Your Fund Isn’t Killing You, But It Isn’t Helping Either

September 12, 2012

A parade of fund managers, showing both their eclectic viewpoints and love of the United States and its capitalist system

Last month we claimed that the same stocks are often held by the same funds. But we didn’t back it up with any data.

Lipper is the go-to company for fund research. This is their list of the largest mutual funds by net assets. Let’s walk through the relevant abbreviations and codes.

The 3rd column lists the funds’ objectives.

IID is intermediate investment-grade debt. “Intermediate” refers to the length of the debt, 5 to 10 years.

SPSP means the fund is supposed to replicate what the S&P 500 does.

MLCE is multi-cap core funds. “Multi-cap” means the fund invests in a range of market capitalization sizes; everything from giant companies to small ones, with no more than ¾ of its value in any one size. If you want that size quantified, well, you’re asking too many questions. (That’s not a copout. We seriously couldn’t find a formal definition.)

CMP is commodities precious metals, which means not just physical gold and silver, etc., but their corresponding derivatives.

MLGE is multi-cap growth funds. Same as MLCE, except MLGE funds invest in stocks with above-average price-to-earnings ratios, price-to-book ratios and 3-year sales-per-share growth value.

We’ll spare you the rest of them – if you want the details, they’re here – but now we’ve got 3 categories (SPSP, MLCE and MLGE) that specialize in equities, as opposed to debt or commodities.

Here are the biggest holdings of the SPDR S&P 500, the largest S&P 500 replicator:

Apple 4.66
Exxon Mobil 3.26
Microsoft 1.81
IBM 1.76
General Electric 1.72
AT&T 1.71
Chevron 1.71
Johnson & Johnson 1.54
Wells Fargo 1.46
Coca-Cola 1.44

Here are the largest of the Vanguard Total Stock Market Index Fund, the largest multi-cap core fund and one whose very summary says it’s “designed to provide investors with exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks.”

1

Apple

2

Exxon Mobil

3

Microsoft

4

IBM

5

AT&T

6

General Electric

7

Chevron

8

Procter & Gamble

9

Johnson & Johnson

10

Pfizer

Wow, what tremendous diversity. Did you notice how although the two funds’ 1st– through 4th– and 7th-largest components are the same companies in the same order, the one fund’s 5th-biggest component is AT&T and 6th-biggest is GE, while the other’s 6th-biggest is AT&T and 5th-biggest is GE? It’s like they’re from different galaxies!

Finally the Fidelity Contrafund, the biggest multi-cap growth fund. It holds the stocks of, according to Fidelity, “companies whose value (we believe) is not fully recognized by the public.

APPLE
GOOGLE
BERKSHIRE HATHAWAY
MCDONALDS
COCA-COLA
WELLS FARGO
NOBLE ENERGY
TJX COMPANIES
WALT DISNEY
NIKE

 

Apple’s value could not be more recognized by the public if the company tattooed its logo on every citizen’s forehead. Same with Google. The only Contrafund major component that you might not have heard of is Noble Energy, a $7 billion oil and gas driller based out of Houston.

Funds make their full holding data difficult to access. Contrafund has 413 components (which is nothing compared to the Vanguard fund, which has 3220 components.) The Fidelity fund’s components are listed here. We can’t put an image in the site, it’d run for way too many columns, but here’s a summary:

Microsoft is 50th on the list. The Contrafund’s 2nd-biggest component, Google, is 13th on the Vanguard Total Stock Market Index Fund list while Berkshire Hathaway is 36th, McDonald’s is 25th, Coca-Cola is 15th, Wells Fargo is 11th and Disney is 33rd.

It doesn’t matter whether you do business with Fidelity, with Vanguard, with American Funds or with PIMCO. Buy a mutual fund, at least one that deals in equities, and you’re paying a fund manager to say “Hmm…this Apple looks like a good buy. I think I’ll pick some up.”

