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

Firm News: New Credentials

We are pleased to announce that both Brad Wasserman and Keith Rybak received designations as Personal Financial Specialists (PFS), during March 2010.

This designation, which can only be acquired by CPAs, requires a minimum of 3,000 hours of financial planning experience, in addition to extensive continuing education requirements and passing a rigorous examination. As CPAs, this credential represents the highest professional standard of any financial planning credential and sets the PFS holder apart from other financial planners.

The PFS credential was established for CPAs who specialize in personal financial planning, and is awarded exclusively to AICPA members who demonstrate considerable experience and expertise in this area. Currently, the AICPA has granted only 3,800 PFS designations throughout the country.

We are proud to have earned this new designation, as it reflects our extensive experience, which has benefited and will continue to benefit our clients in the future.

Source: AICPA.org

Goldman Sachs Lawsuit: Understanding and Implications

On Friday, Goldman Sachs was accused of wrongdoing in a SEC civil lawsuit of fraud. Let me explain, by way of an analogy, what is alleged in the SEC suit. Please note, this is not intended to be a full analysis of lawsuit, only a general explanation intended to help readers of this blog understand some of the issues of this case. These are allegations only and no parties have been proven guilty at this time.

Let’s say the general manager of a baseball team wanted to place a bet in Las Vegas on a baseball game (not legal, but assume it is and follow along). The GM, John Peters, wanted to place a bet against his own team, the Phoenix Mortgages. He went to his manager, A. Choosy, who was preparing the line up. Peters worked with Choosy to put forth the least desirable team of his 25 ball players. Choosy benched the starters for that day and turned in his line up card. Choosy, with Peters’ assistance, started the worst pitcher on the Mortgages for this game.

Peters then went to Las Vegas. He bet $1 Billion that his team, the Phoenix Mortgages would lose the game. When placing the bet, Peters did not disclosure to the casino (professionals at what they do, which is accept bets and wagers) that Peters had helped to select the players involved in the game. However, the casino are professionals and are supposed to be experts at these type of transactions.

You know the outcome. The Phoenix Mortgages lost the game, as the worst players were selected to participate in the game. The casino lost their $1 Billion. Peters however, made out very well, winning $1 Billion.

How does this relate to the Goldman Sachs SEC lawsuit? A hedge fund investor, John Paulson (ie John Peters) thought that the subprime mortgage market was going to do poorly. He went to Goldman in 2007 and requested their assistance in preparing a pool of mortgages, so he could “bet” against them. The suit alleges that Paulson helped to select the mortgages, and tried to find the worst quality ones he could find. Thus, he helped to prepare the lineup card he was going to bet against.

Goldman, per the SEC lawsuit, then went to other experienced, professional institutional investors (not individuals) and sold them the $1 Billion + pool of mortgages, without disclosing that Paulson helped to structure and select the mortgages. They also did not disclose to the investors of the mortgage securities that Paulson was placing a bet against them (or in my example, Peters did not tell the casino that he had been involved in selecting the players for the game). The institutional investors who purchased the pool of mortgages were provided with details of the mortgages, and one of the major investors was also involved in the selection of the mortgages (as a casino would be involved and study a baseball team, before it sets the “spread” of a given game).

In my analogy, the baseball game was over quickly and the bet was won in no time. In the real world, Paulson’s bet was won pretty quickly as well. This deal closed on April 26, 2007. Paulson’s hedge fund paid Goldman $15 million to structure “Abacus” (the name of the pool of mortgage securities). By October 24, 2007, 83% of the mortgages had been downgraded and by January 28, 2008, 99% of the portfolio were downgraded. Investors in Abacus had lost $1 Billion and Paulson’s hedge fund was ahead by $1 Billion.

As investors, this is again a reminder of many concepts. As your financial advisors, we have a fiduciary responsibility to act only in your interest (our interests are aligned with yours). We feel it is important to understand what you are investing in. We do not invest in hedge funds or exotic investment products. We understand the philosophy of the mutual funds that we utilize and they are very transparent about their holdings and actions.

Sources: Wall Street Journal, April 16, 2010; SEC Complaint filed April 16, 2010

Note: this post was updated on 4/19/10, based on Goldman Sachs’ third statement regarding this matter, particularly noting that the investors in this transaction were “two professional institutional investors.” Source: Goldman Sachs statement dated April 19, 2010

Putting Volatility into Perspective: It’s better than you think

The US stock market has seen two very dramatically different years in 2008 and 2009, as 2008 was the worst second worst calendar year in 84 years and then 2009 was one of the best years.

As we base our investment decisions on academic data, principles and discipline, and not predictions of the future, the data below is very helpful to gain a long-term view of market performance and put recent market volatility in perspective.

The following is a review of the total US stock market (defined as all stocks on US stock market exchanges, but not international markets) from 1926 to 2009. The data below shows the number of years that each investment return occurred, for the overall US stock market:

Loss 50% to 40%:…….. 1
Loss 40% to 30%……… 2 (including 2008)
Loss 30% to 20%……… 3
Loss 20% to 10%……… 8
Loss 10% to 0%……….. 8

Gain 0% to 10%………. 15
Gain 10% to 20%…….. 13
Gain 20% to 30%…….. 19 (including 2009)
Gain 30% to 40%…….. 11
Gain 40% to 50%………. 3
Gain 50% to 60%………. 1 (1933, just in case you were wondering!)


Positive v. negative years: There were 62 positive years and 22 negative years. Thus, 74% of the calendar years were positive.

Not just positive, but better: Not only were there many more positive years, but the positive years were concentrated with performance in the higher ranges of returns.

Randomness: I have not presented the year by year data in this blog, but the returns have no sequential pattern. Thus, the ability to predict future performance by an investor or mutual fund manager would not be assisted by this data.

Staying the course: Over time, investors have been rewarded by remaining invested in the US stock market. They will have to endure down years or periods of years, but should be rewarded for remaining committed and disciplined through those down years.

We work with our clients to educate them, so they can remain disciplined in bad and good markets. Establishing an asset allocation of stocks that is in line with your risk tolerance will lead to the ability to stay the course, remain invested as appropriate for you and your family, and which will hopefully provide you with positive stock market returns that occur over the long term.

Note: The above information is based on US stock market performance. We generally recommend that a significant portion of our clients’ stock investments be allocated to foreign markets, which is not included in the above information. We think the conclusions as stated above would be the same, if they were to include foreign stock market data. Further, adding foreign investments generally results in improved diversification, which lessons the volatility of an overall investment portfolio, which would lead to increased returns over time.

Source: Center for Research in Security Prices (CRSP), University of Chicago