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12-10-2011, 06:08 PM
Business Times - 12 Oct 2011
Playing dice with mutual fund returns
Vanguard founder John Bogle says luck plays a bigger role in mutual fund returns than most people understand and that fund marketing often glosses over that fact
(NEW YORK) In sports, the lessons of long-term performance seem obvious. Edwin Moses, the hurdler, wins 122 races over nearly a decade. Roger Federer, the tennis player, reaches the semi-finals in 23 consecutive Grand Slam tournaments. Jeannie Longo, the cyclist, makes seven French Olympic teams. Implied in their feats is the message that doing something so challenging for so long proves enduring excellence.
What about mutual fund management? Does earning top-level returns over, say, 20 or 25 years show that a manager is among the most skilled people in the field? These questions aren't just topics for after-work debate in Wall Street pubs. If investors could reliably pick the best funds, they'd want to own them.
Over decades, the difference between owning a fund with a top-tier total return and a middling one can add up to a hefty sum. If, 25 years ago, you'd invested US$1,000 in, say, the FPA Capital fund, your money would have grown to US$26,000, before expenses, through September. But the same investment in a Standard & Poor's 500- stock index fund would have grown to US$8,700, before expenses.
Some portfolio managers say long-term records separate skilled stock pickers from the merely lucky ones. 'Longevity is really important,' said Richard F Aster Jr, manager of the Meridian Growth fund. 'There are a lot of guys who can get through the good years. But to do this in good and bad years isn't easy.' Mr Aster's fund has a 25-year annualised average total return of 11.4 per cent.
Investment analysts and academics aren't so sure that long-term returns speak so clearly. They have parsed fund performance every which way, trying to discern manager skill. Some of them aren't convinced that even a measure that seems straightforward - a manager's annualised average return over 20 or 25 years - reveals talent. It's influenced by too many factors and requires too much context to be a guarantee of ability, they argue.
John C Bogle, the founder of Vanguard, said that luck played a bigger role in mutual fund returns than most people understand and that fund marketing often glossed over that fact. 'If you ask a bunch of people to flip coins, maybe one out of a thousand will flip heads 20 times in a row,' he said. 'In our business, we'll declare him a genius.'
Could long-term returns at least give retail investors a place to begin their research, as they try to winnow the thousands of different funds on the market? Here, too, some specialists urge caution, saying that all sorts of variables can frustrate assessments.
One simple source of confusion is the distinction between a fund and its manager, said Marcin Kacperczyk, a finance professor at New York University. People often know and follow funds by name, even as managers come and go. Yet the manager can matter a lot.
Consider the Fidelity Magellan fund. It is often linked with Peter Lynch, who produced an average annual return of 29 per cent during his 13 years there. But Mr Lynch left in 1990. Magellan has since had five other managers; the latest, Jeffrey S Feingold, started in September. So far, none have approached Mr Lynch's record.
Investors should also understand that past performance, even over decades, doesn't guarantee future success, said Srikant Dash, a managing director at S&P. 'The sample of managers who have survived for 20 years is so small that you can't draw any statistically significant results,' he said.
'The problem for average investors is that you cannot buy history,' he added. 'Yes, there's evidence that a certain percentage of managers and certain techniques have done well. But you can't buy the past 20 years. You're looking at the next 20 years.'
A manager who has top-level returns over decades - Richie Freeman of the Legg Mason ClearBridge Aggressive Growth fund - also warned against putting too much weight on the past. 'New investors have no call on my prior record,' he said. 'All you need is a few bad years, and we wouldn't be having this conversation.' His fund has a 25-year annualised average total return of 11 per cent.
Mr Freeman says he tries to ensure that new investors will fare as well as his old ones by continuing to try to improve his stock picking and by being patient with good companies when he finds them. He will hold stocks for years, even decades. His fund, which he manages with Evan Bauman, owned shares of Genentech, for example, for more than 25 years, until the company was acquired by Roche in 2009.
