Mutual funds amidst these volatile times

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Oct 28, 2008 1:13 pm

Can we speak about Mutual Funds for a second? I'd like some insight as to why a product that's been pitched as a "diversified" tool has been hit too hard. If you go back and look at some of the American funds that had money invested in at least the past 4 years, you're down under and on pace with the market too. This is astonishing to me and clients are going to want answers.

 
Is it the hedging strategies? The short term short selling ban that took place over the summer? What?
 
Oct 28, 2008 1:24 pm

I think there are a couple of reasons.


 
1.  Managers are paid based on relative performance to their benchmark.  Have you seen the benchmarks lately?
 
2.  Many managers were caught way off-guard in July when financials went up and energy went down.  In just a couple of weeks, many managers lost about 5% relative to their benchmarks right there.
 
3.  Even if fund managers saw this coming, they are bound to the rules of their fund.  They can't short, they can't just move to 80% cash, they can't trade as frequently as this market would allow them.
 
4.  They are essentially investment vehicles that are long-term, 5+ years out. 
 
5.  Most bond managers are getting creamed, unless you're Bill Gross.  Most mixed funds that hold some bonds are seeing that portion down 20% or more.
 
6.  If your fund is having redemptions, the managers may be selling off the highest quality names, leaving the laggards to hopefully come back.  Problem is they are sucking exponentially.
 
7.  What hedging strategies are you talking about?  Pretty much any American Funds mutual fund does not employ any hedging strategy...at least from what I've seen.  Unless your mutual fund can short, what significant effect could the short selling ban have had?
 
Oct 28, 2008 1:28 pm

Thanks for the post Snags and as far as hedging is concerned, I was thinking specifically about Ivy funds.

 
I'm looking at some DCA'ing I did and money that was put in FranklinTempleton, American Funds and even fidelity are down 50%!
Oct 28, 2008 1:40 pm
anabuhabkuss:

Thanks for the post Snags and as far as hedging is concerned, I was thinking specifically about Ivy funds.

 
I'm looking at some DCA'ing I did and money that was put in FranklinTempleton, American Funds and even fidelity are down 50%!
 
Yeah, Ivy's hedging blew up.  I was on the last conference call but I can't recall exactly why the hedging did not work.  I just got something in the mail about their next conference call in the coming weeks.
 
I think the hedging strategy didn't account for 700-900 daily swings.  Get ready for the tax distributions at the end of the year...as of end of 3Q, they are huge.  Hopefully the estimates will go way down for 4Q. 
 
As for FranklinTempleton and American Funds, I run away from both of those, so I can't help you there. 
 
Ice would love to hear this, but people in many American Funds are getting exposure to just about everything, including a decent amount of international, when you might have been buying it for domestic equity.  American Funds is just too big in my opinion.  I hate them just as much as Duke bball, Braves baseball, and Steelers football.
 
 
Oct 28, 2008 2:21 pm
iceco1d:
snaggletooth:

I think there are a couple of reasons.


 
 
3.  Even if fund managers saw this coming, they are bound to the rules of their fund.  They can't short, they can't just move to 80% cash, they can't trade as frequently as this market would allow them.
 
 
 
 
I think this is the main reason, for most funds.  As far as being "diversified" - diversification is not the "end all, be all" to investing.  Diversification cannot reduce exposure to systematic risk, it can only reduce/eliminate non-systematic risk. 



Ana...just so you can understand what Ice is saying...

"Diversified" doesn't help much at times when pretty much EVERYTHING goes down.

Oct 28, 2008 2:24 pm

oh yeah I hear ya both. It's just a way of getting it through clients' minds. I'll use that line of yours to narrow it down for them

 
Thanks.
Oct 28, 2008 4:42 pm

Interesting discussion.  I think that this makes a case for index funds for those who know how much they can stand to lose despite being diversified.  You know what's in them and they're cheaper.  In a long term bull market, a managed-fund is better than an index, but at the cost of a systematic market failure that wipes away all the gains in a couple of weeks.

