- In a market where the mighty have fallen, it is hard for investors to separate the strong from the meek. As a result, they are ready to bail on any mutual-fund manager whose performance has faltered. While it certainly makes sense to abandon a fund that has fallen and can't get up, it is tough to tell just how much strength and vigor an issue has while the entire market is hurting. New research shows that there is a distinct benefit to sticking with a high-performing manager through a rough patch.
- That survey is good news for buy-and-hold investors who picked a management star and need a reason to hang around hoping for a comeback, but it doesn't make it any easier to decide whether a fund's performance problems are temporary or permanent.
- The study, conducted by Baird Advisory Services Research, looked at more than 1,300 funds, defining "high performers" as those that topped their benchmark by one percentage point annually over the 10 years ended in 2007. About 505 funds qualified.
- The key finding was that many of these top funds went through periods where they got killed by the market or their peer group. More than three-quarters of these high achievers had at least one three-year stretch where the fund lagged behind its benchmark by one percentage point or more. More than half of the funds experienced benchmark underperformance of three percentage points or more, and nearly one-third of them lagged behind by five percentage points or more in a three-year period.
- Despite those bouts of underperformance, the funds were able to be superior achievers over the full 10-year window.
- Tim Byrne, director of Baird's Private Wealth Management Research, Products and Services, said the moral of the study is that even the best money managers have periods where they don't look so good, but the longer an investor sticks with them the better the chances for success, for high performance over time.
- "The problem is that people buy a fund after the manager has proven that they are a high performer, but they sell the first time there's a problem," Mr. Byrne said. "They wind up chasing performance -- buying high and selling low -- instead of sticking with a manager who has proven that they can deliver if you give them enough time."
- The trick is in deciding which managers deserve a long leash. (bingo) Mr. Byrne said he looks to see if a manager has "proven that they can dig out of a hole, because you have to believe they can create return fast enough to help you catch up from any down period."
The question is - how much near term failure can one allow for? (1 year? 2 years? 3???) All interesting questions and it also highlights the difference between the hedge fund world and mutual fund world. Many managers have provided meager gains for years on end in mutual fund world and keep acquiring assets. In the hedge fund world, those who do not consistently perform are "weeded" out in relatively short order.
Speaking of fund managers milking the system for years, here is a "star" of the late 90s that I ran across in the WSJ this weekend. It's taken a full decade of literally the WORST performance for him to "leave" the portfolio management.
- Van Wagoner Emerging Growth has consistently disappointed investors, giving it a dubious distinction as the worst-performing U.S. actively managed stock fund over the past 10 years.
- But at least one thing is changing at the woebegone fund: Longtime manager Garrett Van Wagoner is planning to step down, even though Mr. Van Wagoner, 52 years old, controls the company that sponsors the fund, Van Wagoner Capital Management.
- When asked about his best stock pick of the past year, he says, "I don't know if I have any best picks." (hah)
- Specializing in the volatile world of small-growth stocks, many of them tech firms, Van Wagoner Emerging Growth has clocked an annualized 10.2% loss for the past 10 years. During that time, actively managed domestic stock funds were up an average 5.6%, according to fund tracker Morningstar Inc.
- For 2008, the Van Wagoner fund is down 28%, about twice as bad as the broad market's fall.
- In fact, about 95 stock funds have delivered negative annualized returns in the past 10 years. Around two-thirds are growth offerings haunted by bear-market declines earlier in the decade, such as the $4.8 billion Vanguard U.S. Growth, the biggest, down 3% over the past 10 years.
- Mr. Van Wagoner is a vociferous fellow who started Van Wagoner Capital Management in 1995 and regularly appeared on CNBC during the technology-stock bubble. He makes himself available to investors by posting his email address on his Web site.
- Mr. Van Wagoner has posted negative annual returns for seven of the past nine years. For the privilege, it charges investors about 5% of assets in yearly expenses, more than three times the level of the typical stock fund. Mr. Van Wagoner says fees are so high despite efforts to reduce it because it is spread among a declining asset base.
- Mr. Van Wagoner thinks his approach of reviewing company fundamentals has gone "the way of the dinosaur." He believes the market has shifted to trading with a herd mentality that doesn't reward the small, risky technology companies he focuses on. (on this point I do have to agree - its a new era led by hedge funds who pile in and out of similar positions causing major dislocations in price, many times without regard to fundamentals - they are paid on 90 day holding periods. "Have to make the quarter" - "Have to make the quarter" - "Have to make the quarter" - it is all about quarterly fees and I think it has truly changed the market dynamic - especially in volatile times)
- The firm's funds are down to less than $50 million in assets from $3 billion in 2000. (staggering but that is what a 300%+ year in 1999 will do for you)
