Warning-Best Stock Fund of the Decade Makes 18 Percent While Investors Lose 11 Percent

Hey, good morning everyone, this is Brian Fricke, BT you there?

Yep, still here, and take it away!

Wonderful. Well let’s just get started and jump right into it. Today we’re gonna’ talk about why some of the best stock mutual funds of the decade make money but the people that put money into those funds end up losing money. So we’re gonna’ talk about that. I’m gonna’ tell you why we stopped using Morning Star, if you’re familiar with Morning Star, it’s a popular mutual fund rating service. And we’re also gonna’ tell you how you, and just about anybody, can outperform 85% of all the so-called mutual fund professional money institutional money managers out there. So we got a lot to cover and we’ll have time for any financial questions or concerns that you may want to ask as well.

But before we get into that, I just wanted to comment briefly on what’s been going on in the market in, oh, the last week or so. If you haven’t heard, the markets pulled back some. There’s some, depending on whom you talk to, there’s fear and concern for this reason or that reason and all the other stuff. Here’s what we can tell you right now. Our investment system, based on basic economics supply and demand is obviously showing some short-term weakness in the market. Quite frankly it’s nothing that’s really surprising us, given the dramatic run-up that it’s had in the last year or so. So this currently looks like just an expected pullback in the market; the normal market volatility. As far as we’re concerned, as a company performance-wise, what this means is on average, and everybody’s account is a little bit different, but on average you know account values are down maybe 1%.

So, gotta’ make sure you put things in proper perspective as you’re looking at the general news out there today. We’re on top of things, monitoring things. If conditions deteriorate further and suggest that it’s time to step to the sidelines, we most certainly will. But now is not quite yet the time to do just that.

So, with that, I’m going to just jump right into it. I saw an article just a little while ago if you’re curious the best performing mutual fund of the decade was up 18% on an annualized basis and the fund is CGM Focus Fund. We’re not recommending that anybody run out and buy that fund, but here’s the interesting thing that caught my eye. Research would suggest that the typical investor in the CGM Focus Fund, instead of making 18% on an annualized basis over the last ten years, the research suggests actually proves, that the typical investor in that fund actually lost 11%.

Now how on earth can that happen? Well what we’re talking about is what’s known as dollar weighted returns which incorporate the effect of cash flowing into and out of the fund as shareholders, investors, buy and sell the fund. And this fund specifically tends to be a big swinger, if you will; typically it’s got fewer than twenty-five large cap stocks. So when the market is favoring large cap stocks the fund does exceptionally well. When the market is punishing large cap stocks, the fund performs horribly.

So, here’s what happened just to give you an example. The fund had an 80% return in 2007 and what do you think happened? Investors, when they learned about that return, poured $2.6 billion into the fund the following year. That year, 2008. And we all know what happened in 2008, the fund dropped 48%. So what did the average investor in the fund do? The only rational thing, of course, they withdrew three quarters of a billion dollars from the fund in the first eleven months of 2009.

Well what happened in 2009? The market was up, so was this fund. The bottom line is, the investors in this fund we’re chasing returns and zigging when they should have zagged. And that is endemic of what a lot of people do with investments, they look at what an investment did last year or in the past and that’s how they base their investment choices and selection which can be very harmful to your financial future, especially if you let your emotions take over and don’t do your homework before deciding what fund or what investment to place your money in. So, Morning Star, if you’re not familiar with Morning Star they are a very well known research firm, a lot of notoriety for monitoring, tracking mutual fund performance. They have a five star rating system. Five stars is the best and one is the worst. And if you are a mutual fund manager, you are working like crazy to earn a coveted five star or at minimum a four star fund. And there’s tons of research out there that the mutual funds that have a Morning Star ranking of a four or a five star fund, they collect a disproportionate amount of investor capital, or investor money, compared to other funds with just a one, two, or three star rating.

Well here’s the interesting thing; people that make the mutual fund selections based upon the Morning Star four and five star rating system… We went back and looked at future performance. In other words, what if you made all your investment decisions based on keeping your money in nothing but five star funds, as opposed to doing something crazy like maybe putting your money in nothing but one star funds from Morning Star. And here’s what the research has found with this particular rating system is 25% of the time, a five star goes from a five star fund to a one star fund the following year. And as you might expect, 25% of the funds that were ranked as a one star fund the prior year, moved up to a five star rating the following year.

So that just proves to us that it’s very difficult to predict, in advance, which funds are gonna’ be a one or even a five star fund. You just don’t know. And Morning Star, when you talk to their people, they’ll tell you that the star rating system is really nothing more than a good starting point. You don’t want to make your investment selection based on the star rating system. You want to make your investment selection based on the detailed research that’s available with Morning Star.

So we, of course, went and looked at that detailed research and looked at all kinds of different mutual funds. Large cap, small cap, growth, value, and international and the list goes on and on… And what we find is, depending on the time period you measure, 75-85% of all mutual funds under perform their benchmark category. So if you’re putting money into a large cap growth fund, and you measure your fund’s performance by a large cap growth fund index, 75-85% of actively managed, professional managed mutual funds will not outperform just an index fund of a large cap growth fund. And the same analogy holds true with pretty much every asset class. So, you know, logic would suggest perhaps that with today’s technology and computers we certainly ought to be able to screen and filter and sort through and find, you know, the 10 or 15% of these so-called professional money managers that can out-do the bench mark index. Well the reality is that’s very difficult to do, of not downright impossible and it’s certainly becomes almost impossible to do on a prolonged period of time. It’s just not a worthwhile exercise of time or investment research.

