Don't Invest Like This Pension Fund!

Earlier this week, the Massachusetts state pension managers decided to join the crowd and fire Legg Mason's (NYSE: LM  ) Bill Miller, along with a few other managers from top investment firms. The event likely didn't have the flair of a Donald Trump boardroom brouhaha, but the fact that the state instead opted to entrust most of its new cash to a passively managed index fund is a slap in the face to Miller and crew.

Then again, maybe the debacle did have the wrath of a boardroom battle, judging by these harsh comments from Michael Travaglini, director of the Massachusetts Pension Reserve:

  • "'[U]tilizing traditional long-only equity managers has not added value over [the last 24 years].'" (The Wall Street Journal)
  • "'We've determined that active managers add no value over long periods of time. ... The domestic equity structure is not working.'" (Bloomberg)

I'll cut the guy some slack -- he's understandably frustrated by these money managers' recent underperformance. Plus, indexing can be a very smart approach -- even Warren Buffett believes index funds have an advantage over money managers.

But in my opinion, Travaglini couldn't be more wrong to give up on these top money managers during a tough market (particularly for value investors). That goes double when the retirements of so many hardworking teachers and civil servants are on the line.

Don't just take my word for it
A recent study released by Baird's research division backs up my belief. The report determined that more than 80% of high-performing managers go through at least one three-year period wherein they lose to the market.

Even more startling, nearly 90% of high-performing funds experienced a three-year period of losing to their peers. The study's conclusion is clear: "There is an extremely high probability that an investor will own a high-performing mutual fund that will go through at least one sustained period of poor performance not only relative to its benchmark, but also relative to its peers."

So, yes, even the best money managers post poor results from time to time. But how do investors typically react to those periods of underperformance? Not very wisely, Baird's study suggests.

Investors tend to withdraw their money when a high-performing fund hits a rut, opting instead for a fund with better recent results. From the study: "Investors appear to be buying high (funds coming off a strong period) and selling low (funds coming off a weak period)."

Actionable advice
I may not be able to persuade Travaglini to take Miller et al back -- although I think he should, because that was a particularly impressive assembly of fund managers -- but hopefully I'll be able to prevent you from making a similar mistake.

See, even the smartest Wall Street minds will have periods of difficulty and underperformance. And if you've found a top-notch fund manager, these periods of weakness are generally followed by market outperformance: All of the funds in the Baird study outperformed both the market and their peers over a 10-year time frame.

So what can you do with this information? Three things:

  1. When looking for new funds, the manager is among the most important things to look at. Look for a long tenure, long-term outperformance, a consistent strategy adhered to in good times and bad, and previous experience in bear markets.
  2. If you own a fund run by a proven manager but you're considering selling because of recent performance that disappoints, think twice about moving your cash elsewhere.
  3. If you have extra cash you'd like to deploy to a top-notch mutual fund manager, now is a great time to get in.

As a place to start, here are two funds run by brilliant long-term managers that we at Motley Fool Champion Funds believe have merely experienced short-term difficulties. And, in spite of those difficulties, I believe they will outperform when the markets turn upward.


Oakmark Select I (OAKLX)

Muhlenkamp (MUHLX)


Bill Nygren

Ron Muhlenkamp

1-Year Return:



Top Holdings Include:

Washington Mutual (NYSE: WM  ) , Intel (Nasdaq: INTC  ) , JPMorgan Chase (NYSE: JPM  ) , Dell (Nasdaq: DELL  ) , Yum! Brands

Boeing (NYSE: BA  ) , Oracle (Nasdaq: ORCL  ) , Altria, Corning, ConocoPhillips

Morningstar data as of Aug. 6, 2008.

Of course, these aren't the only two funds that would make a smart choice for investors seeking long-term wealth appreciation. If you'd like to browse through our entire list of recommended funds at Motley Fool Champion Funds, click here to try the service completely free for the next 30 days.

Adam J. Wiederman owns shares of Legg Mason, but of no other company mentioned above. The Motley Fool also owns shares of Legg Mason, which is an Inside Value recommendation. Dell and Intel are also Inside Value picks. JPMorgan Chase is an Income Investor pick. Muhlenkamp is a Champion Funds recommendation. The Fool's strict disclosure policy is here.

Read/Post Comments (6) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 08, 2008, at 10:36 PM, prginww wrote:

    Anyone who makes WM his/her top holding should be fired.

  • Report this Comment On August 10, 2008, at 12:20 AM, prginww wrote:

    Not counting their typically very low fees, how many index funds underperform the market?

  • Report this Comment On August 10, 2008, at 3:29 PM, prginww wrote:

    Technology has advanced to the point where it's easy to invest on your own, index funds are cheap and practical, and the level of data available allows for smart indexes. I think these algorithms will eventually become the new "active" management and traditional indexes will remain as the passive alternative. Sorry fund managers.

  • Report this Comment On August 10, 2008, at 3:33 PM, prginww wrote:

    ps. I am a teacher and I'm happy to see Mass. move towards indexing. Teachers aren't in it for the money and devote their precious time to their students rather than their own finances. As the Fool has said many times... for that type of investor - the best option is probably an index.

  • Report this Comment On August 10, 2008, at 9:10 PM, prginww wrote:


    While I do agree (along with greats like Warren Buffett) that for the average investor, index funds are the best, no-brainer means to invest, I disagree that this is a smart move because the pension fund managers are not average no-brainer investors. Their job is to ensure the long-term growth of the money entrusted to their care, so a passive, hands-off approach is neither up to par, nor the smartest way to achieve that goal, in my opinion.

    But thanks for your comments.


    Adam J. Wiederman

  • Report this Comment On August 11, 2008, at 5:37 PM, prginww wrote:

    Nygren & Muhlenkmamp?! Neither one of those guys deserve my money. I've followed them both and Muhlenkamp refused to acknowledge what was going on in the housing sector since day 1. He kept saying homebuilders were cheap the ENTIRE way down. He was so stubborn in his comments and thinking, basically saying the market was wrong and he was right. Nah, you were wrong, just admit it. And Nygren basically did the same thing. Just continue to hold something all the way down to zero. That's dumb. Now he's comparing his fund's performance to the S&P ex-energy. Yeah, feel free to cherry pick your benchmarks based on what will make your fund look better. Neither one of those are good picks, sorry.

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