I have noticed that most mutual funds have their greatest success in their first years-thereafetr, their performance seems to drop back to less than the S&P 500 average. Which leads me to a question: are these highly-paid fund mamagers really all that smart, or is their initial success due to luck? Seems to me that very few mutual funds are able to consistently beat the market-so are these guys worth what they are paid?
Has anyone done a study of the performance of mutual funds over time? I’ve got a few I want to dump!
Finally-the big run-up of the market over the late 1990s-how much of this was just the fact that large numbers of new investors entered the stock market? Will we ever see that level of the DJA/NASDAQ again?:mad:
In the UK recently, a 5 year old girl outperformed a professional.
Most fund managers aim to match a benchmark, so they buy the same stocks that comprise the benchmark (eg S&P 500). They might try and be clever and drop some of the stocks and bring in a few others, or adjust the weightings.
They also work within all sorts of guidelines aimed at lowering risk. For example, it could be that no one stock may account for more than 5% of a portfolio. This limits returns. They often have to sell strong stocks when they come up to the 5% mark.
Also, they may be required to keep the fund fully invested, when an aggressive investor might build up cash when the market is strong and wait for weakening.
I manage my own personal fund, and it has massively outperformed the local index. But I break loads of rules that would apply to a public mutual fund.
(In the unlikely event that the HK stock market interests you…
http://www.geocities.com/hkhemlock/gallery-stocks.html )
Oh, and they’re a bunch of arrogant jerks, too. 
Well, somebody has to have the highest performance… so luck must play a role, especially when success is not repeated.
If you put your money in an index fund, you can skip a big chunk of the management fees. (And I hope that at least you are putting money into a no-load fund).
Vanguard, BTW, is the low cost leader among index mutual funds.
I recommend cranking through fool school at the Motley Fool website. You can even stop at chapter 4.
Here are two mutual fund managers who consistently show up in the Morningstar list of good ones:
Robert D. Goldfarb and William J. Ruane.
Those two guys manage the Sequoia Fund.
A brief Morningstar quote:
“Stable, skilled portfolio management has kept the fund in good stead over the short and long run.”
On December 23, 1982, Goldfarb & Ruane decided the Sequoia Fund had reached the size it should reach and closed the doors to any new investors. The fund remains closed to this day.
During the dot.com mania, everybody looked good. You could have bought just about any basket of stocks or virtually any mutual fund and have done fairly well, if not outstanding.
The trick is to determine your level of risk that you feel comfortable with. It’s pretty easy to invest money in high risk securities when they are going up and up and up. I recall talking to otherwise sober individuals during the height of speculation and they were putting every dollar they could spare into very risky funds. When I heard them say “Things have changed” with respect to market cycles, I knew the end was getting close. I was right.
Don’t confuse gambling or speculation with investing. The terms are not interchangeable. If you understand the differences and are comfortable with the risks of outright speculation, by all means go for it. But realize that’s not investing.
This is probably due to two different effects. One is the “incubator fund effect”. This is where mutual fund companies start not one but dozens of new funds, only they are not made available to the general public. After a few years, the best performing fund is culled, the rest are dumped, and is superior track record is published as if it had always been around. Another reason is survivorship bias. Funds that do very poorly are frequently are liquidated so that their poor performance disappears from the fund company’s record, only funds with good records are left.
The vast majority do not beat the unmanaged index, so I would say their “skills” are worth slightly less than a monkey that can throw darts at the Wall Street Journal.
Since all investors collectively own the market, and since passive investors match the return of the market, it follows that active investors collectively must also match the gross return of the market. But active management has additional costs (operating expenses, cash drag, trading commissions, market impact costs, taxes, etc.), so collectively they are guaranteed to underperform.
Numerous studies have documented that buying active management is a losing proposition. Here are some summaries:
http://www.indexfunds.com/articles/1999_grandinfat_adv_sect_WB.htm
http://www.indexfunds.com/articles/20011114_road_iss_act_LS.htm
http://www.indexfunds.com/articles/20000428_mutfundad_com_md_RF.htm
A very large portion of the run up in the market that occurred in the late 90’s was due to an increase in the P/E ratio, not because of earnings. The market will return to those levels, but it could take a while. Who knows how long it will take?
–Heck, I’ll take issue with that.
