Thursday, November 12, 2009

WSJ: More Mutual Funds Attempt to "Time" the Market

Some interesting developments happening on the edge of the mutual fund industry in response to the ill fated belief in "buy and hold".   What worked beautifully in the "throw a dart at a stock board and win" bull market of 1983 to 1999, has fallen flat on its behind the past decade.  [Feb 5, 2009: Mutual Funds Have Tough Decade]  As it would have in the decades before the 80s.  Cash, the "scourge" of mutual funds is also now being seen as an "asset class". [Apr 10, 2009: More Stock Mutual Funds Declare Cash is King]   I have a separate piece I'm working on regarding a move to hedging techniques in another corner of the mutual fund universe, but we have seen that "innovation" finally explored [Aug 4, 2009: WSJ - Mutual Funds Try "Hedge" Approach in Effort to Trim Stock Losses]. I guess losing 50-60% of your clients money in 1 year tends to get people thinking that maybe *something* is amiss with their dogmatic views on investing.

So we see both timing AND hedging as techniques some mutual fund families are finally adopting, in a market that does not go up 8 out of every 10 years.  Hmm, sounds vaguely familiar... I believe I've seen some mutual fund blog practicing that for a few years. ;)

I don't mind being a trailblazer...or is it imitation is the highest form of flattery? 

Via Wall Street Journal:
  • In an effort to lure back investors still wary of stocks, more mutual-fund managers are playing a risky game: timing the market.  Many of these funds promote their ability to avoid big losses by trading in and out of the stock market at just the right time. Some are labeled "tactical allocation" or "dynamic" funds. But even funds that don't openly tout such strategies are moving in and out of big cash stakes, betting that they can outsmart the volatile market.

Of course this is where the 95% of the industry, which failed miserably at protecting their investors during the past decade, cries out "you can't time the market!".  Please note almost all of these folks also cannot beat an index fund over the long run ....
  • But funds attempting to time the market often deliver erratic performance, charge high fees and rack up big trading costs. 
  • Funds dodging in and out of the market also tend to be quite costly. The A shares of Quaker Small-Cap Growth Tactical Allocation Fund charge annual expenses of 2.59%. The fund, which can move up to 100% in cash, has lagged behind more than 90% of its small-cap growth rivals over the past 12 months, gaining roughly 10%, according to Morningstar.  The expenses are high because the new fund still has relatively few assets, says Stephen Shipman, the fund's manager. "We're achieving what we set out to do for the investor," offering participation in up markets but avoiding much of the downside risk.
All quite true - sometimes you will zig when the market zags... and hefy trading costs a lot to a fund versus "buy and mostly hold".   Hence will ultimately cost more to the end investor.  And as stated above, it's costly for any mutual fund regardless of technique when the asset base is smaller.  Fidelity and Vanguard have huge advantages in economies of scale.
  • These funds are something of a bright spot for the fund industry, which has seen billions flow into bond funds but little cash go to more-profitable stock funds. Investors put $4.1 billion into world-allocation funds (Morningstar's category that tracks the most-flexible funds) in the first nine months of this year, while adding only $4.3 billion to stock funds and plowing $213 billion into taxable bond funds.

Now of course these type of funds are impossible to put in 1 bucket because while "flexible" they are doing completely different techniques.  To wit...
  • Some of these funds have beaten the market in recent years. Ivy Asset Strategy, for example, gained an annual 14.9% in the five years ending Nov. 10, compared with less than 1% for the Standard & Poor's 500-stock index.  (sounds good, as I look at its performance in 2008 it only lost 26.4% which was far better than 95%+ of funds out there - and still participates to some degree in the positive years; true recipe for long term success)
  • But they can also give investors whiplash. The Encompass Fund fell 62% last year, landing at the bottom of its world-stock category. This year it's leading its world-stock category with a nearly 110% gain. (not good at all in my world, that's just high octane gambling with no capital protection - how many of those investors who lost 40, 50, 60%+ would of stuck around to "enjoy" the gains?  Judging by human psychology - very few)
  • Some managers moving in and out of the market rely on macroeconomic views. Others are simply bottom-up stock-pickers who hold lots of cash when they can't find other opportunities. Then there's John Hancock Technical Opportunities Fund, which is guided purely by technical analysis, examining patterns in market data. (this is the second mutual fund purely based on technical analysis - we discussed it in the summer) [Aug 24, 2009: John Hancock Technical Opportunities Becomes Second TA Based Mutual Fund to Launch]

  • Fund companies say investors spooked by the recent market turmoil are demanding more-flexible products. Many investors have been frustrated "with investment products that were not able to react to the environment that we just went through," says Joel Sauber, head of U.S. products at Legg Mason.
Please come and visit FMMF ;)

Ah yes, now the pros and cons argument:
  • A study from New York University's Stern School of Business suggests market-timing can work for some mutual-fund managers. The best stock-pickers during economic expansions also show some market-timing ability in recessions, the study found. 
  • But academic research raises doubts that the typical fund manager can successfully time the market over the long haul. Anders Ekholm, adjunct professor at Hanken School of Economics in Helsinki, recently analyzed more than 4,000 U.S. stock funds' returns between 2000 and 2007. Managers helped their performance through stock-picking, he found, but hurt their returns by market-timing.
  • There are a couple of reasons why the deck is stacked against market-timers, Mr. Ekholm says. Market-timing requires more trading, and transaction costs hurt performance. What's more, while a manager may relatively easily dig up some unique information that gives him an edge in selecting an individual stock, it's difficult to get such superior information about the overall market.

I suppose as in any profession in life, there is a bell curve - some will be poor performers, some average, some solid.  I doubt the ability to "trade" is any different.  If you can avoid the worst of the downdrafts the belief here is those extra trading costs will be more than offset over time.

To close:
  • Given these managers' long leash, it can be tough for investors to keep track of what they're doing. Legg Mason's new tactical-allocation fund, for example, has been in and out of five or six asset classes in the few months it's been on the market, Mr. Sauber says. Mutual funds are only required to disclose portfolio holdings every three months.
Aha! And this is where another layer of differentiation would lie with our vision.  Still innovating.

But circling back to hedging and timing... frankly (in my opinion) they should not be that 'rare' in the mutual fund world, as these concepts are practiced in many parts of the hedge fund arena.  Where in theory the 'smart money' is.  So what does that say about the mutual fund industry? I've made my views known: [Barrons: A New Kind of Fund Manager

[Apr 17, 2009: Decade of Losses, Forces Investors in their 30s to Start Over]
[Oct 7, 2008: 2000s Stock Market Worse than 1930s]
[Mar 26, 2008 - WSJ: Stocks Tarnished by Lost Decade]

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