Karen Dolan has an article at Morningstar about what she calls the biggest cost investors can control. No, not fees. In this case, we are talking about performance chasing. According to Morningstar's calculations, investors have lagged their funds by an average of 1.45% per year due to poor timing. This is even more than the 0.8% that was paid in fees.
Of course, it isn't news that investors lag the funds they invest in. Dalbar has been studying this for years. I did find it interesting, however, that Morningstar was calling attention to this. Is it really surprising that investors chase performance when Morningstar rates funds based only on past performance? They hand out manager of the year awards, and even they know that investors will misinterpret these awards.
If you provide data that you know is not predictive, but you also know that investors will misinterpret that data, aren't you intentionally misleading people?
Monday, February 13, 2012
Tuesday, February 7, 2012
Call me when they announce the manager of next year
There tends to be a lot of talk around this time of year about the Morningstar Managers of the Year, which are announced in January for the previous year.
Marketwatch says that you should think of these like the Oscars, which say how good the actor's last performance was. They go on to point out several high-profile crashes among former award winners. "In fact, looking out over the last three years, managers seemed to have a rough time running money while admiring their trophies. Three of the funds finished in the bottom 10% of their peer group in the year after their triumph, another was in the bottom quartile of its category, and two more were below-average."
Dan Solin at HuffPo points out that we don't really have enough data to know whether these managers were truly skillful or merely lucky.
The Wall Street Journal adds to the noise by claiming that the awards aren't actually that bad. "For domestic managers, the verdict was mostly good. Managers in 16 of the 19 years Rekenthaler looked at either met or exceeded their category average in the following 10 years or the time elapsed since the award." Here's a little tip - anytime someone says that a fund beat it's category average, run in the other direction. You are being misled - remember that the "category average" trails the benchmark, usually significantly.
They do correctly point out, though, that "Like the company’s star ratings, the Manager of the Year awards are supposed to be backward-looking. But as Rekenthaler notes, no one actually reads them that way."
And isn't that the biggest problem with having these "awards" in the first place? Isn't Morningstar deliberately misleading people by releasing data they know will be misinterpreted?
Marketwatch says that you should think of these like the Oscars, which say how good the actor's last performance was. They go on to point out several high-profile crashes among former award winners. "In fact, looking out over the last three years, managers seemed to have a rough time running money while admiring their trophies. Three of the funds finished in the bottom 10% of their peer group in the year after their triumph, another was in the bottom quartile of its category, and two more were below-average."
Dan Solin at HuffPo points out that we don't really have enough data to know whether these managers were truly skillful or merely lucky.
The Wall Street Journal adds to the noise by claiming that the awards aren't actually that bad. "For domestic managers, the verdict was mostly good. Managers in 16 of the 19 years Rekenthaler looked at either met or exceeded their category average in the following 10 years or the time elapsed since the award." Here's a little tip - anytime someone says that a fund beat it's category average, run in the other direction. You are being misled - remember that the "category average" trails the benchmark, usually significantly.
They do correctly point out, though, that "Like the company’s star ratings, the Manager of the Year awards are supposed to be backward-looking. But as Rekenthaler notes, no one actually reads them that way."
And isn't that the biggest problem with having these "awards" in the first place? Isn't Morningstar deliberately misleading people by releasing data they know will be misinterpreted?
Wednesday, February 1, 2012
Can I really outsource my fiduciary responsibility?
Investing is complicated enough, and when you throw a bunch of Department of Labor regulations into the mix, things get even more complicated.
So as this article in Investment News points out, many are reacting to this by trying to outsource some fiduciary functions: "The solution involves outsourcing fiduciary functions, and several investment advisory firms — chief among them Morningstar Investment Management, Wilshire Associates Inc. and the advisory arm of Mesirow Financial Holdings Inc. — now are providing investment menu design, fund selection, market commentary and other services to small-plan sponsors and the broker-dealers and insurers who sell such plans." Who can blame them?
But wait, look a little further an you'll see this little tidbit: "Acting under Section 3(21) of the Employee Retirement Income Security Act of 1974, an asset manager becomes a co-fiduciary and shares fiduciary responsibility..."
