When you choose a mutual fund to buy, you look for good past performance, reasonable expenses, and a highly regarded manager. Is that enough?
I started buying funds in 1969. There were not very many no-load funds in those days and that simplified the choice. As I recall, the Forbes Mutual Fund issue came out in August. There was not much interest in mutual funds then and August was a slow time in the market. According to the Forbes discussion, one fund stood out. The DeVegh Mutual Fund, named after a legendary investor, had a good past performance (I recall an A in up markets and B in down), reasonable expenses with a low minimum investment, and a highly regarded manager (I recall the name A. Oakley Brooks). I invested initially in September 1969. I eventually sold the fund in September 1978. The manager Brooks appeared to be a wise investor; over the many years that I received and looked at reports from investment managers, his reports were the rare ones that deserved careful reading. But like all investors, he made some errors. Famously, he owned Penn Central when it went bankrupt. Another manager once wrote he kept Brooks' comment on the promise of Penn Central over his desk to remind him that even the brightest investors made mistakes. But over the years I watched the Forbes rating slowly slide downward. The fund was taken over by a larger firm, and Brooks was removed. The performance was not awful; over the nine years, the fund gained about 30%. But this was the total gain over nine years, not the annual gain. So what went wrong?
First, this was a good lesson that past performance does not necessarily indicate good future performance. But perhaps one culprit was that it was not really a very good time to invest. Investors, who have seen the string of double-digit annual gains of the great bull market from 1982-1999, might not remember the tough markets of the 70's. The S and P 500 fell 27% from June 1969 until June 1970, and 43% from January 1973 until September 1974. There were obviously some good periods also and DeVegh did not handle the overall period very well. Still, even the best fund can have a difficult time making progress during a choppy up-and-down market. Is there another lesson here? To be honest, I don't know. I am concerned that so many investors seem to think that after the long bull market and a three-year bear market, the good times like the great bull market will roll again. I hope so too. But I have seen some long periods when gains did not come easily and I expect I will see that again.
I owned many mutual funds for four years or less; I owned a few funds for only a year or so. I consider this a short holding period and such a short holding period represents my failure to make a good choice. For those interested, these include: Drexel Equity Fund, Dreyfus Third Century Fund, Mathers Fund, SIT New Beginning Growth Fund, Monetta Fund, Founders Discovery Fund, Gabelli Growth Fund, and Janus Venture Fund. I sold them for various reasons including a change in manager, growth in assets, or disappointing performance. Have I learned something from these investments that I consider errors? I expect I will continue to make mistakes but I have learned an attitude and a way of thinking that influences my choices. I now always assume that when I buy a new fund, it will under-perform for a period of time. There actually is a reason to assume under-performance, since whenever you buy a new fund, that choice was probably made on the basis of excellent recent performance. Thus there is a real chance that the fund performance will "revert to the mean." For any continuing string of consecutive numbers, if the recent numbers are above the average, either the average will go up to better represent the numbers or else the numbers will go down so the average is representative. In the case of fund performance, the average performance rising would be better but doesn't seem to happen to me. The performance dropping down to or below the average is called "reversion to the mean." Actually, I don't think every new fund I buy under-performs; it just feels that way.
The main lesson I have learned is to ask myself the question: when (not if) the fund under-performs, will I be inclined to sell it or is my conviction high enough to ride out the period of weak performance? If the only reason I am thinking of buying the fund is "performance" and a period of under-performance would cause me to sell, I won't buy the fund. This question forces me to think more carefully about the manager and the investment process the manager uses and not to over-emphasize past performance. Past performance might be one of the few clues we have to future performance. But we pay attention to that clue because we have so few clues to future performance, not because it is a very reliable clue.
Obviously, when you buy many funds over a period of years, some of them will count as successes. One example, for me, was to buy Vanguard Windsor Fund managed by John Neff in 1977, for a retirement account. I kept this fund for many years, selling it in 2002; it was not a disappointment. You should notice that I was invested in Windsor during the great bull market 1982-1999. So can I find a lesson in purchases like this to help you choose mutual funds? I am afraid not. The process I used in the successes was similar to the process I used in the failures. I looked at past performance, fund costs, the manager and his investment process, and I prefer to avoid high turnover rates. What was different was the outcome. Perhaps there is a lesson in this, after all.
Email me comments or questions.