Would you buy this fund?

Let’s go back to the early part of this decade, to the year 2000. Let’s consider the experience of a well-known value oriented mutual fund. Providing this example, gives us further evidence of our investment philosophy and the frustrations that investors who try to identify “the best mutual funds” continually face.

In the year 2000, the dot.com bubble was bursting and funds such as this were clearly out of favor. The hot funds were growth funds. Everyone wanted tech funds. Many investors were withdrawing money from this fund. So while the fund was experiencing massive investor withdrawals in 2000 and 2001, the fund returned approximately 26% in each of those two years, far outperforming the S&P 500 by 35% and 38% respectively.

So, in early 2002, if you’d gone to an adviser, he may have looked at the recent track record and advised you to invest in this fund, based on its past few years performance. The fund was considered a mid cap value fund, and was one of the tops in its category.

Great decision, right? In 2002, the fund was in the 48th percentile and exceeded its category benchmark by 2%. Things get worse. For the next five years, the fund underperformed its benchmark during every year between 2003 until 2007. Its category percentile rankings, starting in 2003, were 70%, 83%, 60% and 62% (1% being the best). And finally in 2007, the fund’s performance was in the 99th percentile of its category. So much for that great strategy in early 2002 to jump right in.

So by the end of 2007, when the S&P made approximately 5%, and this fund lost 14%, I’m sure that you and your advisor, along with many other investors, were heading for the hills and withdrawing your money to look for the next great fund. How much underperformance can you take? Isn’t five years enough to show that this fund doesn’t have what it takes?

But then in 2008, the fund loses approximately the same as the S&P 500, around 36%. However, that puts it in the 28th percentile of its new “large blend” category. Then in 2009 it earns over 52%, while the S&P 500 only earned approximately 26%. The fund was in the top 2 percentile of its category for the year. So if you jumped ship and pulled money out after its poor performance in 2007, now must be the time to get back in, right? How can you possibly know?

Through this volatile decade, even with five straight years of significant “underperformance,” the fund is ranked in the top 2 percentile for large blend funds, for the past 10 years, as of the end of 2009. Incredible?

Reviewing this shows the challenges of trying to identify the best actively managed funds out of the thousands of funds that are available. How can an investor know in advance, which fund will outperform others? Answer: you can’t! And that is why we don’t even try to play this game.

We would rather utilize a strategy that relies on investing in specific asset classes, rather than relying on the judgment of a mutual fund manager, which may go in and out of favor.

The fund in this illustration is actually the Oakmark Select fund, which I had personally invested in during the 1990s, prior to entering this business. I highly respect its manager, Bill Nygren, and their firm’s value investment philosophy. I still learn a great amount from reading his quarterly investment commentaries. They diligently adhere to their strategy, but it has resulted in a roller coaster, in terms of annual performance, when tracked against comparable funds.

For our clients, we feel that purchasing mutual funds that do not make huge bets on specific companies or industries, will in the long run, provide them with a better investment experience. We would rather build a globally diversified portfolio that is not reliant on the judgment of a few individuals, as we cannot predict how successful they will be. And I don’t think that you can predict that either.

Source: Morningstar.com

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