Do Your Mutual Funds Outperform the Market?

hank

http://awealthofcommonsense.com/do-your-mutual-funds-outperform-the-market/

Excerpt: "If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. .... It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” – Warren Buffett
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One omission in the article's analysis of why most funds underperform - Funds hold CASH. That's to meet redemptions, pay ongoing administration and fund expenses and sometimes as a buffer against volatility. I wish the author had mentioned that. Any holdings of cash at current rates has to amount to a drag on performance.
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Worth noting - With funds you are paying for convenience (exchange privileges, phone support, record-keeping, newsletters and other materials). The quality of service varies greatly, but in the end you pay in one form or another.
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I like Buffett's comment. I think the ability of small investors to make profitable tactical moves - especially in highly volatile markets - far exceeds what the manager of a multi-billion dollar fund can achieve.

MJG

Hi Hank,

Thank you so very much for your referral to the “Wealth of Common Sense” website. I needed the boost.

Given the emphasis that MFO puts on newbie actively managed mutual funds, my morphing towards a portfolio that is dominated by passively managed products is not universally welcomed with a fair open-mindedness. Sometimes I feel like the Lone Ranger. But persist I will.

The referenced article asks the right question. Since MFO participants tend to reside in Lake Woebegone, I anticipate their answer will be “Yes”. Of course that likely response flies against the statistical base rates that S&P summarizes in their exhaustive SPIVA scorecard and Persistency reports.

It’s amazing that you referenced this concise article at this time. It is difficult to fault it in any way since only a few days ago I posted a similar reply to MFO member mrdarcy . It is the last entry in the “A Short Active or Passive Quiz” thread; here is the internal Link to it:

http://www.mutualfundobserver.com/discussions-3/#/discussion/7717/a-short-active-or-passive-quiz

In part, I said:

“The S&P Indices versus Active Funds (SPIVA) scorecard and the S&P Persistency reports year after year destroy that dream. With an occasional exception, these reports demonstrate that the traditional Indices outdistance their actively managed competitors both annually and statistically over longer timeframes.

The number of active winners in all categories erode more quickly over time than even chance winners are expected to prevail. This gloomy trend remains intact in the international and in the small, value-oriented classes. However, there is some glimmer of hope for the small, value funds in the international marketplace.”

I surely am somewhat guilty of hubris since I’m quoting myself, but the similarities and the timing are astonishing. Like most folks, I need a little succor every now and then. The behavioral wizards would conclude that occasionally I need a heavy dose of the Confirmation bias. I do; I think we all do.

As much as I liked author Ben Carlson’s referenced article, I liked others he crafted much more. His investment do and don’t rules listing is comprehensive. Here is the Link to that exceptional summary:

http://awealthofcommonsense.com/common-sense-investment-rules/

Great stuff. Please click on the “My Approach” section of the website. It lists a large number of stimulating, but passively oriented, essays.

My singular reservation is that the author is a very young (but bright) man, and a relative rookie in the investment industry.

In a sense, I’m a bit envious of him. He learned something overarching about the marketplace after a short exposure that took me decades to absorb. More power to him and to anyone else who also learns that investment simplicity works well.

Have fun everyone.

Best Wishes.

hank

Hi MJG. Glad you found my link and anecdotal comments useful:-)

BobC

The more important quiestion might be, "Do your funds reap 70-80% of their benchmark gains with 30% less volatility?" Whether it's 20% or 30% is not the reall issue. I am perfectly happy with a fund that captures a lot of the upside if it does so with significantly lower volatility. And I do not measure this in calendar years, but rather over rolling time periods. "Beating the markets" is certainly possible, but most folks cannot handle the volatility that comes with it, and that is why they bail at the wrong times. Heck, they don't even stick with index funds long enough to beat the markets.

ron

Reply to @BobC: Aren't index funds "the market"?

hank

I'm more in agreeance with BobC's comments than anything else said here. But, I'll go a step farther. For me, it all STARTS with managing risk. Return, however humble, is the frosting on the cake.

Stumbled upon the Common Sense website and the linked article inadvertently while trying to learn more about the topic of benchmarking raised by AKAFlack's provocative post - "Why benchmarking your portfolio is a losing bet" http://www.mutualfundobserver.com/discuss/index.php?p=/discussion/7832/why-benchmarking-your-portfolio-is-a-losing-bet#Item_3

Sometimes the questions we ask are more important than the answers we get, the reason being: good questions make us think deeply about what it is we're doing and why we do it. That's what I liked about Flack's question. My research into how one selects the right benchmark for a given purpose, and how well our fund managers achieve that came up empty. There doesn't seem to be a lot of discussion out there - although we hear a great deal about "benchmarks" from fund managers and board members alike. It was during the process of looking, that I uncovered and posted the link. Thanks for the good responses.

BobC

Hank, I agree with what you say. I have always had trouble benchmarking accounts and portfolios, since returns alone do not tell the complete story. And I agree with your suggestion that people start with a 'risk budget' (my term, not yours) and then build the portfolio from there. Natixis has done quite a bit of research on this. Unfortunately it is difficultfor retail investors to access the kind of software that does this sort of thing. But it is possible to start with upside/downside fund data, as well as other risk measurements, to at least get started. One study suggests that since much of the risk in an average portfolio comes from large cap domestic stocks, investors should use only long-short funds in this asset class. I am not saying this is how one should go about allocating dollars, but it should cause us to think about how we have traditionally allocated dollars, vs. where we OUGHT to allocate based on a risk budget.

When we do this, or at least try to do it, it puts into question the entire issue of whether a fund beats it benchmark or not. Again, if managing risk is the most important consideration, return, in and of itself, should not be the issue.