more information about the programs offered, call 800-348-3601 or visit the website at


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Copyright © 2005 ProFutures Capital Management, Inc. All Rights Reserved.


"Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend any product or service advertised herein, unless otherwise specifically noted."

Forecasts & Trends is published by ProFutures, Inc., and Gary D. Halbert is the editor of this publication. Information contained herein is taken from sources believed to be reliable, but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgment of Gary D. Halbert and may change at any time without written notice, and ProFutures assumes no duty to update you regarding any changes. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Any references to products offered by Halbert Wealth Management are not a solicitation for any investment. Such offer or solicitation can only be made by way of Halbert Wealth Management’s Form ADV Part II, complete disclosures regarding the product and otherwise in accordance with applicable securities laws. Readers are urged to check with their investment counselors and review all disclosures before making a decision to invest. This electronic newsletter does not constitute an offer of sales of any securities. Gary D. Halbert, ProFutures, Inc. and all affiliated companies, InvestorsInsight, their officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Securities trading is speculative and involves the potential loss of investment. Past results are not necessarily indicative of future results.

Posted 09-06-2005 8:10 PM by Gary D. Halbert