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Are Mutual Funds Really the Best Bet?

 Are Mutual Funds Really the Best Bet?

LVMTX

Above is an equity curve of the Legg Mason Capital Management Value Trust. It is a mutual fund. Bill Miller is the fund manager. Bill Miller is known as the “greatest” mutual fund manager of all time. If you invested $10,000 in 1987 when the market crashed, you would have roughly $30,000 today. The return is 300% over a 23 year period.

Bill Miller is very well known in the investment industry. He is considered to be a god by many. He has a very large following. Let’s take a look at his performance against the market.

LVMTX vs. S&P

The above graph represents the Legg Mason fund in the blue, against the S&P 500 in the green. The S&P 500 is actually beating the “greatest mutual fund manager” in the world. If the greatest mutual fund manager in the world cannot beat the market, who can?

 
There are a select few people who can:

Abraham Trading

Above is an equity curve from Salem Abraham Trading, since it’s inception in 1987. If you invested $10,000 in 1987, it would have been roughly $590,000 by 2008. The yellow line in the graph above represents the S&P 500. Salem Abraham has huge returns that consistently beat the market year over year.

One might say that he might do this because he takes on “more risk”. For those people, I would urge them to compare the “draw downs” between Abraham and Bill Miller’s equity curves. The largest drawdown Bill Miller had occurred between 2007-2008 when his fund lost roughly 75%. Abraham, on the other hand, has no draw downs that large.

Why can’t the most well known mutual fund manager in the world beat the market?

The answer is that there is a fundamental difference between investment styles and incentives for both Miller and Abraham.

Miller is a fundamentalist. He believes that all one has to do is invest in undervalued companies with “great management” and “hold on for the long hall” and everything will work out. If it were this simple, why isn’t Bill Miller beating the market? Again, here is a chart of Bill Miller’s performance:

Blue: Bill Miller

Green: S&P 500

 LMVTX vs. S&P

Like the vast majority of active managers, Bill Miller cannot beat the market. I have been in the investment management business for 6 years, and I do not know of any traditional stock mutual fund managers who actually have “beat” the stock market over the long term.

With that being said, I do know of a number of hedge fund managers who do beat the market,. The vast majority of hedge fund managers however, lag the market as well. This is because there is a very large focus in the investment industry on micro-economic and financial fundamentals. These are things that do not really matter.  This is precisely why Bill Miller lags the markets, while Salem Abraham trounces it.

Bill Miller’s approach is to buy and hold. Abraham, on the other hand is a trend trader. He cuts losers, and rides winners and has long and short positions, so he is hedged. Abraham is a far better risk manager than Miller, and this is clearly why he succeeds.

So what can one do?

Don’t invest in mutual funds. If you have a million dollars, you should find a hedge fund manager who can consistently beat the market (there are very few of these). The best bet for most individuals is to just purchase the S&P 500 index via NYSE: SPY. This index is far better than any mutual fund and most hedge funds over the long term.



Disclosure: No positions