Mutual Funds: Bright Spots And Lessons Learnt

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Includes: CMAFX, CYPIX, FBSOX, FDGRX, FLATX, FOCPX, FSCSX, FSRPX, GMWEX, GWGFX, HSGFX, IMSIX, JETAX, PCRDX, POAGX, PRGTX, PRMTX, SLAFX, USSCX
by: Trading Mates Stock Advisor

Summary

We implemented the bright spots analysis on active mutual funds to find out the best and worst practices in the industry.

Managers that act as long-term value oriented and avoid to time the market are the best performers, independently from their fund category.

Managers that act as market timers, try to predict external factors (e.g. oil price) and invest in politically instable countries are the worst performers.

Following the top performers' best practice in your stock picking strategy may significantly improve your returns.

Some of the management consulting companies adopt a technique called "Bright Spot Analysis." The analysis helps you to identify the best practice that can be scaled in your organization in order to improve the financial results.

The analysis requires to:

  1. Define a metric to rank your sample (for instance in quintiles or deciles).
  2. Eliminate outliers in the top and bottom groups that benefited from special circumstances (for instance one-time big gain or loss).
  3. Go out and interview the top performers to find the bright spots' best practices.
  4. Go out and interview the bottom performers to find out which best practices the bottom performers do not use.

We have applied the bright spot analysis to the mutual fund's performances and we are going to show here our findings.

Point 1. We defined our metric as the total shareholder return, ranked accordingly the yearly mutual funds' performance from 2005 to 2015, and created an aggregate total rank. In such a way, we give a high ranking to the funds that outperformed their peers most of the time. We want to avoid picking a fund that had exceptional performance in just one year, even if that performance significantly improved CAGR on a multi-year time frame.

Additionally, we define our top performers as the ones that achieved a 10-year CAGR of 10% or more. The bottom performers are the ones with the worst aggregate ranking and a 10-year CAGR lower than 0%. Our sample includes ca. 1200 funds where funds with less than a 10-year record, passive funds and funds most frequently used for edging are excluded.

The pictures below show the top performers and bottom performers by fund category.

Exhibit 1 - Top Performers from 2005 to 2015 by fund category.

Exhibit 2 - Bottom Performers from 2005 to 2015 by fund category

Point 2. We are going to consider as potential outliers the funds focused on the Healthcare sector because the whole sector experienced higher than average return and the Energy sector because it got caught into a worldwide price war game.

Point 3 and 4. Go out and interview the top and bottom performers. Luckily, for us, active fund managers extensively describe their annual performance and their picking and portfolio strategies on the annual and semi-annual Certified Shareholder Reports.

Our findings

Most common best practice of top performers and sample statements:

  1. Focus on Valuation
    Fidelity Select Portfolio - "expectations were inflated and valuations were too high for the stock"
    T. Rowe Price Global Technology Fund - "we warned that the high valuations of many of the best companies in our investment universe probably limited the potential for gains in the months ahead"
  2. Don't time the market
    T. Rowe Price Media & Telecommunications Fund - "[…] we are headed for a recession in 2016? […]many variables, such as the condition of the banking system, are currently very different than they were in 2007-2008. Every cycle is different, and as I have said in past letters, it is impossible to foretell consistently where the market is going." Brown Capital Management - "Neither the investment program nor the team pretends to know the direction of the stock market or which asset class will perform best next year. As investors, […] we believe forecasting occurs within the bottom-up research that reveals exceptional companies with sustainable, profitable growth."
  3. Follow a theme investment approach on secular trends
    T. Rowe Price Media & Telecommunications Fund - "we think the best strategy will be to stay consistent in our approach of investing in the powerful secular trends driving the economy"
    T. Rowe Price Global Technology Fund - "the central focus of our approach is on companies that are using technology either to exploit new markets, such as social networking, or to seize market share in established industries"

Most common worst practice of bottom performers and sample statements:

  1. Trying to time the market and ride the market cycles
    Hussman Funds - "recent valuation extremes imply a 40-55% market loss over the completion of the current market cycle, with zero nominal and negative real total returns for the Standard & Poor's 500 Index on a 10-12 year horizon." You can check here our article on why the current valuation are not so extreme.
  2. Trying to predict external factors influencing performance rather than the value drivers that the management can actively influence
    IMS Strategic Income Fund - " our biggest mistake was being incorrect about the direction of energy and commodity prices […] we have the greatest conviction in the opportunity for higher interest rates and higher energy prices. We are confident that eventually higher levels will materialize in both areas and we have invested accordingly."
  3. Investing on politically and fiscally troubled countries (e. g. Latin America)

Here follows the list of the top 10 and bottom 10 performers (excluding the outliers) on our aggregate ranking.

Exhibit 3 - Top 10 performers on aggregate yearly TSR ranking for 2005-2015

Category

Fund

2005-2015 TSR

Consumer Discretionary

Fidelity Select Retailing Portfolio (MUTF:FSRPX)

14.0%

Technology

T. Rowe Price Global Technology Fund (MUTF:PRGTX)

14.2%

Technology

Fidelity Select IT Services Portfolio (MUTF:FBSOX)

13.8%

Mid Cap

PrimeCap Odyssey Aggressive Growth Fund (MUTF:POAGX)

12.7%

Technology

Fidelity Select Software & IT Services Portfolio (MUTF:FSCSX)

14.1%

Communications

T. Rowe Price Media and Telecommunications Fund (MUTF:PRMTX)

13.6%

Large Cap

Fidelity Growth Company Fund (MUTF:FDGRX)

10.3%

Consumer Discretionary

ProFunds Consumer Services Ultra Sector Fund Inv (MUTF:CYPIX)

11.4%

Technology

USAA Science & Technology Fund (MUTF:USSCX)

10.1%

Large Cap

Fidelity OTC Portfolio (MUTF:FOCPX)

11.7%

Exhibit 4 - Bottom 10 performers on aggregate yearly TSR ranking for 2005-2015

Category

Fund

2005-2015 TSR

Long&Short

Hussman Strategic Growth Fund (MUTF:HSGFX)

-3.7%

US Securities

IMS Strategic Income Fund (MUTF:IMSIX)

-1.4%

Large Cap

USA Mutuals Generation Wave Growth Fund (MUTF:GWGFX)

-0.6%

Commodities

PIMCO Commodity Real Return Strategy Fund (MUTF:PCRDX)

-5.5%

Small Cap

Stonebridge Small-Cap Growth Fund (MUTF:SBSGX)

-0.1%

Foreign Stocks

Aberdeen Select International Equity Fund II (MUTF:JETAX)

-0.2%

Small Cap

CM Advisors Fund (MUTF:CMAFX)

-0.9%

Regional Stocks

Fidelity Latin America Fund (MUTF:FLATX)

-1.1%

Regional Stocks

Deutsche Latin America Equity Fund (MUTF:SLAFX)

-0.4%

Foreign Stocks

GuideMark(R) World ex-US Fund (MUTF:GMWEX)

-0.8%

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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