Investing other people’s money brings significant responsibilities and risks that investors need to carefully consider. As a fiduciary, the fund manager has a legal duty to act in the best interest of the investors. This requires expertise in asset allocation, due diligence in selecting investments, and ongoing monitoring and reporting. However, there are inherent risks as the manager has control but not full ownership. The investors face opportunity cost if investments underperform the market. There are also agency risks if incentives are not aligned. Investors should thoroughly vet any investment manager to ensure they have the skills, transparency and incentive structure to justify trusting them with capital.
Acting as a fiduciary requires expertise and experience in investing
When investing on behalf of others, the fund manager is legally considered a fiduciary and has a responsibility to act in the best interest of the investors. This is a high standard requiring financial acumen to construct a thoughtful investment portfolio, conduct rigorous due diligence in selecting investments, and provide clear ongoing reporting. The manager should have an established track record of strong risk-adjusted returns to demonstrate their investing capabilities.
The principal-agent dilemma poses risks if incentives are misaligned
In any principal-agent relationship, there is an inherent dilemma that the agent’s incentives may not fully align with the principal’s interests. This can lead to problems like moral hazard where the agent takes inappropriate risks with the principal’s money knowing the principal bears the downside. Investors should ensure the fund manager’s fee structure incentivizes long-term returns rather than short-term gains. There should also be transparency through regular audited financial reporting to ensure proper controls are in place.
Investors face opportunity cost if investments underperform viable alternatives
Investors always face opportunity cost in choosing one investment over another. If the funds underperform what the investor could have earned through a low-cost index fund or other easily accessible investment, then they incur a loss relative to that benchmark. Investors should set clear return expectations and require detailed reporting on both absolute and relative performance to fully assess the value being generated.
Investing other people’s money brings fiduciary duties and risks that warrant careful evaluation of any fund manager. Their expertise, transparency, controls and incentive alignment should justify the capital entrusted to them. Investors should set clear performance expectations and require regular reporting to ensure their interests are properly served.