Oct 28, 2008 6:18 pm
iceco1d:
gregoron:

Interesting discussion.  I think that this makes a case for index funds for those who know how much they can stand to lose despite being diversified.  You know what's in them and they're cheaper.  In a long term bull market, a managed-fund is better than an index, but at the cost of a systematic market failure that wipes away all the gains in a couple of weeks.

 
Wrong-O!



Why-O?

Oct 28, 2008 7:02 pm
gregoron:
iceco1d:
gregoron:

Interesting discussion.  I think that this makes a case for index funds for those who know how much they can stand to lose despite being diversified.  You know what's in them and they're cheaper.  In a long term bull market, a managed-fund is better than an index, but at the cost of a systematic market failure that wipes away all the gains in a couple of weeks.

 
Wrong-O!
 
Here we go again.

Why-O?
Oct 28, 2008 7:10 pm
anabuhabkuss:

Can we speak about Mutual Funds for a second? I'd like some insight as to why a product that's been pitched as a "diversified" tool has been hit too hard. If you go back and look at some of the American funds that had money invested in at least the past 4 years, you're down under and on pace with the market too. This is astonishing to me and clients are going to want answers.

 
Is it the hedging strategies? The short term short selling ban that took place over the summer? What?
 
 
Here is the thing about American Funds.  People seem to forget that they were not the cat's meow in the 90's.   Why?  Because we were in a growth market.  AF is a value manager.  In addition they were heavily invested in financials.  Here comes the bear of 2000-02.  What got hit the hardest?  Growth.  What held up reasonably well?  Value, more specifically financials.  The bull from 02-07 was a value market led by....financials (and energy).  So AF did very well in the last bear and during the bull.  What is happening now? value is out of favor and financials are getting hit very hard.  This is why AF are not doing well.  Asset allocation should always come first.  Large vs. small, value vs. growth, intl vs. domestic etc. etc.  AF is your large cap value portion if you choose to use active managers.  Because brokers fail to look behing the returns, they thought AF was impervious to market down turns and had clients way overweighted into large cap value during a bear market where large value is getting hit the hardest.  Does this make AF a bad manager?  No.  Just like the success they achieved from 2000-2007 does not make them a genius.
Oct 29, 2008 11:16 am

This has nothing to do with American Funds, or Ivy, or Fidelity, or whatever.  There are really a couple kep points (and I think someone mentioned them):

 
1. Funds are bound by their prospectus.  Just because the managers of Capital Income Builder think the market is going into the shitter, they are not allowed to just move into all cash.  They MUST, by RULE, stay within their prospectus guidelines.  So if that means staying 80% or 90% invested, so be it.  They have no choice but to employ their best ideas and sink with the tide.  I think this fact is often lost on both investors and advisors.  Mutual Fund managers CANNOT save you!  Neither can index funds or etf's, or whatever.  Think about it this way - what if you were buying a balanced portfolio of "style-box" type funds to stay diversified, and all of a sudden one of them decided that large-cap value wasn't very sexy so they went all-in with high-yield international bonds?  That just might screw you up a little, no?  Yes, there are some go-anywhere funds that have much more lattitude, but by and large, the fund objectives are rather narrow in terms of the space they can play in.  It's just that our focus is rather jaded during a time like this.
 
This leads to my next point.....this is where it is OUR job to decide how much stocks, bonds, cash, alternatives, etc. we are going to employ.  Maybe we take our cues from our BD, or Morningstar, or GOldman, or whoever.  But we can't expect that if we own 10 funds, each with vastly different objectives, that they will each move their money all to cash when the going gets tough.  I think our fingers need to point a bit less at the money managers, and a bit back at ourselves.
 
Right now, I think you need to compare funds to their true peers and the indexes they represent (if they do).  For example, American Funds is tough to compare to other peers, because they use more of a goal-oriented style rather than a "style-box" approach.  So you sort of have to break it into componants.  So maybe for CAIBX you would compare 50% large-cap dom value, 20% EAFE index, and 20% domestic bond (and don't forget cash - they hold about 8-10%).
 