Look, this isn’t necessarily an argument for you to stop whatever your occupation is and devote the requisite hours to becoming an amateur fund manager. Whatever motivates you. Rather, we’re asking you to acknowledge that “picking” hundreds of stocks en masse barely counts as picking. Choosing the stocks of the largest, most profitable, most widely held companies doesn’t take any special aptitude or knowledge. It’s a defensive measure, done purely out of the fund manager’s self-interest. He’s thinking:

I’m 20-something. I’m making ridiculous money, way out of proportion to the value I’m creating. Women are enamored of me, or at least of what I can buy. Should I actually do some research, look for nothing but undervalued stocks (which there won’t be 413 of, at least not simultaneously), sell all of my fund’s current components and buy those instead?

Of course not. The higher-ups wouldn’t have it. They’d have me, roasting on a spit. My job isn’t to provide the highest possible returns. It’s to avoid mistakes.

Understand that there is no room for outliers nor independent thinkers among the ranks of the major fund managers. The managers’ job is to be as conservative as possible. Which means your money is going to be treated conservatively, which means little chance for legitimately large appreciation. When a fund hits big returns, it’s an accident. Yes, there’s a top-performing fund, and a top 10 list. Every year and every quarter. There has to be. Someone’s got to be at the top. Whether the SPDR S&P 500 outperforms the Vanguard Total Stock Market Index Fund thus reduces to little more than the question of whether AT&T will outperform GE.

You can do better than this. You can also do worse, but we’re talking to the ambitious among you.

Synthesizing the classical proverb with Mark Twain’s updating of it, “Put your eggs in a few baskets. And watch those baskets.” You need to buy individual stocks. You can start by reading here.

Filed Under: Bad Examples, Capitalism, Economics, Economy, Finance Tagged With: , , , ,

You, CFA

August 1, 2012

If you don’t handle your retirement, he might do it for you. IS THAT WHAT YOU WANT?

You can do this.

Fund managers have to be conservative, by definition. Even the smallest fund has tens of millions of OPM (Other people’s money. What are you, 80?) under its control. A fund manager has far less margin for error than does a private investor, at least professionally. If you maintain your own portfolio, and it loses 40% of its value in a given year, that’ll affect you and a handful of others. Do so as a fund manager, and your career will be dead on impact. (Actually, that’s not true. You’d be fired way before you lost 40%.) Imagine the looks of horror and sotto voce comments at the Wharton class of ’07 reunion. (And yes, plenty of fund managers are indeed that young.) You wouldn’t dare show your face. “Is that Spencer? Wasn’t he on the fast track at Vanguard? I heard he’s working in the suburbs now. Had to cut his cocaine use back to weekends only. Poor bastard.”

Fund management, for the most part, is regression to the mean. The same funds hold the same damn stocks, over and over again. Some funds are required to hold the stocks of companies that have reached a certain size. Make the Wilshire 5000, and that automatically qualifies you to be in somebody’s fund. Join the Dow (and someone soon will, to replace recently departed Kraft), and the same thing happens.

This is perverse. The tail is wagging the dog, for lack of a more original phrase. A fund doesn’t take on a new component because the fund manager sees something he likes and discreetly buys a position before someone else can. Funds take on new components because they have to. Or because everyone else is doing it.

Furthermore, fund managers aren’t just sheep. By and large, they’re hypocrites and liars. (Yes, we know. Welcome to the human species.)

Joe Light recently wrote in The Wall Street Journal that Facebook didn’t just seduce ordinary investors suffering from Streisand Syndrome. The professionals got sucked in, too. Big names. Fidelity. JPMorgan. The most successful website since Google (by number of users, anyway) went public, and did so in at least a couple of senses of the phrase. Everyone was talking about it and familiar with the story of its origin (thanks to a timely and critically acclaimed big-budget movie), and few institutional investors had the fortitude to say “no”. Or even say, “Can we take a look at the company’s financials?”

