Is your mutual fund manager consistently underperforming against the fund's benchmark? Or is your fund merely matching an index while you're paying a hefty fee for such mediocrity?
If you answered "yes" to either of those two questions, it may be time to sever ties with your fund manager. It's not personal, of course.
Portrait of futility
My beloved Chicago Cubs inspired this article. Like most Cubs fans, I thought the team's $94 million payroll and key off-season acquisitions would make 2006 a season to remember. Unfortunately, those hopes unraveled more quickly than usual, with the team putting 50 games in the loss column by the end of June for only the second time ever. That leaves this year's squad rivalling the 1962 Cubs as the worst team in franchise history -- and that's saying something.
Judging by the number of "Fire Dusty" T-shirts and signs in the stands at Wrigley Field, many fans place the responsibility squarely on the shoulders of the team's manager.
Those who don't care for the Cubs -- or baseball at all for that matter -- please bear with me here.
Severing the ties
I've compiled a list of three of Baker's most egregious managerial flaws. (I could have flagged others, but something tells me that non-germane topics like Dusty's "walks clog the bases" mentality probably won't fly with my editors.)
Baseball and investing have much in common. So if you spot these same traits in your fund managers, it might be time to send them packing. Who knows, maybe by putting the microscope to some of these errors, fans everywhere can escape this season with not only their pride intact -- but their portfolios as well.
Mistake No. 1: Throwing darts to see what sticks.
It seems that Dusty Baker turns in a different lineup card every game. He is constantly shuffling here and tweaking there in a vain attempt to find a magical combination.
Of course, in baseball, injuries and slumps make it impossible for the same combination of players to start all 162 games. Nevertheless, Baker's constant tinkering makes it tough for players to settle into a groove when they have no idea where (or if) they'll be playing the next day.
Imagine if a mutual fund manager was that capricious with the fund's portfolio, indecisively buying one day and selling the next. Actually, some managers out there think "buy-and-hold" investing is as outdated as AstroTurf.
Consider Hartford Global Advisers, a lackluster balanced fund with an annual turnover of -- get this -- 500%. That means the managers replaced every holding in the fund an average of five times over the past year. That excessive trading increases hidden brokerage commissions and other frictional costs, and chips away at a fund's tax efficiency.
Currently, the fund's top three stock positions are Cardinal Health (NYSE:CAH), Google (NASDAQ:GOOG), and Las Vegas Sands (NYSE:LVS) -- though all could be gone tomorrow. Not surprisingly, the fund's tax-adjusted five-year return of 5% trails 93% of its category rivals.
Fund managers should be flexible, but too much of a good thing can be dangerous.
Mistake No. 2: Failing to handle adversity.
Baker refuses to hold himself accountable for anything, instead shifting blame everywhere else -- in the case of this year's freefall to the cellar, he's blamed the injuries of two key pitchers (Mark Prior and Kerry Wood). He then derided the rest of the team by insinuating that it would be impossible to win without his "horses."
It is a manager's responsibility to work through adversity -- not let it derail an entire season.
Similarly, mutual fund managers will also see highs and lows and shouldn't crumble during a bear market or whenever their particular asset class happens to fall out of favor. When faced with adverse market conditions, good managers will at least tread water. Be leery of those who crack under pressure.
By all accounts, 2001 and 2002 were difficult years for equity managers, particularly those in the large-cap growth category. The average manager in that group steered his or her fund to losses of 20.9% and 26.9%, respectively, in those two years.
However, even by those standards, ING Large Cap Growth simply hemorrhaged money, tumbling 38.9% in 2001 and 36.8% in 2002. And during this year's setback, it has been more of the same: The fund has lagged its benchmark, while holding slumping companies such as Electronic Arts (NASDAQ:ERTS) and Medtronic (NYSE:MDT) at the top of its lineup.
As a result, though ING Large Cap Growth has reeled off some impressive wins -- soaring 95% in 1999 -- its inability to avoid losing streaks has left the fund near the bottom of the standings over the long run.
When it comes to achieving top-decile results over the long haul, the key is not necessarily earning huge gains when the market is up, but avoiding painful losses when it is down.
Mistake No. 3: Not getting the most from your players.
In general, those who still support Baker all sing the same tune: He's not on the field playing, so the losses aren't really his fault. By that same logic, anyone could steer an all-star caliber team into last place and keep earning a paycheck -- simply because his name wasn't in the lineup.
In the end, no manager can make the plays, but he is responsible for just about everything else. Not only in-game situational strategy -- like when to bunt, steal, or hit-and-run -- but also putting the right people in the right spots and demanding that they hustle.
Likewise, mutual fund managers can't make the stocks in their portfolio perform well, but they are responsible for assembling the strongest roster from what is available in their corner of the market.
Case in point, some would have expected Federated International Equity to post a strong showing last year -- after all, foreign stocks were among the strongest of all asset classes in 2005, with the MSCI EAFE Index gaining 13.6% on the year.
Unfortunately, the fund only delivered an 8.9% gain -- roughly half of the 15.3% return of its peer group. While the fund does have some heavy hitters such as GlaxoSmithKline (NYSE:GSK) and Diageo (NYSE:DEO), this is a classic example of an underperforming coaching staff that hasn't made the most of its available players. In fact, the fund has lagged its category average for the past six consecutive years and ranks in the bottom 6% of its peer group over the past five.
Postgame analysis
Winning percentage alone doesn't tell the entire story for a manager, but judging by the Cubs' lackadaisical play, mental errors, baserunning blunders, and sheer lack of fundamentals, Baker is simply not doing enough with the tools at his disposal.
Affable and popular with his players though he may be, the time has come to dip into the managerial bullpen.
Likewise, you can't always judge a mutual fund manager by his or her absolute performance. However, the fund universe is filled with mediocre offerings that fail to participate in rallies and then tumble more than most when the market tanks.
If the strikeouts have begun to outnumber the homeruns, it may be time to say goodbye. Fortunately, our Motley Fool Champion Funds service has made it very simple to find a replacement. Small-cap, global, fixed income -- whatever type of fund you need to round out your portfolio -- fund guru Shannon Zimmerman can point you in the right direction.
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Fool contributor Nathan Slaughter owns none of the stocks mentioned, but he did once play high school baseball against former Cubs second baseman Todd Walker -- who deserved better. Electronic Arts is a Stock Advisor pick. Diageo and GlaxoSmithKline are Income Investor picks. The Fool has adisclosure policy.