As the name of Mr Freeman's fund indicates, he hunts for growth stocks - shares in companies whose earnings are expected to grow at an above-average rate. His is just one of the many investing niches that a stock fund manager might choose. Others include value, small-capitalisation, and international stocks, and among those managers may mix and match.
Thus, Will Danoff of the Fidelity Contrafund, which has a 20-year annualised average total return of 10.6 per cent, seeks out large-cap growth companies, while William J Nasgovitz of Heartland Value, which has a 12 per cent annualised average return over the same period, hunts for small-cap value stocks.
Records like these don't really tell an investor much unless they're compared with a relevant benchmark, said Russ Wermers, a finance professor at the University of Maryland. Companies like Morningstar, Lipper, and S&P provide such benchmarks for individual funds.
'You can look at how many times managers have outperformed the benchmark,' he said. 'I think that tells you a lot about luck versus skill.' Fund managers, too, say that without context, their long-term numbers don't mean much.
'If you say my fund returned 12 per cent a year over 20 years, that has to be in relation to something else,' said Preston G Athey of the T Rowe Price Small-Cap Value fund. 'If stocks had done 15 per cent a year, then it wouldn't have been good. But the Russell 2000 Value Index was up 10.7 per cent a year,' he said, while Mr Athey's own fund returned 11.4 per cent annualised over that period.
Fund management doesn't require fast reflexes, young muscles or an excess of energy. Mostly, it demands knowledge and discipline, two qualities that can grow with age. So it would seem to make sense that some managers would improve with experience.
When asked, several said they believed that they had. Mr Danoff of the Fidelity Contrafund, for example, said time had taught him not to sell winning stocks just because they had risen a certain amount. These days, he's more likely to hang onto a winner if the reasons he bought it endure.
'I can't predict the future, but I do feel more confident in making judgements,' he said. 'But you do have to challenge your thesis on why you own a particular company and continue your research. The world changes and stock prices change. This is a very competitive business and nothing is forever.' - NYT
Playing dice with mutual fund returns
Vanguard founder John Bogle says luck plays a bigger role in mutual fund returns than most people understand and that fund marketing often glosses over that fact
(NEW YORK) In sports, the lessons of long-term performance seem obvious. Edwin Moses, the hurdler, wins 122 races over nearly a decade. Roger Federer, the tennis player, reaches the semi-finals in 23 consecutive Grand Slam tournaments. Jeannie Longo, the cyclist, makes seven French Olympic teams. Implied in their feats is the message that doing something so challenging for so long proves enduring excellence.
What about mutual fund management? Does earning top-level returns over, say, 20 or 25 years show that a manager is among the most skilled people in the field? These questions aren't just topics for after-work debate in Wall Street pubs. If investors could reliably pick the best funds, they'd want to own them.
Over decades, the difference between owning a fund with a top-tier total return and a middling one can add up to a hefty sum. If, 25 years ago, you'd invested US$1,000 in, say, the FPA Capital fund, your money would have grown to US$26,000, before expenses, through September. But the same investment in a Standard & Poor's 500- stock index fund would have grown to US$8,700, before expenses.
Some portfolio managers say long-term records separate skilled stock pickers from the merely lucky ones. 'Longevity is really important,' said Richard F Aster Jr, manager of the Meridian Growth fund. 'There are a lot of guys who can get through the good years. But to do this in good and bad years isn't easy.' Mr Aster's fund has a 25-year annualised average total return of 11.4 per cent.
Investment analysts and academics aren't so sure that long-term returns speak so clearly. They have parsed fund performance every which way, trying to discern manager skill. Some of them aren't convinced that even a measure that seems straightforward - a manager's annualised average return over 20 or 25 years - reveals talent. It's influenced by too many factors and requires too much context to be a guarantee of ability, they argue.
