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There are certain things you just shouldn't do as an investor: chase performance, jump out of good mutual funds because they've momentarily cooled, or try out the latest "hot" investing fad.
Yet each of those things is exactly what Massachusetts' state pension fund is doing. It could be that the $50.6 billion fund is doing the right thing for the wrong reasons, but you might want to check your own assumptions so you don't find yourself in a similar situation.
Massachusetts dumped five of its portfolio managers, including investing legend Bill Miller's Legg Mason (NYSE: LM ) , because of poor performance. Instead, it will roll $1.5 billion into State Street's (NYSE: STT ) Global Advisors, which will park much of the money into a Russell 3000 index fund. It will also invest $540 million in a "fund of hedge funds" portfolio run by Blackstone Group (NYSE: BX ) , and it will put about $300 million into inflation-linked bonds.
The indexing part of the change is Massachusetts' smart move. The Fool itself has said that with three-quarters of all actively managed funds routinely underperforming the market, they bring little to the table for the fees they charge.
The analysts at Motley Fool Champion Funds know a bit of the travails of finding managers who consistently offer market-beating returns, so they can perhaps relate to the pension fund's dilemma. Every month, the Champion Funds team scours the fund world in search of the best, and they have a good track record of double-digit outperformance to prove it.
As the investment service has proved, not every fund is abysmal. Bill Miller, for example, is a legend for having beaten the S&P 500 for 15 years straight. The past three years have been an admitted struggle, because he's owned stocks such as Amazon.com (Nasdaq: AMZN ) , JPMorgan Chase (NYSE: JPM ) , Freddie Mac (NYSE: FRE ) , and Bear Stearns before it collapsed. He has steadfastly invested in financials while he just as resolutely avoided energy stocks. But when it comes right down to it, a value investor has to stick with his strategy, so it's natural for Miller to experience some lean years.
Just as savvy as the index move is, though, the hedge-fund ploy seems risky. Such alternative investments were hot a few years ago. Nowadays ... not so much.
Last month, Morningstar (Nasdaq: MORN ) reported that while its hedge-funds index and fund-of-hedge-funds index outperformed global equity markets, which experienced double-digit declines in the second quarter, they both underperformed the bond markets.
It's also hard to square the pension fund's suggestion that its "active managers add no value over long periods of time." According to the Pioneer Institute, the state pension fund averaged 11.6% annually over the past 10 years and lost 1.8% last year. However, the S&P 500 has averaged just 8.4% from 1997 to 2006.
Dumping Bill Miller's Legg Mason along with the other advisors because of short-term poor performance and trying to juice returns with a hedging strategy is a dicey maneuver. Ultimately, though, the bulk of the money will be invested in a broad-based index fund, and that's good news for contributors who need to know their pensions will be there when they're ready for retirement.
If you want help finding mutual funds that offer the winning combination of low fees and veteran managers, check out Champion Funds free for 30 days. What you find in those pages may just help you survive until it's time for your own gold-watch ceremony.