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Expectations in Regard to Mutual Funds: A Historical Snapshot

I am not going to go into any explanations with regards to the mechanics of the different types of funds, how they work, how they are structured, and their advantages and disadvantages due to their structures. Rather I will focus on their returns. How they have performed against their benchmark, the market. Ultimately, this is what interest’s investors.

Therefore the primary questions that the prospective investor within the Mutual Funds Industry tends to the following: [i] Is there any method by which I, an investor, can assure myself of choosing the right, or best fund? [ii] If not, how can I avoid picking a really bad one?

To answer this question, let us first examine the empirical record. How have the investment funds performed against the general market, the benchmark of performance? Let us examine three discrete periods of market history.
 

Year

Mutual Fund

S&P 500

1961

+257%

+27%

1962

[-146%]

[-87%]

1963

+193%+

+24%

1964

+136%

+148%

1965

+248%

+122%

1966

[-41%]

[-10%]

1967

+37%

+23%

1968

+154%

+104%

1969

[-125%]

[-83%]

1970

[-53%]

+35%


The above is the average performance of Mutual Funds, as against the general market. The problem with the average performance is that it hides the variability of the individual funds that compose the market.

Fund

1961-1965

1966-1970

1961-1970

1969

1970

Affiliated

+71%

+19.7%

+103.3%

[-14.3%]

2.2%

Dreyfuss

+97%

+18.7%

+135.4%

[-11.9%]

[-6.4%]

Fidelity

+79%

+31.8%

+137.1%

[-7.4%]

+2.2%

Investors Stock

+54%

+5.6%

+63.5%

[-80%]

[-7.2%]

National Inv

+61%

+31.5%

+112%

+4%

[-9.1%]

Putnam

+62%

+23.3%

+104%

[-13.3%]

[-3.8%]

S&P500

+77%

+16.1%

+104.7%

[-8.3%]

+3.5%


Coming more up-to-date we can examine some of the funds performance through the Bear market of 2000-2003.

Fund

1999

2000

2001

2002

Van Wagoner

+291%

[-20%]

[-50%]

[-64%]

Monument Internet

+273%

[-56%]

[-52%]

[-51%]

Janus Global Tech

+211%

[-33%]

[-40%]

[-40%]

ProFunds Ultra

+233%

[-73%]

[-69%]

[-69%]

Thurlow Growth

+213.3%

[-56%]

[-26%]

[-31%]

Wilshire 5000

+23.8%

[-10.9%]

[-11%]

[-20%]


The situation over the last five years:

Fund

2005-2010

2007-2010

2009-2010

FPA Value

+5.2%

+7.8%

+24%

INVESCO Value

+5.8%

+1.8%

+28%

Aston Growth

+0.6%

[-0.3%]

+29.4%

American Growth

+5.2%

[-0.9%]

+36%

ProFunds Materials

+5.7%

[-8.9%]

+40%

Hartford Int. Growth

 

[-11%]

+22%

American Market Neutral

+1.5%

[-2.3%]

+2.2%

TFS Market Neutral

+9.8%

+5%

+6.5%

Fidelity Tech

+1.4%

+2%

+22%

US Global Resources

+8%

[-3%]

+28%

Fidelity Natural Res

+8%

[-3%]

+21%

JP Morgan Real Estate

 

[-5%]

+15%

S&P500

[-0.2%]

[-6%]

+35%


The first observation is that the funds tend to mirror the overall market. If the market has a good year, the fund tends to have a good year. If the market has a bad year, the fund has a bad year, sometimes much worse, as evidenced in the 2000-2003 Bear market. The two Market Neutral Funds did provide returns that offset the broad market, but with only two examples in the sample, I wouldn’t read too much into this without examining further the records of a larger sample.

What accounts for the performances of the funds? After all, the managers are professionals, well qualified, experienced. The first problem is AUM, or, assets under management. The larger the capital fund that needs to be invested, the closer the results will conform to the overall market, as, the money is spread wider through a diversified range of securities.

Diversification itself will drive performance towards the market performance: the market after all is a diversified list of businesses and investments.

There is also the problem of survivorship bias: simply, what is survivorship bias? Survivorship bias is the distortion of an index that results from not including certain members in the average. If the funds with poor results dissolve, the remaining positive funds cause the average to overstate the industry average.

As mutual funds are registered securities, active funds must report their results. Funds with good performance continue to exist— and as registered securities must report—so the average always includes positive members. Therefore, the exclusion of deceased funds skews the average by excluding those members that had poor results. This will seriously distort the average results of the industry, and makes picking an individual fund, or group of funds, much more difficult than one might at first think.

So what qualities would one look for in an investment fund or advisory? To start with we must make the assumption that tracking the overall market is not the path that the investor wishes to take, which is the way to avoid picking a bad fund, simply pick the overall market and accept market returns.

The investor needs to find a small fund or advisory, which, due to its smaller capital base is more agile than the industry behemoths: that positions can be taken in securities that are not available to huge investments due to small capitalizations of the issue. Second, that the investor is willing to concentrate his portfolio: in other words, eschew diversification. To carry very well researched securities/investments that have well delineated fundamentals, catalysts, and macro-trends that will drive the returns of the investment.

Insurial is a small boutique Wall St firm that advises individuals, institutions, pension and profit sharing plans, trusts, estates and foundations on managing fixed income, and domestic and international equity. Insurial's consulting has resulted in consistent long-term growth for its clients - at an acceptable level of risk. This is achieved by using a proven long-term and tax sensitive investment philosophy.

The ideas and portfolio generated will therefore likely be in under-researched and less well known securities, with a smaller capitalization and with a greater emphasis on concentration, and less on a wide non-discriminatory diversification.



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

Additional disclosure: I work for Insurial, the company mentioned at the end of the article.