This may come off as an unpleasant rant. Between a couple of articles I found over the weekend and watching the Consuelo Mack show on PBS I came away with a very low regard for the way some folks do things.
First up was an article from Morningstar about what they got wrong in 2008. I have been writing about how worthless the analysis is for as long as I have been writing. They are a bottom up shop and from what I can tell it is a rare day when bottoms up warns of a bear market. Low PEs and other ratios don't matter when the market is going to rollover into a bear. When the market is going up most stocks go up so a good bottoms up might find stocks that go up more than market but being right about the market would seem to be more important. So with that backdrop Morningstar says the learned a bunch of things in 2008. I would wonder what they learned in 2001 and why that seemingly did not help in 2008.
This article from Seeking Alpha contributor Marc Gerstein posits that collectively the crew at Morningstar is just too young. He believes that experience matters a lot when it comes to navigating the market. I find his take interesting because at 42 I am probably in between his definition of too young and experienced. One reader commented that Morningstar has a bullish bias which hurts them. I don't know if that is true or not but there might be something to the youth angle but I do think it is bigger than that. Look at Larry Kudlow who must be close to 60 either way or Art Laffer or even Brian Westbury (I think Brian is older than me) they are all experienced and all missed this coming in hideous fashion, bizarre really.
This gets me to the Connie Mack show which this week featured Brian Rogers from T Rowe Price and Chris Davis from the Davis funds. Brian's fund the T Rowe Price Equity Income Fund lost 35.8% in 2008 which was the worst year for the fund going back to 1985 "by a lot." He said that when there is a severe credit contraction there are very few places to hide. Even safe areas like utilities were "traumatic." Consuelo asked if there was anything he would have done differently or could have done differently and he answered "no I don't think there is." He said they would continue to focus on good quality companies that have struggled, with good balance sheets and valuations. He then said there are things he would have done differently but he didn't say what.
So I guess the next time the market drops 38% his fund will be pretty close either way? Did he really not know that credit contractions cause problems in the markets? That is the entire idea behind the inverted yield curve.
Chris Davis didn't really distinguish himself with anything he said. He admitted completely missing AIG and underestimating the effects of constrained liquidity. For as long as I have been aware of the fund they have had a colossal weighting to financial stocks. I will concede the following is unfair but somehow when he speaks (and he is on this show as often as anyone) I get the feeling he is reciting someone else's thinking. His is a family business started by his grandfather so maybe that is what I think I am hearing but something just never quite seems right there. Very unfair on my part but that is the sense I get.
In past posts I have mentioned that mutual fund managers are not the asset allocators. It is reasonable for a fund manager to invest all of the money in his fund so this post is a bit of a contradiction but I was dismayed by Rogers' comments and to a lesser extent Davis'. So an active fund manager might be all in but these funds can invest at the sector level in any manner they want so they could have underweighted or avoided financial stocks (financials clearly hurt Davis, not sure about Rogers but JPM, GE and WFC show up in his top ten).
I am so critical here because I think well if I saw something bad coming (but did not correctly guess the magnitude) how did these guys miss it so badly? They both are smarter than I am and that is not false modesty. Davis might say something about the capital gains embedded in the positions (a point made on past episodes of the show) so maybe no one should buy the fund going forward but that would also mean he made taxes the priority which will lead to tears more often then not. Taxes should never be the first priority.
In a video a few weeks ago I made a joke about never wanting to say to someone "I just never saw it coming" and while I'm not sure, it seemed like both Rogers and Davis said they never saw it coming. I'm sorry but I find that inexcusable. I feel much better about being able to say I tried to protect your assets and then explain where it did work and where it could have worked better.
24 comments:
My thoughts are:
1) as you alluded to, they may not have the option of not being fully invested. That is, shareholders expect to be fully exposed to the market. I would presume the prospectus spells this out.
2) the managers probably fear performance that strays too far from traditional benchmarks (SP500). Therefore, they weight their funds in a similar manner. If they grossly underperform, investors leave. They are paid by investments under management, not performance. Follow the money!
3) if many funds give index like performance, you might as well just invest in an index fund and keep the money that goes for expenses for yourself.
4) I have said this before, if the warning signs said avoid equities in general, and financials in particular, the capital has to be placed somewhere. Someone with a balanced 50/50 approach with fixed income that is uncorrelated to equities (treasuries) has not faired all that badly. However, history is full of false warnings and missed opportunities. Opportunity costs can be quite expensive. (Same for blunders of being invested in the wrong sectors)
5) Mutual funds are in business to make a profit for their owners first. In my opinion, that is why shops like Vanguard are thriving in today's culture of greed. The shareholders are the owners. No conflict of interest.
