11/26/2013 07:06 pm ET Updated Jan 26, 2014

Flawed Investment Advice From the "Car Czar"

Steven Rattner has an impressive background. According to his website, Mr. Rattner is known as the "car czar" because of his appointment by the Obama administration to lead the restructuring of the auto industry. He is the chairman of Willett Advisors LLC, the investment arm for outgoing New York Mayor Michael Bloomberg's vast wealth. He is a regular commentator on financial matters on MSNBC and is a contributing writer to The New York Times' op-ed page.

Mr. Rattner's otherwise stellar career has also hit some bumps in the road. According to an article from Bloomberg dated December 31, 2010, he settled kickback allegations involving New York's pension fund, by agreeing to pay $10 million and consenting to a ban from appearing in any capacity before any public pension fund in the state for five years. According to the civil complaint filed by then New York Attorney General Andrew Cuomo, Rattner, a co-founder of a private-equity firm, Quadrangle Group LLC, allegedly caused that firm to pay kickbacks in order to obtain $150 million in investments from New York's pension fund.

In settling this lawsuit, Mr. Rattner paid less than half of what was being sought by Cuomo, now New York's governor. Mr. Rattner also denied any liability.

According to the same article, in November 2010, Mr. Rattner settled a "parallel probe" with the Securities Exchange Commission by paying $6.2 million and agreeing to a two-year ban from associating with broker-dealers or investment advisers.

On November 14, 2013, Mr. Rattner published an op-ed piece in The New York Times entitled: "Who's Right on the Stock Market?" The article sets forth his views on the different opinions of Nobel Prize winners Robert Shiller and Eugene Fama over whether the markets are efficient. Describing himself as "someone whose professional life centers on evaluating investment managers," Mr. Rattner comes down "emphatically" on the side of Mr. Shiller, who believes markets are "often irrational and therefore beatable."

Nevertheless, Mr. Rattner counsels against investing in actively managed funds, stock picking or market timing by most individuals. He notes that many do so based on information derived from cable television or "their own intuition." He recommends that the "nonexpert" should park his or her money in low-management-fee index funds.

Mr. Rattner observes that "... selecting good managers or attractive stocks has led to superior returns for the savvy... " This observation perpetuates the myth that sophisticated investors have a good shot at "beating the markets," while "nonexpert" investors should settle for market returns available from index funds. The overwhelming data is contrary to these views.

Hedge funds investors are certainly sophisticated, yet the annualized return of the HFRX Global Hedge Fund Index from 2003-2012 was a puny 1.6 percent, compared with 7.1 percent for the S&P 500 Index over the same period. The average hedge fund during this period even underperformed the Bank of America Merrill Lynch One-Year Treasury Note Index, which had an annualized return of 2.2 percent. Worse still, according to a recent survey, many in the hedge fund industry feel pressure to engage in unethical behavior in order to obtain higher returns. Surely, the fund managers of these funds are "savvy" investors. What accounts for their dismal performance and questionable ethics?

Pension funds have the ability to hire consultants like Mr. Rattner to help them select managers who will outperform prospectively. Yet, according to a September 30 article in The New York Times by Andrew Ross Sorkin, a study by professors at the University of Oxford raised deeply troubling issues about the value (or lack thereof) of the advice provided by these consultants. The study found no evidence that the recommendations of the consultants advising on U.S. stocks "enabled investors to outperform their benchmarks or generate alpha." One of the authors of the study was quoted by Mr. Sorkin as telling him that listening to consultants is "a waste of money" and that their service was "useless."

Mr. Rattner noted that the eminent economist John Maynard Keynes "outperformed the averages in his own investing," presumably as support for his view that "experts" can beat the markets. I would urge him (and you) to read John F. Wasik's excellent new book, Keynes's Way to Wealth. Wasik exhaustively researched investments made by Keynes. It's true that Keynes evolved into a skilled investor. He died a wealthy man, whose investing acumen benefitted Cambridge University, insurance companies, friends and family. However, one the lessons Wasik learned from his analysis of Keynes's investing was to "put most of your money in cheap index funds."

Keynes's efforts to "beat the markets" were not encouraging. He got clobbered in both the late 1920s and the late 1930s. He lost almost 80 percent of his net worth after the market crashed in 1929. He lost another fortune trading in commodities. These experiences taught Keynes a valuable lesson that should not be lost on investors today. He concluded that "animal spirits" were the force behind market activity, making predictions exceedingly difficult, if not impossible. Keynes changed from a speculator who thought his economic expertise permitted him to outwit the markets to a long-term investor who ignored short-term valuations and market trends.

Mr. Rattner is correct that there are lessons to be learned from the investment history of John Maynard Keynes. Trying to "beat the markets" -- regardless of your level of investment expertise -- is not one of them.

Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You'll Ever Read, will be published March 3, 2014.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.