Chiangmai Mail - Vol. VII No. 34 - Tuesday August 19

As everyone knows, what goes up must come down. This is equally applicable to a certain item of clothing as it is to fund prices and share performances. The biggest and, supposed, best make as many poor calls as the rest of us mere mortals. For example, Goldman Sachs (GS) had Marks & Spencer (M&S) as a ‘Buy’ recommendation from when it was priced at 745p. They finally realized that this was not the brightest option when they recently removed the aforementioned tag when it was at 235p. So, if someone had taken the advice when it was given in May last year they would have lost over 68% of the money invested. However, GS were not the only ones with egg on their faces. Investec still had M&S as a ‘Buy’ when it was at 230p.
This is from the same people that recommended Sub-prime to us all and look where that got us. The research done on this was a tad poor to say the least and many of the investment companies’ managers looked at the potential size of their bonuses as opposed to their clients’ wallets.
The question is, who are these researchers and how do they come up with their recommendations? Some recent wag came out with the glorious statement that it just “keeps the mentally disadvantaged off the streets.” It reminds me of JK Galbraith who said that “economics is extremely useful as a form of employment for economists.”
Anyway, I digress. Back to market timing. Another classic is what happened to the Legg Mason Value Trust. Over the last ten years this has consistently outperformed the S&P500. However, in the space of six months, it is now lower than its benchmark and people are now left with the same amount as when they originally invested in 1998. This just goes to show that nothing keeps on going up for ever and that those who invested recently will be ruing the day they did. It also shows that fund managers that rely on growth in assets under management for a source of income as opposed to value delivered (i.e. the vast majority of them) are extremely vulnerable to their own success.
Another good example of this is the old Fidelity Magellan Fund which at it’s height a few years ago had over USD100 billion in it.
Dan Gross of Slate Magazine wrote about the problems that a very large fund has to face: “When you have to buy as much as they do, it’s difficult to open and close positions quietly. Hedge funds and other quick-fire traders are constantly trying to figure out which stocks the big dogs are buying and selling and how they can profit by jumping in and out ahead of them. And unless you want to buy hundreds upon hundreds of positions - in which case you’re essentially mimicking the broader market - a huge mutual-fund manager has to confine himself to huge stocks. Magellan has 207 positions, and its top 10 holdings are the same giant stocks that everybody owns.”
Regular readers of this column will know that, with honourable exceptions like Man Investments, we prefer active funds that are hungry for success. This is because, as can be seen from above, excessive size is a real problem when trying to achieve continued investment success. It behooves investors to select a manager who has no loyalty to anyone but the investor who has elected to put money into that fund. It will sort out the men from the boys and those that manage to survive this bear market will emerge leaner, meaner and a lot stronger.
Now that the poor times have fallen on us again, it is an opportune moment to remind us of what the Yale University Endowment CIO David Swensen said three years ago: “Unfortunately, the track record of individual investors with plain-vanilla mutual funds fails to inspire confidence… [they] overwhelmingly fail to beat the market. In a well-structured study published in 2000, an investment manager, Robert Arnott, showed that over a two-decade period, excessive management fees ... reduce the chance that a mutual fund investor will beat the market to less than one in seven.”
Swenson went on, “Most mutual funds do not produce even minimally acceptable results because of the conflict between the mutual fund company’s profit motive and the mutual fund manager’s fiduciary responsibility. Mutual fund companies profit by gathering assets, charging high fees and churning portfolios. Mutual fund managers produce superior investment returns by limiting assets, assessing low fees and trading infrequently. In case after case, profits trump returns. The mutual fund manager abrogates fiduciary responsibility for personal gain.”
Not all fund managers are greedy incompetents but a lot of the managers are managed by their companies and told that profits for the company are more important than those of the investor. As stated above, I cannot emphasise strongly enough that if you do own funds then you will do a damn sight better by going with a high quality fund manager than just picking a large well-known one.
Many fund managers are also limited in what they can do by the make up of the fund itself. If the fund insists that it can only invest in equities then that is it. There is no facility to allow the manager to jump into alternative funds, commodities, property etc. There is the crux of the matter, as the real challenge now is actual asset allocation - especially having the ability to move money away from any particular area where it may be vulnerable.
Just to show how bad the markets have had it this year you only have to look at the chart on this page. Sector after sector shows massive losses with the only ones not suffering are those industries linked to commodities. This is just the FTSE All Share but it is equally applicable to any major market in the world right now.
The world is a different place now than it was recently. What to do?
1. Do not tie money up in something that you cannot get out of relatively quickly - especially in the equity market.
2. Cash is king.
3. Bonds are not necessarily a good alternative either - not even government ones. For example, the UK government is going to find it difficult to give any tax cuts in this recession and inflation looks as though it is rearing its ugly head at the moment. What with the British Pound looking increasingly vulnerable, it is not the time to be buying these instruments
4. If you have not already done so then it is a good time to consider getting into good quality absolute return funds with a multi-asset class approach.
5. If Option 4 is still too aggressive for you then there is always that option called … Gold.
What all of this basically amounts to is that nobody, not even Warren Buffet, can time individual markets or stocks. Even if you could then it would not really help that as much as 90% of returns comes from asset selection, i.e., market timing at asset selection level just does not work and can be very expensive. Asset allocation, however, is a form of market timing and results in almost all of the growth your portfolio will make.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Paul Gambles on paul@mbmg-international.com

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