You have been fooled by con artists. I'll bet long term mediocre performers, stealth index funds, get paid better than anyone else in the business. Like the previous poster said, follow the money.
Devil's advocate here ...
Suppose you believed that the markets were random and that the SMA rule you follow didn't actually work? What would you do differently? If you look at it from that perspective, I say the fact that they didn't change anything is a good move. Changing in the middle of the game is always a recipe for making a bad thing worse. Like you, they had a game plan ahead of time and for better or worse, they stuck to it.
I think you find in the long haul, defensive action is usually costly, especially if it's put on consistently (i.e. buying puts, double shorts, etc). So your only alternative is to be out of the market or in the market.
Their analysis lead them to believe that being in the market all of the time was the best move for their clients.
You severely underestimate your self.
Maybe that is one of your advantages :)
I've been following Morningstar analysis for over a decade since they are available at the local library.
Question: why would you expect Morningstar to provide anything BUT bottom up analysis? To me, that's what they do. I use them to give me some fundamentals on a stock or fund and as a basis for comparing performances.
I will say that I've never looked at any of their newsletters; I think they have a newsletter of ETF portfolios.
The following link is an EXCELLENT post yesterday by Mish criticizing Schiff and his investment performance as well as outlining Sitka Pacific's ideas.
I am contemplating giving money to Mish, does anyone here have any personal experience?
the thigh-bone connected to the knee-bone, the knee-bone connected to the leg-bone, the leg-bone etc....
Given the current state of the 'patient', what bone has to be mended first for a successful and complete recovery?
Employment? Liquidity? Housing? What??? Where???
Too young to pick winners or convince investors?
Mish's rip would mean a lot more if he'd post his own results for the last 10 years.
IMO, posting that portfolio page goes well over the line. Assuming one can define a "line" in blogging.
Just another reason to have multiple income streams and diversification of assets. And, to remember the golden rule of investing: almost nothing turns out as expected.
T
There are few managers that aren't asset gatherers, T.Rowe and Davis are NOT the exception. It is the whole problem with using funds in general - as pointed out if the stray they pay. The lessons from 2001 for many magers were simply "If i dont go with the herd, people will leave my fund even though I don't feel tech is the place to be." TRowe and Davis both knew things would rollover, but when everyone needs to own JPM, BAC, Wells, GE etc. because "everyone else owns them" beating the market by 3% on the downside becomes the new killing it. Why is XOM holding it's value so well? Because all the major players own it...not because it is a good company. The mutual fund business stinks.
Why does the performance of the T. Rowe Price mutual fund have anything to do with "what everyone else owns"?
His fund objective says he owns equities. Given that, is it logical to expect him to go to cash if he thinks things will go bad? Or is it logical to expect him to stay in equities 'cause that's his fund objective?
I don't have an answer. I will say that I would expect a mutual fund like that to stay in equities.
I would expect any equity mutual fund to only hold a bit of cash, but what I would expect is for the managers to see some of the trouble coming and therefore outperform the S&P by 3-5% or so last year. Any fund that rode financials down and underperformed the S&P should probably be sold. If you ever neede active mgt. to show some value last year would be it. Regarding Morningstar, yes all the analysts are young. My feeling is 3 to 4 people at the top make all editorially decisions and the younger workers are simply researchers. Most disappointing about Morningstar is their predicatable analysis of mutual funds. Once, they "like" a fund (always low expense, turnover) they will "stick with it" far longer than any reader on this blog probably would. Underperformance in a down market to me would be a sell because the fund has invalidated whatever reason someone may have had to buy it.
The issue is not should they have been in cash, since many are capped at owning xyz% of cash. The question becomes how are they valuing BAC, C, GE et al? You have 5 pages of financials with 80 pages of footnotes. They own them not because they offer a good investment, but because they are owned by fellow funds and the S&P - there is no way to value these companies. Their business is not to invest as well as they can, their business is to collect assets and generate fees. There is no incentive for T.Rowe to take a "risk" by not investing in a sector. They would rather do nothing and lose the money, than be "wrong" by not owning a sector.
Morningstar "likes" funds that perform. The equation for their star rating heavily favors performance.
I think these guys, pros that they are, just missed it. They do bottoms up analysis primarily, just like Morningstar, and they just don't believe forecasting the economy is possible. It's a little ridiculous but not unusual in our profession.
Now that I think of it, you could tie this into a discussion about Bill Miller.
