- The “stupid penalty”: the gap between the top and bottom quartile of managers in a given fund category. Over a long time period (e.g. 10 years) the gap is large. Even a top quartile bond fund outperforms a bottom quartile equity fund.
- The average investor actually beats the average fund. The performance of average asset-weighted dollar outperforms the average category fund—all because large funds are cheaper.
- Over half of S. stock funds and some two-thirds of U.S. bond do not have any manager co-investment. Do not invest with a manager who won’t “eat his own cooking”.
- Along with the expense ratio, trading costs can be a strong predictor of fund performance. The turnover ratio, however, does not approximate trading costs well. Smaller cap and momentum stocks have the highest costs; large, non-discretionary (flow-related) trades also have a high cost.
- Choosing a fund in the cheapest quintile doubles to triples your chances of outperforming a fund in the most expensive quintile. This is especially true for bond funds.
- Raw returns have little predictive power. Category ranks may have predictive power in the short term (up to 3 years) likely due to a momentum effect, but peters out and reverses over the long term (>5 years). Use performance data to understand how a fund performs in different market environments.
- Look for: managers who treat shareholders like partners, in-depth shareholder reports, ethical culture, experience and proven performance, competitive advantages, manager personal co-investment, and aligned compensation schemes (salary vs. bonus).
- Key fund strategies:
- Deep Value: Ben Graham, buy assets dirt cheap to limit downside risk, margin of error; biggest risk is a value trap, fundamentally bad companies.
- Momentum: high growth, can deliver quick and big returns, growing companies; big price risk, high turnover, need constant computational arms race.
- GARP: popular, easy story, growing companies with low valuations; efficiently priced since it is popular; need a deep research edge.
- Quant: lack of transparency, competition from other quant funds, needs to be constantly evolving to adapt to markets, susceptible to market shocks.
- Great Companies at Fair Prices: Warren Buffett, instead of fair companies at great prices, economic moats; needs very long-term horizon to realize value.
- Classic Growth: Peter Lynch, buy stocks that go up, deep fundamental research; price and business risk.
- Vulture: Marty Whitman, super cheap stocks and distressed securities; risk of bankruptcy and needs long time horizon.
- Indexing: low fees, low turnover, diversified, low tracking error.
- Top-Down blend with Bottom-Up: Tom Marsico, thematic macro outlook combined with strong fundamental analysis; macro calls difficult to make and time.
Finished: 6-Apr-2009