Monday, January 14, 2013

Read the Rest of the Paper, Not The Mutual Fund Review

Read the Rest of the Paper, Not The Mutual Fund Review

For the better part of my career, the annual mutual reviews in newspapers and magazines were a source of great interest.  I wasn’t expecting to learn anything.  Rather I was hoping that the if our mutual funds received coverage, our brokers and phone centers would do a lot more business.  Yesterday’s special report in The New York Times[1] is typical.  The short-term dominates the articles and the investment tables.  In fact, the sports department should write this section of the paper because all they are reporting are the results of a race.  If you peruse the fifteen-page section, you won’t find any comparisons to an index like the S&P 500 or Barclays Bond Index. We know who won the race, particularly in the sprints.  However, we don’t know if their times were any good.  We might have well been better off investing in an index fund or ETF.  Let me share a few of my favorite highlights from the Times’ report.

Putting Me On the Road (1997)

Bill Miller, the star portfolio at Legg Mason, will be getting a lot of phone calls in the next few weeks.  His Opportunity Fund earned the distinction of the top performing equity mutual fund in the fourth quarter and for all of 2012.  The Times features his accomplishment in a table on the front page of the special section.  The Opportunity Fund, along with two other high fliers also gets a laudatory write up on page 19.[2] However, if you take the time to look at the blizzard of returns posted on page 20, you’ll see that the very same fund was the sixth worst over the past five-years.  I continue to think that Bill is a gifted money manager, but the time to invest with him was when he was down on his luck, not when his returns are soaring again.  Sadly investors chase short-term performance results.

There are are two advertisements worth mentioning.  Fidelity has a full page add touting its Select Health Care Fund, which has beaten the MSCI IMI Health Care 25/50 index over the one, three, five, and ten-year periods.  It’s one of the only references to an index in the entire section, and an obscure one at that.  A sector fund is seldom a useful way to invest for the long run, which Fidelity acknowledges in the fine print at the bottom of their ad.  They are simply too narrowly focused.  Nonetheless, the 21.4% return for the fund in 2012, and its large margin over the MSCI index, represents a marketing opportunity that Fidelity can’t afford to pass up.

A page later, Prudential highlights eight funds with four or five-star ratings in an ad entitled “A Few of Our Brightest Stars.”  The ad is intended to emphasize Pru’s investment genius.  What do you think happens to four or five-star mutual funds?  In due course most of them lose a star or two as their performance comes back to earth.  In fact, all eight funds lose a bunch of stars by the time you get to print at the bottom of the ad.  The tiny disclaimer informs us that the funds mentioned in the ad are only open to investors with a $10 million minimum.  Every one of the funds that you and I might be eligible to purchase (retail shares) has lower ratings.  You have to do you own research to find this out.  For example, in its institutional form, the Prudential Municipal High-Income Fund rates five-stars, while the retail version only carries a three-star rating.  The difference is entirely the result of fees.  The ad should have read, “A Few of Our Dimming Stars.”

After skimming several articles lauding the genius of portfolio managers, I finally found one useful report as I was about to fold up the section and put it in the recycling bin.  On the back page, Anna Bernasek[3] discusses the fact that mutual funds have not exercised much sway over executive pay.  Most mutual funds are short–term investors.  As a result, they don’t spend much time on the long-term issues of corporate governance.  If they weren’t legally required to vote on corporate matters, my guess is that most managers would toss out the proxy statements.  However, since they are obligated to vote, mutual funds tend to vote for management including their pay packages. 

I’d recommend that you avoid these types of annual and quarterly reviews.  They create the irresistible urge to invest in “hot” funds, and add to the pile in your recycling bin.

Full Disclosure:  I wrote some of the sections of the original prospectus for the Legg Mason Opportunity Fund, and I was a day-one investor in the fund.


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