MDCigan

Judging Fund Performance: Part 2

"At this point, each investor needs to ask himself or herself whether there is evidence that the managers’ skill has generated the impressive trailing performance or, alternatively, simply an aggressive investment policy, along with a tolerance for taking on some risky positions—such as 10+% in Russian wireless. Is there evidence for sufficient incremental value (beyond asset allocation) to merit the fees that these funds charge and expense that they incur on the basis of their high turnover?"

Good article, and certainly food for thought. My question I would pose to you is what exactly constitutes "manager skill"? Is it just individual stock-picking with basically identical sector weights to the S&P 500, or can manager skill also be part of determining when to have substantial overweights in sectors like utilities, materials, energy, etc.

I think it is fairly easy (as you demonstrate) to do a backwards looking analysis to determine a fund's performance could have been replicated with particular sector and asset class weights using low-cost ETFs. But how would you have known to use that SPECIFIC sector/asset class composition at that point in time? Perhaps the manager skill is knowing when to overweight what sector and when to get out of that sector.

Take your example of CGMFX. I've actually wanted to buy this fund for a long time, but unfortunately my broker does not offer it. I've studied the fund and the manager's investment approach and an integral component of his "skill" is making big sector and industry bets based on top-down analysis. At one point, the fund was loaded with homebuilders, and was responsible for strong performance. You could have done a backwards analysis sometime back demonstrating replicating his performance by purchasing the homebuilder ETF, XHB. But he dumped all the homebuilders before they crashed, and therefore captured the gain and missed the losses. Would a static portfolio based on backwards analysis still be holding XHB?

I think there is more to analyzing a mutual fund then just trying to decompose what sector and asset class are driving returns because you have to also try to understand the manager's thought process behind it. Managing a portfolio is a dynamic and not static process so the sector and asset class weighting could be changing quite frequently.