John C Bogle, the founder of Vanguard, said that luck played a bigger role in mutual fund returns than most people understand and that fund marketing often glossed over that fact. 'If you ask a bunch of people to flip coins, maybe one out of a thousand will flip heads 20 times in a row,' he said. 'In our business, we'll declare him a genius.'
Could long-term returns at least give retail investors a place to begin their research, as they try to winnow the thousands of different funds on the market? Here, too, some specialists urge caution, saying that all sorts of variables can frustrate assessments.
One simple source of confusion is the distinction between a fund and its manager, said Marcin Kacperczyk, a finance professor at New York University. People often know and follow funds by name, even as managers come and go. Yet the manager can matter a lot.
Consider the Fidelity Magellan fund. It is often linked with Peter Lynch, who produced an average annual return of 29 per cent during his 13 years there. But Mr Lynch left in 1990. Magellan has since had five other managers; the latest, Jeffrey S Feingold, started in September. So far, none have approached Mr Lynch's record.
Investors should also understand that past performance, even over decades, doesn't guarantee future success, said Srikant Dash, a managing director at S&P. 'The sample of managers who have survived for 20 years is so small that you can't draw any statistically significant results,' he said.
'The problem for average investors is that you cannot buy history,' he added. 'Yes, there's evidence that a certain percentage of managers and certain techniques have done well. But you can't buy the past 20 years. You're looking at the next 20 years.'
A manager who has top-level returns over decades - Richie Freeman of the Legg Mason ClearBridge Aggressive Growth fund - also warned against putting too much weight on the past. 'New investors have no call on my prior record,' he said. 'All you need is a few bad years, and we wouldn't be having this conversation.' His fund has a 25-year annualised average total return of 11 per cent.
Mr Freeman says he tries to ensure that new investors will fare as well as his old ones by continuing to try to improve his stock picking and by being patient with good companies when he finds them. He will hold stocks for years, even decades. His fund, which he manages with Evan Bauman, owned shares of Genentech, for example, for more than 25 years, until the company was acquired by Roche in 2009.
As the name of Mr Freeman's fund indicates, he hunts for growth stocks - shares in companies whose earnings are expected to grow at an above-average rate. His is just one of the many investing niches that a stock fund manager might choose. Others include value, small-capitalisation, and international stocks, and among those managers may mix and match.
Thus, Will Danoff of the Fidelity Contrafund, which has a 20-year annualised average total return of 10.6 per cent, seeks out large-cap growth companies, while William J Nasgovitz of Heartland Value, which has a 12 per cent annualised average return over the same period, hunts for small-cap value stocks.
Records like these don't really tell an investor much unless they're compared with a relevant benchmark, said Russ Wermers, a finance professor at the University of Maryland. Companies like Morningstar, Lipper, and S&P provide such benchmarks for individual funds.
'You can look at how many times managers have outperformed the benchmark,' he said. 'I think that tells you a lot about luck versus skill.' Fund managers, too, say that without context, their long-term numbers don't mean much.
'If you say my fund returned 12 per cent a year over 20 years, that has to be in relation to something else,' said Preston G Athey of the T Rowe Price Small-Cap Value fund. 'If stocks had done 15 per cent a year, then it wouldn't have been good. But the Russell 2000 Value Index was up 10.7 per cent a year,' he said, while Mr Athey's own fund returned 11.4 per cent annualised over that period.
Fund management doesn't require fast reflexes, young muscles or an excess of energy. Mostly, it demands knowledge and discipline, two qualities that can grow with age. So it would seem to make sense that some managers would improve with experience.
When asked, several said they believed that they had. Mr Danoff of the Fidelity Contrafund, for example, said time had taught him not to sell winning stocks just because they had risen a certain amount. These days, he's more likely to hang onto a winner if the reasons he bought it endure.
'I can't predict the future, but I do feel more confident in making judgements,' he said. 'But you do have to challenge your thesis on why you own a particular company and continue your research. The world changes and stock prices change. This is a very competitive business and nothing is forever.' - NYT
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