by Harry Jones

(July 15, 1999) -- It wasn't the best week. The new lawnmower found a rock big enough to give it pause. It halted when the blade bent. Irv took it apart and we're waiting on delivery of a new part. Of course, 98% of the lawnmower is strong and like new, so it will be fine. There's always some small part that needs tending to, in most things, time and again.

Problems with Mutual Funds, Part 2

by Jeff Fischer (TMF Jeff)

Last week we considered three disadvantages facing managed mutual funds.

  1. Mutual funds must hold cash
  2. More cash often must be raised during a down market, hurting every investor
  3. Mutual funds can be hampered by high cash inflow, and eventually harmed by success

If these weaknesses aren't enough, there are many others.

4) Mutual Funds Managers Must Act on Predictions

They can't help it. A majority of mutual fund managers make market predictions and act on them. The 10% of fund managers who don't focus on the market, but on owning companies, are those most likely to beat the market. Unfortunately, though, fund managers are paid to actively manage money and most feel they must very actively work at managing it. Translation: they trade actively. Or gamble.

Of course, nobody can predict the stock market and nobody can always find good investments. The S&P 500 isn't a collection of flawless performances, but the 500 companies in the index are large enough, and enough of them are strong enough, that its double-digit historic annual return has beaten most mutual funds that stray from the index and insert human nature, or decision, in the investing equation. Aside from the obvious (that predictions are impossible), actively managed funds face other shortfalls.

5) Fund Managers Compete Fiercely

Knowing that they're in a fishbowl, one where "return" is the ultimate measure of job performance, fund managers fight hard to perform well against the market and peers. In most professions, this daily diligence would be rewarded. In the world of Wall Street, this behavior is often punishing.

Most of a successful investment's value is created at the tail-end of its lifetime. You need to hold a stock long enough for this to occur. We already know that most mutual funds sell 80% of holdings within a year (a number that continues to be hard to believe). But why?

Many managers are too focused on quarterly returns. "Window dressing," or buying and selling at the end of a quarter, is done merely to make a fund's holdings "look "better based on recent market action. Fund managers also naively jump in and out of holdings in hopes to maximize returns. Before even accounting for taxes, this active buying and selling almost always works to their detriment.

6) Investing in Strange Places

The desire to perform better than peers also leads fund managers to invest in high risk, unfamiliar territory, or strange asset classes. Hundreds to even thousands of funds are doing this right now. They invest beyond their normal competency, dipping into overseas investments, commodities, hedging, and more, all in hopes of earning a much higher return. Instead, usually, they get burned.

With the S&P 500 index, you know exactly what you're getting: far from burned. Rewarded, over time.

 Recent Harry Jones Portfolio Headlines
  08/26/99  Is it a Nifty 500? Part II
  08/19/99  Is it a Nifty 500? Part I
  08/12/99  Illuminating Index Funds, Part Two
  08/05/99  Illuminating Index Funds
  07/29/99  The Foolishness of Index Funds
Harry Jones Portfolio Archives »  

07/15/99 Close

Stock Change Close SPY + 57/64 141.05
Day Month Year History HARRY +0.64% 2.95% 10.52% 10.52% S&P: +0.82% 2.69% 15.25% 15.25% NASDAQ: +0.76% 5.72% 29.49% 29.49% Rec'd # Security In At Now Change 1/4/99 16 S&P Depos 127.63 141.05 10.52% Rec'd # Security In At Value Change 1/4/99 16 S&P Depos 2042.00 2256.75 $214.75 CASH $0.00 TOTAL $2256.75 Yesterday Today Change S&P Depos 140.16 141.05 SPY + 57/64


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