(Bloomberg) -- Jason Hsu has a word of investing advice: Today’s least successful fund managers often blossom into tomorrow’s biggest winners.
Standard hiring and firing procedures for money managers are backward, the UCLA-trained economist found after analyzing more than 4,000 mutual funds over the past 25 years. Poor performers over three years often revert to outperformers, while top managers frequently reverse, according to Hsu, chairman of Rayliant Global Advisors and vice chairman of Research Affiliates, a sub-adviser to firms including Pacific Investment Management Co.
So what would he use to select the next top investor?
"I’d focus on large funds that score high on Morningstar’s governance ratings," Hsu said by phone from Newport Beach, California. "I’d probably bet on mean reversion -- funds with quality people and bad luck, so their stocks would be cheaper. I’d also focus on funds with high insider ownership."
Gone are the days when investors such as Bill Gross, Ray Dalio and Jeff Gundlach carved out reputations for long stretches of success. Hsu said that’s in part due to the rise of indexes and fund managers who track them closely, a shift that can make betting against big names a lucrative wager. In China, the reversals can be even more staggering given its shallower market.
"When a fund is successful, it attracts a lot of investor flows and creates a self-fulfilling positive prophecy,” he said. “The reversal is really traumatic.”
Not all losers are poised for success, Hsu said. He should know: As a CalTech undergraduate in the 1990s, during the basketball program’s historic three-decade conference losing streak, just about anyone was allowed to play -- including Hsu, who came in for a few unmemorable minutes at point guard. The Beavers didn’t snap the streak until 2011.
In the investing world, it’s best to avoid poor-performing funds that maintain high clients fees as their assets under management dwindle, Hsu said. Instead, investors should favor funds with low fees, low turnovers, a consistent philosophy, positive corporate culture and sense of humility, he said.
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