Most of the funds I follow that are able to move into cash in "desperate" times, missed the downturn. If this was not a desperate time, then when is it?? My conclusion, is that most managers got this wrong.
It seems to me that financials were a great outperforming sector right up until they weren't.
"Don't confuse genius with a bull market." (Old Wall St adage)
My new version
"Don't confuse the financial panic of 2008 with a bear market."
OG
First, being "smart" has amost nothing to do with making good common sense decisions. You seem to have no problem walking away from things you don't understand or feel uncomfortable with. Second, some equity funds do maintain over 90% holdings regardless of the market cycle. They refer to this in their letter to fundholders. Some don't. I've owned Fidelity Low Priced Stock Fund, and have tracked the fund manager's positions as well as the data allows. He has like you been as high as 30% in short term bond positions or notes when he felt the market dictated that action. The fact that the smartest folks made a bad call is Taleb's thesis. Being right is sometimes more luck than being smart. Then again, Madoff has taught us that being smart can be more profitable than being right or being lucky. The bottom up and top down observation about morning star is interesting. The overweighing in financials has been a concern of mine for several years. After you discussed it in 2007, I looked hard at my OEF's in my 401K and moved to cash. You saved me alot of money and heartache. Thanks, Sam
Stephen Drone,
You can access Mish's 4 year return at his website at Sitka Pacific. Sitka has performed very well check out their hedged growth strategy.
These are the smart guys. They have ho-hum performance that gives most apathetic investors no reason to leave. They also probably have an army of "advisors" collecting 12b-1 fees recruiting new investors all the time. Their compensation structure as has been pointed out increases as assets under management increases. I would venture to say that they never close their funds to new investors like Vanguard does from time to time. They are smart because they have job security and an increasing income stream.
The question is, what do they do with their own money? You think most of it is parked in their own funds?
Excerpt from the Hussman Funds' Weekly Market Comment (1/26/09):
As of last week, the Market Climate for stocks remained characterized by favorable valuations and unfavorable market action. The appropriate investment policy in this climate is to gradually, and I emphasize gradually, expand market exposure on significant price weakness.
Unfortunately, the failure to address the foreclosure aspect of this financial crisis has revealed itself in a fresh widening in credit default spreads, which suggests that the add-on effects to the economy will be worse than they would otherwise have been. That suggests that we allow for the possibility of 'revulsion' against stocks, at least until we observe market action that suggests better tolerance of risk.
There are numerous stocks that I believe will be seen in hindsight as fantastic bargains a few years from now, and investors are only beginning to separate the wheat from the chaff. Hopefully, we'll observe that process continue even if the general behavior of the market is uncertain. The Strategic Growth Fund is predominantly hedged here, with only a small exposure to market fluctuations, so most of our returns at present are likely to be driven by differences in performance between the stocks we own and the indices we use to hedge (primarily the S&P 500 and Russell 2000).
There will probably be enough ebb-and-flow in the economic data to allow for significant strength in the financial markets at various points this year, but we will respond to economic developments, stock valuations and market action as that evidence unfolds. Meanwhile, it may be helpful to reiterate some comments I made in December (Recognition, Fear and Revulsion):
Strong intermittent advances are typical during bear markets, and can often achieve gains of 20% as we've seen in recent weeks, and sometimes substantially more. But the very existence of bear market rallies can be a problem for investors, because they clear the way for fresh weakness. The scariest declines in bear markets are typically the ones when investors think they are making progress and recovering their losses, only to see stocks go into a new free-fall.
That cycle of decline, followed by hope, followed by fresh losses, is really what ultimately puts a final low in place. The final decline of a bear market tends to be based on 'revulsion' - a growing impatience among investors who conclude that stocks are simply bad investments, that the economy will continue to languish, and that nothing will work to help it recover. Revulsion is not based so much on fear or panic, but instead on despair and disillusionment. In a very real sense, investors abandon stocks at the end of a bear market because stocks have repeatedly proved themselves to be unreliable and disappointing.
My impression is that regardless of near-term prospects, we will observe a tone of 'revulsion' at some point next year, which we should certainly allow for especially during the first half of 2009. At that point, we should not rule out a low that would compete with the November lows and perhaps break them, but we should also expect that the market will be more selective at that point, so there will be many stocks that hold above the lows that have already been set
It took objective thinking to see this bear market coming. Ideology dictates the views of many, e.g, Kudlow, and following old rules like buy the dip doesn't help when a historic financial collapse trumps everything. A few saw it, like Doug Kass, but they don't follow group think.
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