January 2021 IssueLong scroll reading

Managers with some serious explaining to do

By David Snowball

There are about 7,000 mutual funds. Of those, 3,800 have been around for 20 years or more. Of these long-lived funds, over 1500 have more than a billion in assets.

You’d think “large and long-lived” were synonymous with “successful.” Not so much. A few of the funds have been consistently top-notch, and the vast majority have been miscellaneously mediocre.

But only twelve have managed to combine huge asset bases with decades of bottom-tier performance. They are

The Roll Call of the Wretched.

In order to earn a spot on this Rollcall of the Wretched, you had to meet two basic criteria: (1) you needed to have more than $1 billion in assets, and (2) you need to trail at least 90% of your Morningstar peers for the past 3, 5, 10 and 15 year periods. For context, we added two bits of information that you might find useful: (1) the longest-serving manager’s tenure and (2) the fund’s 2020 performance through Christmas. Some of the funds were marginally less awful in 2020 than over the long term, but we did not use 2020 as part of the screening criteria because it’s a short period and a weird year.

The Roll Call of the Wretched, 2020

  Lead manager / since 2020 3 yr 5 yr 10 yr 15 yr
ClearBridge Aggressive Growth SHRAX Richie Freeman, 1983 89% 97 99 90 94
ClearBridge Value LMVTX Sam Peters, 2010 85 96 97 94 100
DFA Two-Year Global Fixed-Income DFGFX David Plecha, 1996 100 99 100 100 100
First Eagle US Value FEVIX Matthew McLennan, 2009 93 95 95 97 90
Franklin Mutual Shares MUTHX Deborah Turner, 2001 97 99 92 92 96
Gabelli Utilities AAA GABUX Mario Gabelli, 1996 79 91 94 98 95
JPMorgan International Advantage JFTAX Zenah Shuhaiber, 2013 84 95 97 93 94
Mercer US Small/Mid Cap Equity MSCGX Lee, Meyers and Muggia, 2005 94 91 94 91 91
Oakmark Select OAKLX William Nygren, 1996 84 99 99 91 93
Russell LifePoints Balanced Strategy RBVLX Brian Meath, 1998 90 93 93 95 93

Dishonorable mention

The New York Jets had a near-lock on their quarterback of the future, Trevor Lawrence, by virtue of 13 consecutive losses. They were scoring 15 points a game while surrendering nearly 30 and had a 75% chance of owning the top spot in the 2021 NFL Draft. Then they went and messed everything up since winning two meaningless games at season’s end and forfeiting the right to draft Mr. Lawrence to the Jacksonville Jaguars.

Two funds did likewise. They were solid locks for the list of long-term losers then, just in the last couple months of 2020, they messed everything up by surging to freakish gains.

JHancock Classic Value (PZFVX) qualified in the first draft of this essay with 3, 5, 10, and 15 ranks of 99, 99, 97, and 100. Then, in the last three months of 2020, it scored a 35.6% gain. (Not 35.6% annualized, just 35.6% total in 12 weeks.) That popped its five- and ten-year returns to the 85% percentile. But really … YTD, the fund is underwater and trailing 85% of its peers despite a 35% fourth-quarter gain!  Lead manager Richard Pzena has been on board since 1996.

A similar but smaller surge in the fourth quarter lifted Selected American Shares (SLASX) off the Rollcall of the Wretched, though barely. The fund posted an 18% gain in the quarter, boosting its five-year record to “bottom 15%”.  Chris Davis has been at the helm since 1994.

Skin in the Game

Big Disappointments

36 funds are clocking in at $50 billion or more. Three of them – all American Funds, AMCAP, Investment Company of America, and Washington Mutual – have finished in the bottom half of their peer groups for the past 3-, 5-, 10- and 15-year periods. These are not “bad” funds. They are huge, cautious, inexpensive, and intended for retirement portfolios. Those features pretty much doom them to slightly and consistently lag their peers, especially in bull markets.

If we have one piece of advice to offer investors, it would be this: if a fund’s managers and board of directors have decided that their fund is not worth their money, then it is surely not worth yours. With that in mind, we checked the personal investments made by the lead managers in each of these funds.

Despite the continuingly weak, long-term performance, the vast majority of the managers had investments of more than a million dollars (apparently fund managers make somewhat more than college professors) in their funds. The exceptions are:

Mr. Plecha at DFA Two-Year Global Fixed Income has a nominal investment after a quarter-century at the helm.

Mr. Gabelli at Gabelli Utilities has a modest investment, and his co-managers have no investments.

Messrs. Lee, Meyers, and Muggia have, collectively, invested as much in the Mercer fund as I have; which is to say, nothing.

Mr. Meath at Russell LifePoints Balanced, likewise, has not invested in his fund.

There are sometimes plausible explanations for the behavior. Sometimes a fund invests in a tiny niche or is designed for use by frequent traders or in funds-of-funds. The team at JPMorgan has not invested in their fund, which quite likely reflects the fact that they’re based in London, which would give them access to the European version of the fund while making an investment in the US version a headache. Still, the evidence is pretty consistent and persuasive: skin in the game matters, and your boss’s skin in the game matters most of all.

