While I am not a fan of active management, David Swensen outlines some characteristics of truly outstanding managers in a chapter titled “Winning the Active Management Game”. These principles are in turn sourced from a 1998 report of Longleaf Partners funds. A winning mutual fund will:
- Treat investor’s money as their own.
- Have managers invest significant portions of their wealth in their own fund.
- Invest for the long-term and exhibit low turnover.
- Have a clear investment strategy.
- Concentrate their portfolio in their best ideas.
- Have low costs, recognizing its importance in earning attractive returns.
- Limit assets under management by closing the fund to new investors.
The vast majority of mutual funds fail to meet these criteria and Mr. Swensen notes that perhaps a few dozen out of the 9,000 or 10,000 funds in the U.S. would merit consideration. He adds a few words of caution for a hopeful market beater:
Even after identifying an extraordinarily talented team willing to act in investor interest by pursuing superior returns, a harsh reality intrudes. The standard prospectus boilerplate language defines the problem: “Past performance provides no guarantee of future results.” People change. Markets change. Circumstances change. Even with all the stars properly aligned, the most carefully considered decisions sometimes prove wrong.
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20 responses so far ↓
1 Four Pillars // Sep 25, 2008 at 10:51 am
a few dozen out of the 9,000 or 10,000 funds in the U.S. would merit consideration
Wow, talk about trying to find a needle in the haystack. Sounds like a lot of effort for little reward.
Index funds and ETFs all the way!
2 Dividend Growth Investor // Sep 25, 2008 at 11:12 am
This sums it up:
“Past performance provides no guarantee of future results.”
Just because Warren Buffett has been outperforming the market over the past 5 decades doesn’t mean that he will be outperforming them over the next 5 decades.
3 Jon202 // Sep 25, 2008 at 11:16 am
Warren Buffett *IS* the market.
4 James // Sep 25, 2008 at 11:58 am
DON’T
Then you instantly save that approximate 2% MER they charge you your trouble. Look you’re ahead already!
5 Canadian Capitalist // Sep 25, 2008 at 12:38 pm
I agree with your comments. Still, there might be situations where you have to. For instance, at my group RRSP at work, we have access to active funds but not index funds. Of course, the vast majority is indexed.
6 Aleks // Sep 25, 2008 at 1:05 pm
“7. Limit assets under management by closing the fund to new investors.”
This is a bit of a catch-22, don’t you think? If you’re shopping around you are a new investor.
7 Robillard // Sep 25, 2008 at 2:26 pm
It looks like hedge funds would fail most of the criteria listed. For hedge funds, only number 2 normally applies. Also, if a hedge fund stops taking new investors, it may mean that they are limiting assets under management, or it may mean that the fund manager and custodian is closing it because it has a bad record.
8 NN // Sep 25, 2008 at 9:18 pm
DGI: Warren Buffett is the proverbial monkey in front of the typewriter that churned out The Illiad……. followed by The Odyssey - not a chance event. He might very well underperform the market over the next 5 years, but almost certainly will outperform handsomely over the next 50 should his successors adhere to his philosophies).
The real problem is that the average investor in active funds underperform the active index!, I guess mainly due to ‘chasing last year’s winner’.
9 Blogging About Money // Sep 25, 2008 at 10:27 pm
Aleks, the purpose of closing the fund to new investors is to only seek out opportunities to invest funds in a manner that doesn’t dilute the current fundholders, and not to farm out funds for increased MER revenue. When opportunities are abundant, funds usually open for new investors.
There are very few options available in Canada. http://www.gurufocus.com really documents who the better active fund managers are.
10 prakash // Sep 26, 2008 at 4:14 am
nice
11 Weekend Reading - Sept 26, 2008 | Million Dollar Journey // Sep 26, 2008 at 8:00 am
[...] Canadian Capitalist shows us how to pick a winning mutual fund. [...]
12 mike at second opinions // Sep 26, 2008 at 4:30 pm
Finding a quality low cost active fund is definitely like searching for the needle in the hay stack! Index funds on the other hand are like buying the whole haystack at a ridiculously low price and knowing that no matter what goes up you own it. Of course, that will also mean you own the dogs with fleas as well. But on average I will go with cheap and diversified and leave the guess work to the fund folks!
13 Thankful For Fools // Sep 26, 2008 at 6:03 pm
I believe that mutual funds are primarily an investment which a beginning investor uses for several aims:
a) learning the basics of investing, tracking your fund performance, etc.
b) starting a nest egg, most banks offer preauthorized contributions to funds starting as low as $25 a month, it’s easier to start out with investing by gradually increasing the amount you contribute until you can focus strongly on more serious stock investing
If you have holdings exceeding 25000 there’s no real reason to rely on funds.
14 The Financial Blogger | Financial Ramblings // Sep 27, 2008 at 6:01 am
[...] Capitalist wrote a quick but very useful-straigt-to-the-point post about how to pick a winning mutual fund. Not bad for an ETF [...]
15 memery2000 // Sep 28, 2008 at 1:11 pm
as salary incomed small investors, with limited days before lost earning capacity,how can they make money if their investments are becoming less today? how can they be sure getting better next 5yrs?
is there anyone here who made money from his investment?
16 Eat Well and Keep Warm For Less! // Sep 28, 2008 at 5:31 pm
[...] The Canadian Capitalist shows us how to pick a great mutual fund. Here are 7 features of a solid fund. [...]
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[...] In the state that the stock market is in, there sure aren’t many mutual funds that are working but Canadian Capitalist gives us 7 traits that a solid mutual fund should have. [...]
18 Weekly Roundup: Chronic Neck Pain Edition at Clever Dude Personal Finance & Money // Sep 29, 2008 at 8:52 am
[...] pick mutual funds? Almost randomly I guess. Maybe I should read Canadian Capitalists quick list for picking a winning mutual fund before I buy more next [...]
19 Cassandra Parker // Oct 1, 2008 at 12:21 am
Hi,
I am surprised. How can Canadian Capitalist seem like a stormy rain in the time of financial drought. They are doing good.
And thank you for the post.
20 Hot Link » Blog Archive » Weekend Reading - Sept 26, 2008 // Oct 18, 2008 at 6:59 am
[...] Canadian Capitalist shows us how to pick a winning mutual fund. [...]
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