I Fired My First Mutual Fund Managers
My first mutual funds were purchased back in 1995. I had just started work a year earlier and was pretty tuned in to my “personal finance”. My first funds were Stein Roe Opportunity Fund (acquired by Columbus Management), AIM Constellation Fund and American Century Ultra Growth Fund.
Looking back, I took months to research what funds to buy. I went over Morningstar a gazillion times, going over past performance. Back then, these funds had some of the best 10 year performances. I could only dream what they would be worth 10 years later with such “stellar performances”.
Well guess what? Ten Years is up and sadly speaking, these funds gave me an average return of 5-6% (nominal return) over the last 10 years. To say that I was disappointed was an understatement. Historically, stocks have given holders a 6% real return. With inflation at about 2-3%, we should expect norminal return to be about 8%-9%. 5%-6% falls short of that.
What did I do with these funds? Well, I have sold them. But looking back, I have learnt a few things as choosing funds and investment philosophy.
1. Past performance is certainly not an indicator of future performance.
2. You should never bother about the index.
Why do I say that? It is because during the bear market in the earlier 2000s, I did not care about the fund outperforming the S&P. A negative return is a negative return. What disappointed me was finding out that there were actually funds that had positives returns during the bear market.
Proponents of indexing do not address the underlying flaw of indexing, which is the index could be overvalued at set for a dramatic fall as witnessed during the late 90s and early 2000s. Which leads me to my next lesson?
3. The investment discipline of a fund manager is so important.
When I went through the fund prospectus of each of the funds that I held, I realize that each one was set up and invested just to “beat the market”. The fund managers chose stocks that they believe would “outperform” because of “earning momentum” or because they looked “relatively cheap compared to the sector”. Yet when I looked at funds that really did well during the bear market, they had one thing in common. That one common thing was they only bought stocks that were deemed to be “undervalued by the market”. Buying stocks that a discount to where they think intrinsic value is minimizes the risk of a “permanent loss of capital”. After the tech bubble, many investors and fund managers suffered a permanent loss of capital. The best example is to compare an investment in Coke and a busted tech stock. If you had invested in Coke over the last few years, it really has not done much. It was priced at a 40 PE back in the mid and late 90s. Buying this “great company” at expensive prices would not have been wise. But at least, you do not lose your capital. You lose opportunity cost. In contrast, had you bought any internet stock with no earnings in the late 90s, you would have suffered a “permanent loss” in your capital. Unlike Coke, it is gone!
These are the few takaways I have from Lessons from Past. I will soon be discussing how I chose my new mutual fund. Stay tuned.