Inside Money-Finance Making Your Money Work!

Summary: There are still some mutual funds that outperform,
and you can grow wealthier by using them instead of index
funds. You just need to know what to look for.

You have heard here in the past, and from most of my
counterparts, that index funds and ETFs are the way to go,
and to do otherwise is a fool’s errand. Index funds have
lower costs, and will beat the majority of mutual funds over
time.

There are myriad reasons why most mutual funds underperform.
The fact is, mutual fund companies are primarily asset
gatherers. They do not benefit from outperformance, unless
it gains them assets. They only get revenues from assets
under management, not their performance. Investors being the
herding animals that they are, if a fund outperforms most
years and then has a bad year, money will pour out of the
fund like a leaky bucket. The CEO, being a good businessman
(or woman), will recognize that the most profitable way is
to try and immunize the fund from underperformance.

The
solution is to make sure that your fund keeps up with your
competitors. For example, if the rival funds are piling into
energy stocks, you had better have the same exposure, or
risk being left out. In the end, funds mimic each other so
that they don’t risk losing clients.

Also, financial advisors are more concerned with keeping

their clients in the correct Morningstar style box for
diversification than in creating the highest possible
terminal wealth. That is why the best managers that go
anywhere for returns are penalized by Advisor Joe, CFP who
is only concerned with whether a fund can be labelled large
value or large growth. Advisor Joe would much rather put you
in a bloated, underperforming fund with a static mandate
than an outperformer that disregards style boxes.

How can you profit by this?

Look for these characteristics:

DO NOT USE massive, bloated funds. If a manager outperforms
frequently, and their fund increases in size from a few
hundred million to 10+ billion dollars, the fund is much
less likely to outperform (i.e. Fidelity Contrafund). The
smaller the fund, the better.

Look for funds that are not “closet indexers.”

If it
performs like the benchmark index every year, disregard.

Find funds with a history of outperformance. The best
managers, regardless of style, outperform over longer
timeframes.

Select managers that are not concerned with fitting a
particular style box and invest based on a theme, such as
future inflation.

Do you want an example? Hussman Strategic Growth picks
quality stocks that the manager (Hussman) believes will
outperform. Then he hedges the portfolio (incrementally
removing the stock market risk) based on his views of how
cheap or expensive the stock market is at the moment. If
stocks are cheap (based on historical average valuation) and
the market has positive momentum, there will be little or no
hedges on the portfolio.

If stocks are expensive and the
recent market action is poor, the portfolio will be fully
hedged.

Another example is CGM Focus by Ken Heebner (underperformed
in this bear market, but overall a good fund) that doesn’t
correlate highly to the stock market.

Just remember, if you want a solid portfolio without much
effort, just use indexes and forget about it. But if are
willing to put forth the effort, there are opportunities in
mutual funds.

There are still some mutual funds that outperform, and you
can grow wealthier by using them instead of index funds.
You just need to learn what to look for!

Posted under Finance