But when almost everything is down, there's not much hope.  Some funds get lucky, a few use good hedging strategies, and soem happen to be in the right market (i.e. international bond, govies, etc.).
Oct 29, 2008 12:05 pm
B24:

This has nothing to do with American Funds, or Ivy, or Fidelity, or whatever.  There are really a couple kep points (and I think someone mentioned them):

 
1. Funds are bound by their prospectus.  Just because the managers of Capital Income Builder think the market is going into the shitter, they are not allowed to just move into all cash.  They MUST, by RULE, stay within their prospectus guidelines.  So if that means staying 80% or 90% invested, so be it.  They have no choice but to employ their best ideas and sink with the tide.  I think this fact is often lost on both investors and advisors.  Mutual Fund managers CANNOT save you!  Neither can index funds or etf's, or whatever.  Think about it this way - what if you were buying a balanced portfolio of "style-box" type funds to stay diversified, and all of a sudden one of them decided that large-cap value wasn't very sexy so they went all-in with high-yield international bonds?  That just might screw you up a little, no?  Yes, there are some go-anywhere funds that have much more lattitude, but by and large, the fund objectives are rather narrow in terms of the space they can play in.  It's just that our focus is rather jaded during a time like this.
 
This leads to my next point.....this is where it is OUR job to decide how much stocks, bonds, cash, alternatives, etc. we are going to employ.  Maybe we take our cues from our BD, or Morningstar, or GOldman, or whoever.  But we can't expect that if we own 10 funds, each with vastly different objectives, that they will each move their money all to cash when the going gets tough.  I think our fingers need to point a bit less at the money managers, and a bit back at ourselves.
 
Right now, I think you need to compare funds to their true peers and the indexes they represent (if they do).  For example, American Funds is tough to compare to other peers, because they use more of a goal-oriented style rather than a "style-box" approach.  So you sort of have to break it into componants.  So maybe for CAIBX you would compare 50% large-cap dom value, 20% EAFE index, and 20% domestic bond (and don't forget cash - they hold about 8-10%).
 
But when almost everything is down, there's not much hope.  Some funds get lucky, a few use good hedging strategies, and soem happen to be in the right market (i.e. international bond, govies, etc.).
 
There is a wholesaler I trust that was telling me when he worked for a different company during the tech bubble, he was flying in a private jet with the fund manager of their company's hottest tech fund in 1998 or 1999.  They were leaving an event where they talked to a room full of advisors about tech and how great it was.
 
On the plane, after the event, they get to talking and the fund manager basically tells the wholesaler, "This is going to crash and it is going to be one of the ugliest things we'll see.  You'll be fine and life will go on for you.  But as a fund manager, I will not be ok".
 
Keep in mind, this fund manager just did like 300% in the fund.  So the wholesaler asks, "What are you talking about?  We just talked to this room of advisors telling them how great this stuff is".
 
The manager says, "What can I do?  I am bound by the criteria of this fund.  I can't short anything, I can't move to cash, what can I do?  I see this collapsing, but I can't do anything".
 
Anyways, long story short, he was right.  The fund lost its ass, investors got killed, and the manager lost his job.
 
It makes you wonder if any of the managers of the funds you invest in would have told you candidly that this was going to be bad, but sat there with a smile on their face and told you it's all gravy because they can't do anything about it.  
 
 
Oct 29, 2008 3:06 pm
snaggletooth:
 
It makes you wonder if any of the managers of the funds you invest in would have told you candidly that this was going to be bad, but sat there with a smile on their face and told you it's all gravy because they can't do anything about it.  
 
 



I'm pretty sure their wholesalers are doing that for them too.  Been getting lots of calls and invites to conference calls from them lately. 

Oct 29, 2008 4:02 pm

That's one of the weaknesses of the actively managed fund model.  At least with index funds, you KNOW that the fund isn't going to do anything to avoid a calamity.  However, with actively managed funds, you somehow look at history and just KNOW (wrongly) that they are going to avoid it.