160 mutual funds bought Facebook. These included Fidelity’s Dividend Growth Fund.

Read that last sentence again. Facebook doesn’t pay a dividend.

The JPMorgan Intrepid Value Fund presumably invests in value stocks. An unproven IPO (that ended up losing 1/3 of its market cap out of the gate) doesn’t fit anyone’s definition of a “value” stock.

The managers of these funds didn’t answer the allegations of impropriety. Neither did any company spokespeople. And for the sake of consistency, we’ll end this paragraph in italics, too.

So why the hell were these funds, with their objectives included in their titles, buying a stock that had nothing to do with those objectives?

Again, defense. Say Facebook did what its devotees wanted, and exploded out of the gate. The punishment, professional and otherwise, for being the manager who could’ve bought Facebook but didn’t is overwhelming.

You can complain about how the financiers are screwing the little guy, Wall Street over Main Street, etc. if it makes you feel good. Or you can go David and aim for their heads.

Being small and nimble, i.e. an individual investor, gives you advantages that no fund manager can ever enjoy. Why?

  • You don’t have to answer to anyone.
  • You can take calculated, intelligent risks. Ones where you’ve weighed the potential downside and have decided you can live with it. Professional fund managers can do that too, to some extent, but when they do it it’s no bold move. It’s a piddling activity whose downside is mitigated by there being so many components to their funds. Hundreds of funds owned General Motors stock when it got delisted and the company eventually went bankrupt. No manager who bought GM lost his job, at least not for buying GM.
  • Your objectives are clearer. You’re there to make money. To maximize return by finding value and exploiting it.
    Is a fund manager there to make money? Yes, but not as unambiguously as you are. A fund manager makes a cut, yes, and also makes a salary. Thanks to that salary, the fund manager is operating under the same directive that most people do – I must preserve my job at all costs. The higher the salary, the more tightly someone will hold onto that job and the less they’ll to do risk getting fired. Playing not to lose isn’t just acceptable, from a fund manager’s perspective, it’s good business sense. At least as far as longevity is concerned.

Yes, selecting investments (it’s not “picking stocks”, thank you very much) is hard. It’s not an intellectual exercise along the lines of solving one of Hilbert’s Problems, but it’s hard in that it requires discipline. The same intestinal fortitude that gets your heart in shape or your lungs tobacco-free, can get you rich. Here’s how to start.

Filed Under: Estate Planning, Finance, Healthy Living, Investments, Making Smart Choices Tagged With: , , , ,

It’s Time To Get Unbalanced

June 8, 2012

Also, the circus pays next to nothing

 

NOTE: A big, sloppy welcome to all The Simple Dollar readers who discovered us this week. Unlike that site, where the comments are the only parts worth reading, here it’s the exact opposite. (Primarily because we don’t run comments. If you want to say something compelling or critical, try us here. Check out the archives, too. Reams of actionable, non-obvious advice and analysis for the upwardly aspiring. Enjoy.) 

Can you handle another food/investing analogy? Well, you’re getting one.

The standard recommendation is to invest 60% of your portfolio in stocks and 40% in bonds. Or (110 – your age)% in stocks and (your age – 10)% in bonds. Or 57% in stocks and 53% in bonds (awesome if you can do it). All of the above are useless, pointless and unhelpful.

It’s like saying 40% of your daily caloric intake should be carbohydrates, 30% protein and 30% fat.

Okay, then let’s eat a diet consisting of 40% Gummi bears, 30% bearded seal meat and 30% lard. DONE!

You can’t look at classifications. They tell you nothing. You have to look at individual cases. Otherwise, you’d be forced to believe that:

-All pit bulls are dangerous
-All Jews are stingy
-All blacks enjoy grape soda
-All Armenians beat their wives
-All Canadians are sensitive.

Alright, that last one is demonstrably true.