The Sequoia Fund had its worst year in 1999.
Fundamental value funds looked old fashioned during the dot-bomb bubble.
Now they’re heros.
Diversify!
First off I would hardly call it skill or luck when the majority of fund manager’s underperform the broad averages. The real question here is when they do outperform, why do they typically do so early in the life of the fund. 2 Answers - The first has been mentioned - that is the culling of the poor performers leaving the best. This is only a slight effect though. The more important reason is the manageability of a smaller fund. I am a futures speculator. My average return with 40 million is about 35%/year (with 7% peak to valley drawdowns ) . When i first started out with a couple hundred grand my returns were on the order of a few hundred percent. The smaller trading size gives you alot more liquidity to take low risk high reward trades with monster size because you know you can get out with the amount your trading.
I think this question is a very good one although maybe one more suited to a great debate. The question is why active managed mutual funds exist at all and are supported, marketed, and sold throughout the financial industry when the entire scam could be replaced by a few unmanaged indexes. Their only purpose is to pump money to a few people whose service is simply to make a consumer less than he or she could have made on an index fund unless the manager gets for the first few years. The gross misunderstandings of statistical principles in this one industry are either laughable or one of the greatest fraud conspiracies of our time.
When I took Mergers & Acquisitions in law school, we touched on statistical analysis of stock prices. According to my professor, generally speaking, mutual fund managers do no better than chance. There are a few exceptions - Simon Templeton, Warren Buffet, and Peter Lynch, according to my prof.
Anyway, I agree with the other posters that when you look at funds that did well the first few years, you’re probably looking at a biased sample.
And as the old saying goes, “past performance is no guarantee of future results.”
Those are pretty much the reasons says an ex institutional salesman who’s clients were fund managers and hedge funds with a few corporations and governments thrown in. It’s not as easy as it looks, especially if you are looking at monthly or quarterly performance. Once you start operating with the above constraints it gets much tougher.
Fund managers are generally pretty smart. Few dummies ever get their foot in the door of an investment bank or fund management company. Remember most funds were originally started by an individual who either had their own money or were able to talk other people into giving them a lot of money or both. Generally, dumb people usually can’t talk their way into 50 million dollars.
Fund managers can be insufferable arrogant jerks. Especially to salesmen. Generally speaking, I didn’t think they were too bad as a rule. Most people in the finance industry are fairly arrogant and competitive to begin with. Most won’t waste air trying to explain to someone who doesn’t have a basic understanding of markets, economies and companies. Maybe that’s arrogance, and maybe it’s just geekishness. I have several personal friends who are fund managers, and we are still friends even though I’ve been out of the business for 4 years now.
One reason not mentioned earlier is Darwinian selection. MAny funds go bust pretty quickly. Start out with a few bad investments, or start out with some good investments at a really bad time, the fund makes some losses, investors pull out money or you fail to attract new money, and the fund shuts quite quickly. I’ve got a friend in a start up fund management company, they really have to double the amount of funds they manage in the next 12 months or they can’t make enough fees to continue.
IIRC Manhattan is a fund manager or analyst.
Thanks so much for the many good cites and excellent, insightful replies. Now, another burning question: are you better off dumping an underperforming mutual fund, and shifting your (depleted) assests into a more successful fund? Or are you trapped here as well-you lose by getting out, then you have a large chance of getting into a fund (just as its performance begins its decline) into below-average territory?
In a study conducted by Mark Carhart published in the Journal of Finance it was revealed that funds that are in the top 10% one year based on performance are more likely to be in the bottom 10% the following year than repeat in the top 10%. Fund-hopping does not appear to be a very effective strategy.
Others studies of Forbes Honor Roll funds have shown that they have below average performance after they have been nominated. Without a doubt, past performance does not predict future results.
–You’ll love this answer…it depends.
What type of fund did you get into? How is it performing vs. other funds just like it(in the same category)?
If the fund you’re in lost 10% the last year it may seem bad.
If every other fund invested like this one lost 40%, well, it may deserve a longer look.
The most important question is can you sleep with this investment?
After all, you’re the one who has to live with it.
If you’re willing to go off-line, read Burton Malkiel’s A Random Walk Down Wall Street. It will tell you all you need to know about fund management vs. index funds.