 
That's why I think a good wholesaler/fund company is worth their weight in gold.  If they could be impartial and tell you "yeah, we think you should move out of this area and into this area..." etc. that would be great.  However, fund companies are not set up to operate like that.  They are set up to provide the best returns in each fund, not coach you on which fund mix to use (expect that they offer model portfolios).  Not their fault, I guess it is assumed that it's the job of the investor (i.e. Vanguard, Fidelity, etc.) or advisor to determine when to "exit" a market or a strategy.
 
Here's the problem....a fund company CAN'T do that.  It would cause funds to implode.  If American thought Developing Markets were going to suck wind, and told everyone to get out of New World Fund, and move into Capital World GI (just an example), the outflows would be so disastrous, that existing shareholders would get absolutely hammered into yesterday.  On top of that, they would risk breaching their prospectus guidelines of how much needs to be invested.  It would blow up the expense ratios.  It would be a disaster and there would be lawsuits.  So, in short, fund companies CANNOT really do this.
Oct 29, 2008 5:01 pm
 
"This leads to my next point.....this is where it is OUR job to decide how much stocks, bonds, cash, alternatives, etc. we are going to employ.  Maybe we take our cues from our BD, or Morningstar, or GOldman, or whoever.  But we can't expect that if we own 10 funds, each with vastly different objectives, that they will each move their money all to cash when the going gets tough.  I think our fingers need to point a bit less at the money managers, and a bit back at ourselves."
 
 
 
Great point B24! At the the end of the day the client hires us, not the managers.   A tactical approach reviewed quarterly is the way to go and this market only makes the argument stronger from an investment management and practice management view.  Keeps you accountable and in touch. 
Oct 29, 2008 5:05 pm

Bottom line...

 
80% of mutual funds underperform their benchmark
 
Hence...
 
Invest in the indicies
Oct 29, 2008 5:42 pm
iceco1d:
peacock:

Bottom line...



80% of mutual funds underperform their benchmark



The longer time period you examine, the closer that number gets to 100%.





Good point, but with some managers, you are also allowing them to decide on mix. With stricly index approaches, you are banking on knowing the proper mix to use. In other words, what if you decide that the EAFE should be overweighted, and it gets killed? But maybe American Funds or Goldman decides that EAFE should be underweighted, and they are right. If you use some of their "balanced" funds, you can outperform by better asset allocation from the manager, NOT because of better specific security selection. Capital Income Builder trounces the S&P 500 over most time periods, while taking on less risk. Yes, they use int'l in the fund, so "not fair". but they also use fixed income and cash (like 20%+ combined). IOW, they are deciding on the mix between dom stocks, bonds, cash, and int'l. Could you have done better at the same level of risk, with the same segments?



I'm not trying to argue for using that fund - it was just an example of how and when active management outperforms. I totally agree that it is very tough to pick pure style-play funds in each style box and outperform their corresponding indexes.

Oct 29, 2008 6:41 pm
peacock:

Bottom line...

 
80% of mutual funds underperform their benchmark
 
Hence...
 
Invest in the indicies
 
VFINX is in the 43rd percentile for the last 10 years in its category.  Maybe you should change your statement to "42% of mutual funds underperform their benchmark".
Oct 29, 2008 9:19 pm

I always love to hear the vanguard standard investing 101 line about the indexes beating 80% of all funds. Half truth statement, of course they beat money mkt funds, bond funds, balanced, g&i, and growth taking less risk than the market.  If you pull active funds doing around the 1.0 beta the argument loses steam very quickly.  There's a ton of funds, even today that have done better than the mkt with much less risk.  

 
The 80% basic concept is about as true as the other infamous investing 101 line that "housing only goes up". 
 
Either way, if you use an allocation approach paired to risk tolerance not too many clients are taking the risk of the overall mkt, so we should be happy we're not down 36% ytd. 
Oct 29, 2008 10:36 pm

I would rather be a chest thumper than a Bengals fan!!