It's a cardinal principle of smart fund investing: Buy the manager, not the fund. Alas, like most pieces of investment "advice" that are a little too pithy for their own good -- not to mention yours -- it's a catchy phrase that'll likely leave you scratching your head after the charm of its bumper sticker appeal wears off. (Buy low, sell high, anyone?)
What exactly does it mean, after all, to "buy the manager"?
Glad you asked. As the go-to guy for the Fool's Champion Funds newsletter service, I spend an inordinate amount of time (just ask my wife) poring over mutual fund data, all in pursuit of just those managers who are actually worth their expense ratios. With that as a backdrop, I can safely say that, in the first instance, buying the manager means looking past a fund's star ratings and Lipper scores and finding out who, exactly, is responsible for all those impressive numbers that the fund company brandishes in its glossy brochures. If that skipper has left the ship, those accolades mean precious little.
Step lively
Still, while finding out who really owns a fund's track record is a good and necessary first step when it comes to successful, um, manager acquisition, it's hardly the only one. Let's say, for instance, that you've identified a fund with a manager whose tenure of at least five years has coincided with a period during which his charge has beaten grade A benchmark trackers like Vanguard's 500 Index (FUND:VFINX) and Total Stock Market (FUND:VTSMX) funds and the popular SPDRs (AMEX:SPY) exchange-traded fund by significant margins.
That guy's gotta be pretty good, right?
Well, maybe. Could be he's just been lucky, too. To wit: If the fund you've found is of the small-cap persuasion and if the period you're looking at happens to be the last five years, well, it's no wonder he's beaten the market. During that stretch of time, small-cap funds have had it all over those that invest in such big boys as Cendant (NYSE:CD), Pfizer (NYSE:PFE), Oracle (NASDAQ:ORCL), and Home Depot (NYSE:HD).
Indeed, according to fund tracker Morningstar, for the five-year period that ended on Oct. 21, the typical "small-blend" fund has sailed past the average "large-blend" fund by nearly 11.4 annualized percentage points. With that stat in mind, it would be downright embarrassing if the small-cap manager hadn't beaten the market -- and by a quite tidy sum at that.
Your guy may still be a winner, though. You'll just have to dig a little deeper to make sure.
It's all relative
That's where relative performance comes in. When cherry-picking Champs for the newsletter, I control for "style" -- i.e., where on the growth/value and market-cap spectrums a fund lands -- by gauging how funds stack up against their relevant peer groups and benchmarks. That way, I can be sure that my comparisons are of the apples-to-apples variety -- and that I'm recommending funds based on their fundamental strengths and forward-looking prospects rather than a track record that may simply owe to what fund geeks (such as yours truly) refer to as a "stylistic tailwind."
Relative performance numbers are available lots of places. For starters, any fund worth its expense ratio will likely include information as to how it fared against an appropriate benchmark in its annual and semiannual reports. And websites such as Yahoo! and Morningstar provide relative numbers, too.
Be careful, though. As helpful as relative performance figures are -- and as necessary as they are to examine -- they generally come in standard-issue reporting figures (you know, time frames of the one-, three-, and five-year variety. Alas, your prospective manager's tenure won't likely coincide exactly with such nice and neat trailing-year periods.
What to do?
Well, at the risk of seeming immodest, you might consider giving our Champion Funds service a risk-free 30-day spin and see what you think. Before giving a fund the nod, I vet it for how it's done in relative and absolute terms on its current manager's watch. I also zero in on such salient details as fees, volatility, tax efficiency, and the overall shareholder friendliness of the shop behind the fund. Beyond that, I'm also a big fan of managers who eat their cooking by investing their own money in the funds they run.
So take the newsletter for a test-drive. I think you'll find it a helpful shopping list when cruising the aisles for those managers who really are worth their asking price.
Shannon Zimmerman is the lead analyst for Champion Funds and owns shares of Vanguard Total Stock Market. The Motley Fool has a strict disclosure policy.