So, as Ari Rosenbaum also points out, plan sponsors are still on the hook. There is just no easy replacement for understanding the fund lineup being offered and making sure the plan participants have the information they need to make good decisions.
But wait, look a little further an you'll see this little tidbit: "Acting under Section 3(21) of the Employee Retirement Income Security Act of 1974, an asset manager becomes a co-fiduciary and shares fiduciary responsibility..."
So, as Ari Rosenbaum also points out, plan sponsors are still on the hook. There is just no easy replacement for understanding the fund lineup being offered and making sure the plan participants have the information they need to make good decisions.
Monday, January 23, 2012
If we could design the mutual fund landscape from the ground up...
Our previous post discussed the poor results of mutual funds in 2011 at least partly due to the prevalence of closet indexing. So it was refreshing to see that one company is doing something really different. This article in the Christian Science Monitor talks about a new fund from Gamco Investors called "Focus Five." A full 50% of the fund will be invested in only 5 stocks — what the company calls its best ideas. The remaining 50% of the fund will still be focused relative to the rest of the market, investing in between 10 and 20 stocks.
Now, it remains to be seen whether Gamco will be any good at stock picking. But whether they fly high or crash and burn, you'll at least know why. Their disclosures will be crystal clear, leaving no mysteries, so that it will be easy to hold them accountable for their picks.
It makes one think about a different way mutual funds could be built if one had the opportunity to rebuild the ecosystem from scratch. One could imagine that investors desiring active management would split each asset class exposure between two funds - a passively managed index fund and a small, highly focused fund with few holdings. Investors would then get their market exposure cheaply, as they should, in a fund that is an index fund and says so. That wouldn't be muddied together with active picks — bringing transparency and accountability to those picks.
It will probably never happen — investors may not like the complexity of using lots of funds, and they could hurt their returns badly if they overload on a single, badly-chosen focused fund – but it's an interesting idea, and one we may hear more about if Gamco has success.
Now, it remains to be seen whether Gamco will be any good at stock picking. But whether they fly high or crash and burn, you'll at least know why. Their disclosures will be crystal clear, leaving no mysteries, so that it will be easy to hold them accountable for their picks.
It makes one think about a different way mutual funds could be built if one had the opportunity to rebuild the ecosystem from scratch. One could imagine that investors desiring active management would split each asset class exposure between two funds - a passively managed index fund and a small, highly focused fund with few holdings. Investors would then get their market exposure cheaply, as they should, in a fund that is an index fund and says so. That wouldn't be muddied together with active picks — bringing transparency and accountability to those picks.
It will probably never happen — investors may not like the complexity of using lots of funds, and they could hurt their returns badly if they overload on a single, badly-chosen focused fund – but it's an interesting idea, and one we may hear more about if Gamco has success.
Tuesday, January 17, 2012
2011: A terrible year for mutual funds
A Businessweek article by Lu Wang last week which reported on the terrible year mutual funds had in 2011 should give investors a lot to chew on when selecting funds. The facts are stunning – only 17% of actively managed large-cap funds beat their benchmark. What might this mean for investors going forward and what are the implications for how mutual funds are rated?
We have written about closet indexing before, and it's important to consider that 2011 may be a result of the trend noted in some academic studies that closet indexing is increasing. The Businessweek article also points out that correlations among stocks were at a record high in 2011, making stock picking more difficult. This is known to happen in rough times before, but what good are historical analyses if such fundamental things can change so quickly? Would something like Active Share be a better measure to use in such times?
There are many open questions, but we do think that in times like these, analysis based on holdings could give investors a valuable, different view into funds.
We have written about closet indexing before, and it's important to consider that 2011 may be a result of the trend noted in some academic studies that closet indexing is increasing. The Businessweek article also points out that correlations among stocks were at a record high in 2011, making stock picking more difficult. This is known to happen in rough times before, but what good are historical analyses if such fundamental things can change so quickly? Would something like Active Share be a better measure to use in such times?
There are many open questions, but we do think that in times like these, analysis based on holdings could give investors a valuable, different view into funds.
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