Mutual Fund History: The Terrible Truth

By Dr. Mark Skousen, Chairman, Investment U
Thursday, September 29, 2005: Issue #473

I collect rare financial books, and one of my favorites is The Terrible Truth About Mutual Funds. It’s long out of print, but the author’s basic premise is as true today as when it was written half a century ag Mutual funds do a terrible job for most investors by underperforming the market over the long run, and charging exorbitant fees to boot.

While mutual fund history should speak for itself, modern studies confirm this “terrible truth.” In the book, Stocks for the Long Run, Professor Jeremy Siegel reports that in the past 20 years, there were only three years in which the majority of funds beat the market index (as measured by the S&P 500).

Take a look at the 20-year historical performance of the S&P (brown) and the blue chip funds from T. Rowe Price, Putnam, Vanguard, AIM and Fidelity:

Why Most Mutual Funds Fall Behind the S&P… and What You Can Do About It

There are two main reasons for mutual fund underperformance:

• Market conditions change, and are hard to predict even by the best stock pickers. 

• Top performers have a hard time staying on top.

This “terrible truth” came to my mind upon reading the latest Forbes Honor Roll of Mutual Funds that comes out every September. To make the Honor Roll, a mutual fund usually needs to get an “A” or “B” in up and down markets, a tough requirement. Ten funds qualified, including the notable Martin Whitman’s Third Avenue Value Fund.

But let’s take a look at the single most important fact, in its historical context: Not a single one of these top mutual funds were on the Honor Roll in 1994 or 1984. Not a single Honor Roll mutual fund in 1984 or 1994 are on the Honor Roll today. For example:

• The Magellan Fund was one of the premier funds in the 1980s, run by Peter Lynch. This year, it is not even mentioned in the magazine’s fund survey! 

• Mutual Shares was the darling of investors in the 1980s and 1990s, founded by Max Heine and taken over by Michael Price when Mr. Heine died. But after Price retired in 1997, Mutual Shares lost its Midas Touch, and has been losing investors ever since. It is now part of the Franklin Templeton group of funds, and Forbes gave it a “D” in up markets, “A” in down markets. It hasn’t made the Honor Roll in years. 

• The Nicholas Fund, run by founder Albert Nicholas, beat the markets consistently into the 1990s. But today, Forbes gives the fund (now run by him and his son) a “D” in up markets and a “C” in down markets.

The lesson is clear: If you want to make consistent profits investing in mutual funds, you would be wise to avoid staying invested too long in your favorite “growth” fund. You are bound to be disappointed when the genius running your fund moves, retires or makes a major blunder.

What To Do about Mutual Funds?

In a September 6 interview in The Wall Street Journal, David Swensen, famed manager of Yale University’s $15 billion endowment fund (who has returned an average 16% a year, far outpacing the market), said that the best thing individuals can do is to stop trying to beat the market and invest in index funds.

Which, of course, translates into an absolutely zero return on your money since 1998!

We can do better than that. By trying to do what Swensen does at Yale: use knowledge and skill to pick stocks.

How? The answer can be found in the wisdom of old-timer Gerald Loeb, author of The Battle for Investment Survival (another collectible in my financial bookshelf). “The real fortunes in the marketplace have been made by concentration, not diversification!”

In The Wall Street Journal interview, Mr. Swensen agreed. When asked how the Yale Endowment Fund beats the market, he replied: “We have managers in Yale’s portfolio that will hold three or four or five stocks, or maybe eight or 10 stocks. One of the best managers out there has had as few as three securities and never more than 10.”

Don’t be afraid to do your own reading and research. Studies have shown that individual investors generally do better than the professional money managers. Remember, nobody is more concerned about your money than you are.

Taking advantage of Investment U’s practical, off-Wall Street investing tips – and even the recommendations of The Oxford Club and my newsletter, Forecasts & Strategies – is a great way to start moving ahead of the S&P… and especially mutual funds.

Good trading, AEIOU,

Mark

• Another Reason to Avoid Mutual Funds
• Money Managers: An Easy Way to Find the Best
• The Dodge and Cox Stock Fund: Get into this Mutual Fund Before it Closes Again

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