Yes, we get the conventional wisdom. You’re supposed to be invested in equities when you’re young, i.e. when you can withstand greater variation in your investments. If you’re 22 and you get wiped out because you loaded up on Electronic Arts stock, the thinking goes that it’s not the end of the world because you have decades left in which to earn money. And if you bought lots of Recon Technology (a penny stock that’s up 4- or 5-fold this year, and will probably come crashing down to Earth soon enough), well, that’ll increase your options and require you to work incrementally less hard for a living in the long road ahead of you.

And when you’re old, you need to limit your downside – and by extension, your upside. No fancy swings for me, young man. Instead I’ll load up on debentures and other low-risk investments. I just want to come as close to a fixed income as I can. Now let me watch 60 Minutes in peace, and turn that damn music down.

No one should invest in asset classes. But people hear advice that’s easy to swallow, or at least easy to remember, and they say to the person in charge of their 401(k), “Put me in that one fund, with the 60-40 stock-bond split.” BOOM! Investing now completed! That was easy!

When you passively manage your investments – that is, when you get someone else to do it – you’re letting that person dictate your potential return. More accurately, you’re letting that person’s biases and instincts dictate your return. Here’s what we mean:

Your company’s comptroller has one overriding professional objective, and it has nothing to do with making sure you have a comfortable retirement. Rather, it’s far more mundane. Like most people on this planet, all he wants is to keep his job. Same goes for the fund manager’s representative who shows up at your workplace on open enrollment day. She could give a damn whether you sign up for the aggressive no-load fund or the generic income fund. She just wants you to sign up for something, and wants you to not lose so much money that it’ll jeopardize her position.

Further up the chain, the fund manager is playing it conservatively, too. Invest in too few blue chips, and you’re running the risk of higher returns. Which means you’re running the risk of lower returns, which if they come to fruition could lead to angry investors. Enough angry investors means the fund manager gets fired and has to do something else for a living, maybe even work retail in a building with fewer than 80 floors. Most fund managers would rather die, so they continue playing it safe, creating largely indistinguishable mutual funds that each do not-too-horribly. And everyone’s happy. The fund manager doesn’t have to worry about returns that are far from average, the Morgan Stanley or Ameriprise advisor doesn’t have to worry about losing your company’s business, the aforementioned comptroller thus keeps your company’s owner satisfied, and your future is now invested in a hideously complex 401(k) that includes minute amounts of hundreds of large companies, almost all of which will stay stable enough on balance to keep your investment from vanishing.

But you can do so much more. It doesn’t matter how old you are, what your sensitivity to risk is, or whether Dave Ramsey thinks your portfolio incurs a suitable split between stocks and bonds; underpriced securities (really, underpriced investments of any kind) are always there, and always available to whomever’s in the mood for mostly free money.

Buy individual stocks, not just mutual funds. Stocks with powerful fundamentals are always worth buying. And if you’re unclear, by “powerful fundamentals” we mean regular profits, little debt (or at least, debt that the company’s profitable operations can afford to cover), possible treasury stock, and a high ratio of assets to liabilities. If any of those terms sound unfamiliar, buy our book.

God’s greatest gift to the amateur investor is stocks whose prices have temporarily fallen for irrational reasons, yet whose underlying businesses still have those powerful fundamentals. When public pressure is on the stock of a healthy company like British Petroleum to fall (as it was a couple of years ago), or on Netflix to fall (as it was last autumn), that’s a buy sign if ever there was one. It’s the exact opposite of the recent love-in between dilettante investors and Facebook, a company awash in publicity but with no publicly verifiable financial data to speak of. Quite the opposite, in fact.

Unballyhooed is good. Temporarily beleaguered is good (accent on “temporarily”). But nothing substitutes for a strong set of financial statements. A mere $3 can get you on your way to learning how to add a little self-determination to your investing. And give you a chance to make far, far more than if you’re merely letting someone else pick out a mutual fund for you.

Filed Under: Estate Planning, Finance, Investments Tagged With: , , ,
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