One of the earliest ideas I had for this blog was to help provide advice for anyone out there who was looking for a better way to select active mutual fund managers, something that was a big part of my life over the last several years. I know everyone has been predicting the death of active management for a while now, but don’t count me among them. Yes, there are plenty of terrible mutual fund managers out there who are happy to charge you a lot of money for sub par performance, but like my flower beds, there are occasionally flowers hidden in the weeds. Where else can you get easy access to some of the best investment minds in the world and sometimes for an incredibly reasonable fee?
One of the biggest heartbreaks since leaving my last paid position was giving up Morningstar access. Yes, more quality time with Steam has been nice, but the depth of resources that Morningstar Direct could provide was staggering, so for the last few days I’ve been downloading data, updating returns using Excel and looking at the free Morningstar data available on-line to up-date a few of my lists of favorite funds figure out what worked and what didn’t.
That’s no easy task and at the end of the day, there’s no easy system to picking great managers. What you’re trying to do is really just develop a system to help skew the odds in your favor. Picking funds blindly off a list provided by your broker is a great way to lose money; even some basic research could improve your odds to a coin toss. Sometimes you’ll hit it out of the park and other times your portfolio could look like it just made a trip to Jonestown but over the next few posts we’ll talk about ways you can screen out losers from winners and at least improve the odds you can get your picks into the upper half of active managers by avoiding the trouble signs given off by future underperformers.
Before diving into the big winners, it’s a lot easier to start by pointing out how to spot the losers and trust me; we’re going to have our pick of problem children to start with. First we need to define “winners” and in this context, it doesn’t mean adding the biggest return. What we’re looking for are managers who are consistent, stay within their investment mandate and most importantly who can show they know how to repeatedly deliver solid performance. This brings me to our first test case or as I call it, “Watch out for the Campers.”
If you’ve ever played a game on-line, you’ve met a camper before and probably didn’t even know it, largely because they most likely shot you down from a distance before you could ever see them. In the Call of Duty games, campers are snipers, players who find a vantage point and wait for the perfect shot. Or maybe they park themselves behind a door and wait for you to coming running in. While everyone else is running around like a lunatic, they take their time and wait for the odds (and you) to come to them. If you’re good at it, you can earn a high score as well as the animosity of your fellow gamers. There’s similar phenomenon among mutual fund managers and it might not be working in your favor.
When it comes to investing, campers sound like they could really clean up. At its core, value investing is about funding the unloved and the overlooked and sitting on those stocks until the market comes to you. After all, wasn’t it Benjamin Graham who came up with the concept of Mr. Market and waiting for him to offer a price you found too irresistible to pass up? All well and good for individual investors who are willing to hold onto a stock for an extended period, but a different story with mutual funds.
I’m sure everyone out there has, at one time or another bought a “hot fund” only to have it go from being a top performer to one of the worst. Ask Bill Miller’s clients at Legg Mason and this year you can see it in Oakmark International or Mainstay Marketfield. Everyone has rough spells and mutual fund managers are no exceptions. But often times the reason it lags is that the manager is a camper. He/She found the “perfect” stock that has such an amazing “story” and they just need to be patient until it comes around again. And if they loved it at $50, they should love it even more at $45, $40, and you get the idea. They could be right, but you’ll spend a lot of time waiting for them to get there while your portfolio suffers. Not to mention you’re being charged a management fee for substandard performance.
I can hear you saying now….”but think how great the performance will be when the stock finally has its day.” You could well be right on that, which is why I don’t hate camper managers the way I hate closet indexers. They could be selling a true value added service in searching out unloved stocks and when we discuss information ratios in the next posting, you’ll see that they are taking active positions and trying to outperform their benchmark. But you should know the manager you’re investing with and with these fellows, you buy these managers on the downswing, when performance has hit a rough patch and prices are low, and ride them back to success and the inevitable cover of Barron’s. How to spot them?
Take a look at the table below where I’ve culled five funds that I feel best represent the Camper tradition from a pool of funds in the foreign large blend category.
Tell-Tale Warning Signs:
As you can see, there are several clear patterns that emerge when you look closely at the data:
- Low Turnover – Three of the funds in 2012 had turnover that could be described in an absolute sense while Cambiar and Pioneer have relatively low turnover in the 60% range, close to the average for the 69 funds we screened. Low turnover is indicative of longer holding periods meaning the manager probably has a great answer as to how they buy stocks, but never can tell you about their sell discipline.
- Manager Tenure – Make sure the current manager of the fund links up to the history. Aberdeen was running with a newer manager but the 3 year track record was his. Since this report, all of the managers have stayed with their funds. If these two match up, you can move onto to final determinant.
- Cyclical Performance – Scroll to the right hand side of the chart and look at their rankings within the foreign large blend category from 2009 to 2014 year-to-date and notice the pattern. Look at Invesco International Allocation; in 2011 it was in the top decile only to spend 2012 and 2013 at the bottom.
For me, that is the main detractor of campers. Those who can spot a camper know what they’re getting but how many advisors can devote the time necessary to really understanding the managers they recommend?
Think of it like this; you want a great international equity fund and here’s this fund on the cover of Barron’s, top-rated by Morningstar, and it seems like a slam dunk. Next thing you know, it’s been a year, EFA is up 18% and you’re up 9% wondering what the heck happened. Clients who take even yearly reviews of their investments will start asking hard questions of their advisors (human or robo) and will probably leave their “hot” manager to start a new position (hopefully without a big front-end load taken out) in a hot fund run by another camper due to underperform. Look at the rankings, can you imagine the damage to your financial capital from running from Invesco or Aberdeen at the end of 2013 and taking their money to Oppenheimer? Ouch.
Even then, there are still some managers who can deliver on their promise of active management even with volatile performance. The question is, compared with a passive index like Vanguard that charges .3%, how much are you willing to pay for the upside potential?