Thinking about the pattern of futility

Little Disappointments

Truly awful funds are rarely truly large funds. To find eye-popping ineptitude, you need to look down the size scale. Of the 4600 funds with under $1 billion in assets, three have trailed 100% of their peers for the past 3-, 5-, 10- and 15-year periods. They are CGM Focus, Highland Small-Cap Equity, and Merk Hard Currency. If you count funds that have trailed 95-100% of their peers for each period, you would add IMS Capital Value, Midas, Muhlenkamp, Northeast Investors Trust, Permanent Portfolio Short-Term, Upright Growth, and Value Line Tax-Exempt. Collectively, they hold just over $1 billion, with the majority in three funds: CGM, Muhlenkamp, and Northeast Investors. 

Two words of advice: Run away!

So how did apparently bad funds grow to be so large? Typically, the fund had a run of good years, got added (often too late) to your portfolio, and languished there even after the investment environment changes, the managers didn’t, and performance suffered.

And the environment has changed dramatically. The global financial crisis of 2007-09 moved the Federal Reserve to make, then to continuing making, utterly unprecedented interventions in the financial markets. At the national level, no institution moved more quickly or more decisively. Their actions might well have prevented a spiral into economic depression. But their actions also fundamentally rewrote the investment rulebook. It bought $3.7 trillion in bonds during the crisis and another trillion thereafter. It launched the Troubled Asset Relief Program (TARP), bought $9 billion in fixed-income ETFs, and provided a trillion dollars a day in overnight loans to big banks. They’ve announced a relaxation of their anti-inflation mandate and have projected zero interest rates through 2023. That’s made cash and bonds unattractive, which, in turn, made sky-high equity valuations tolerable. An equity market once described as being on steroids is now described as being on opioids.

Some once-great funds continue to resist the song of the “newest normal,” which has led to performance that substantially lags their more-flexible (or less principled, depending on your view) peers. One way to examine that guess is to look at the funds’ relative performance before and after the global financial crisis of 2007-09.

Below we report each fund’s full market-cycle performance for the cycle that immediately preceded the global financial crisis (a cycle that began with the bursting of the dot-com bubble) and for the cycle that includes the crisis. The results do not perfectly align with the table above because here, we are using the MFO Premium screener and the Lipper Global Datafeed to capture market-cycle performance, where above, we used Morningstar data and categories to capture trailing periods.

Relative performance of funds against their Lipper peers

  2000-2007 2007-19 Change
DFA Two-Year -3.4 -2.4 +1.0
JHancock Classic +5.4 -1.8 -7.2
Oakmark Select +6.4 +0.1 -6.3
Selected American +2.6 -1.6 -4.2
Mutual Shares 2.2 -1.2 -3.4
ClearBridge Value -1.1 -4.4 -3.3
Russell Balanced +0.4 -2.1 -2.5
ClearBridge Aggressive +0.8 -1.1 -1.9
Gabelli Utilities -0.1 -0.5 -0.4
First Eagle US n/a +0.8 n/a
JPMorgan Int’l n/a -1.5 n/a

Here’s how to read the table: JHancock Classic Value returned 5.4% more than its average peers from 2000-2007 but 1.8% less from late 2007-2019, a relative decline of 7.2% between the two periods.

On the whole, eight of nine funds have better relative performance before the global financial crisis (when six were clear market leaders) than after. Two funds weren’t around in 2000, and one, Mercer US Small/Mid, does not appear in the Lipper database. (We’re investigating.)

In general, the failure (or principled refusal) to adapt to the new reality (or temporary insanity) of the market post-2008 offers a plausible explanation for the prolonged failure. Investors who anticipate a return to pre-2008 market rules might have cause to hold on.

The special case of DFA Two-Year Global Fixed Income

By MFO’s calculation, this is actually a Great Owl fund: one which lands in the top 20% of its peer group, based on risk-adjusted returns, for the past 3-, 5-, 10- and 20-year periods. The Global Income group is a mishmash at both Lipper and Morningstar, including high-yield and government bond funds, regional and global. In general, though, it’s dominated by intermediate-term funds that offer more thrills and more spills than an ultra-short fund like DFA. DFA’s effective maturity right now is measured in months rather than years; it has the lowest standard deviation (by far) and highest Martin ratio (by far) of any fund in its group – but it also has nearly the lowest total returns. In short, low returns for ultra-low volatility.

Bottom line

If you’re invested in one of the 10 (or 12) funds above, you need to have a serious talk with your fund’s manager or the financial adviser who placed you in the fund. “A serious talk” means precisely what it sounds like: these funds might be perfectly appropriate to your portfolio, they might embody a discipline in which you have unshakeable faith, and they might have virtues that are important to you but which aren’t captured in performance metrics.

Or they might be horrible mistakes made long ago and allowed to drift toward the rocks.

You owe it to yourself to know which. If it’s the latter, accept the fact that mistakes happen (I owned Muhlenkamp Fund MUHLX for several years longer than was good for my portfolio, but he was a Pittsburgh guy – kind of stubborn, but still a Steelers fan – who’d made me a lot of money over the years until “stubborn” became “intransigent” and we hit the rocks) and move on!

Move where? Start with this month’s feature on the greatest of the Great Owl funds: funds with a strong equity component and top tier risk-adjusted returns over the past 3, 5, 10- and 20-year periods. While there are no guarantees in life, starting with investors who’ve gotten it right for decades, across a range of market conditions and challenges, is a solid place to start.

This entry was posted in Mutual Fund Commentary on by .

About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.