Frank Thoughts: Pooled Account - Separate Account
Frank Boland
May 17, 2021

Every significant bull market has at least one mutual fund manager who becomes rich and famous. A portfolio manager, such as Peter Lynch, can even achieve – for a period of time - cult status. But only, if he or she has the good luck to be at the right place at the right time. Such fame only occurs during a period of low correlation in the stock market. Then a manager can choose individual stocks based on their perceived uniqueness. But that has not been the experience in the market since the debt crisis ended 12 years ago. Interestingly, after the crash of 1929, correlation also lasted 12 years.

So how does one explain Cathy Wood’s ARK Innovation Fund being up 150% last year? As the name might suggest, it has a theme - Innovation. It also uses what’s known as a concentrated portfolio. As many pooled accounts do, they will typically hold half the portfolio in 10 stocks. It increases leverage up … and down. But in a pooled account you don’t own the individual stocks. Instead, you own shares in the fund. In a separate account you own the stocks and the tax consequences of it. A disadvantage to a pooled account is, you can get a tax bill for gains that you never had the benefit from.

That reality is one of the principle reasons why individuals with portfolios of six, seven figures or more will generally hire a private “fiduciary” management firm. The term fiduciary was introduced by Massachusetts Justice Samuel Putnam (Harvard College v. Amory) in 1830.  His decision directs trustees “to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.”

Today we would say, a fiduciary manager has to treat his client’s money as though it were his own; that legal dictum is the antithetical goal of a portfolio manager running a pooled account. The fund manager’s goal is to increase the performance of “his” account as much as possible. He/she must take risk. This means fewer stocks and a higher risk profile among those chosen. We all know the greater the risk the greater the potential reward; no risk no reward. This leads today to many funds owning unprofitable stocks. It’s why famous money managers all have a pooled management background.

But that tolerance for risk diminishes as we become older. In line with that, it’s important to understand the motivational difference between pooled and separate account managers. They have different masters. The pooled account manager serves himself; his job is to put up breathtaking performance numbers. If it happens, money flows in and he gets rich; if it doesn’t, the fund is closed. Last year 226 ETFs and 2,000 plus mutual funds were closed. Obviously, there is a survivor bias for those who remain. Risk for the separate account manager has to be lower, because he’s a fiduciary.

Fidelity Investments was a pioneer in thematic investing, focusing on growth stocks. In 1958 Fidelity Capital Fund was formed with Jerry Tsai as its manager. Tsai in the period of 1958-1965 was up 296%! In one year Fidelity new accounts increased from 6,000 to 36,000. Jerry Tsai took that as a sign to start his own mutual fund which was called the Manhattan Fund. His original goal was 25 million. The fund attracted 247 million! Its performance from the beginning was muted. But by 1969 it was down 90%! The problem was it had one theme. Growth stocks. Having one theme when you encounter a bear market, such as happened in 1969, means you really own just one stock idea. The theme.

Francis Patrick Boland

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