So that’s why we tell folks, if you want to outperform 75-85% of all the professional money managers and mutual funds out there, the simplest, easiest thing to do is buy an index fund or what we use are called ETFs (Exchange Traded Funds). And you too, can outperform 75-85% of all mutual fund companies. And that, in essence, is why we years ago stopped our subscription to the Morning Star fund rating system. It’s just, you know, good information, but why would we want to look into actively managed funds when 75-85% of the time, we’re gonna’ get better performance with a low-cost index fund.

And, by the way, these costs are not small. They seem small, but they add up. And here’s what I mean by this. The average no-load mutual funds, so we’re assuming you pay no commissions but you’re paying for active management, the average no-load mutual fund probably has an expense per year of about I’d say 1.5.% compared to an index fund that could be as inexpensive as .1-.2%. So you start multiplying an extra 1% return, less fees that you pay. More money in your pocket. When you start multiplying that over years and years, that adds up to serious money. We did a quick calculation for accounts that we supervise or manage on behalf of clients and just because of the fee savings, we estimate that we are saving our clients almost $2 million dollars a year in hidden fees and expenses just by using low cost index funds.

So that really is just what I wanted to bring your attention to with what’s going on in the market place. You’re gonna’ hear stories about this fund that fund and the other fund did great. The bottom line is investor emotions always tend to take over and cause us to do the wrong thing at the wrong time. A good example our people that got sucked into this CGM Focus fund and put money in at the peak of the market, if you will, and pulled money out at the, almost, the very bottom of the marked.

So we want to keep you from making choices like that. That becomes even more difficult to recover from. And with that, I think I’ve covered what I want to share with everyone. We want to open the line up for questions. Unless, BT, I’ve missed something.

No, not that I can think of. I’m ready to un-mute the line if you’re prepared.

Alright, tell everybody how this works.

Alrighty. Well everyone, I’m gonna’ take a moment and just let you know how this is gonna’ work out. We have what we call a party line. So everyone will hear everything once I un-mute the line, that is. We’ll hear everything that’s going on behind you and near you and if everybody talks at once, we’ll hear everybody at once. So if we could all form a line, so to speak, just raise your hand verbally, let us know you have a question and we’ll get to everybody most likely. We’ve got about fifteen minutes left in our half hour just to let everybody know that as well. I’m gonna’ un-mute the line and we’ll see who has a question. We’re all set.

And before we get started, if you’ve got stuff going on in the background that you don’t want the rest of us to hear, you can mute your individual line by pressing *6. And if you have a question to ask, and you’re on mute, make sure you press *6 again and that will un-mute your line. So, let’s go ahead and open it up. If anybody’s got a question, just go ahead and ask away.
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Oh, everybody’s shy today. Questions?

Brian, I got one, Mike Wenzo.

Hey Mike.

What do you guys think about maybe overseas? China Market now. I know, over the last year or so, we’ve, you’ve done, really well with that stuff and now all of a sudden, perhaps they’re having some problems over there with their economy. What does it look like, BT, if you know that right now?

BT, I’ll let you go ahead and take that.

Sure. Well as far as what’s going on in China, for the most part there’s plenty of interesting things going on economically. I’m not going to try and recap it all. But here’s how we look at that from an investment standpoint. Do we invest there? Or do we not invest there? And it’s kinda’ of, and not trying to skirt the issue of your question about what’s going on there, but I just want you to know how we’ll answer.

That’s what I’m really interested in though.

OK, well I’ll tell you about that too then. But, purely from an investment standpoint first. We’ll take a look at our investment system and we’ll use the supply and demand indicators that we have to figure out if there’s strength in that investment basket, so to speak. I’ll just call China a basket for now. And whether it’s China, or whether its Latin America or whether it’s small cap Europe, each of these areas, we can take a look at it and analyze is one stronger than the other from a demand standpoint? And that is not a perfect predictor, you know, the investment performance because there really is not crystal ball. But what we can do is take a look at history. You know, take a look at the trends. Look at, and analyze, you know, one investment versus the other, and at least gauge for the short term where we think the most strength is and then invest there. So, if China is going to, or any other part of the world for that matter, is going to fall apart, we’ll be able to take a look at that versus, say being invested in the US. Compare the two and say, “Do we want to be invested in the US Market, or do we want to be invested in China?” We’ll just go there. And that’s the beauty of the system is regardless of the mess or whatever’s going on, we can make a decision based on actual performance numbers and you know, really we’re not trying to hit a home run with investments. We’re trying to not to: A, not lose money – this is something that Brian always says, “Don’t lose money. And then make money while not losing money.” And.

I agree

Absolutely, and while we… Brian and I argue this all the time, because, you know, I always say, “Hey, when you’re playing in the sand box, sometimes you’re gonna’ get dirty. The market is the market and sometimes you’ll have, you’re gonna’ have some performance that, you know, goes backwards. You know and definitely, we don’t proclaim to be perfect, but we have figured out how to read our system and how to make sure that we’re not losing money most of the time. So much of the China situation are you reading into and is concerning you right now?

Oh no, it’s not concerning me at all, I just, no, no, no, no, I am just extremely interested in when you get in and when you get out of these things. No it’s not a concern, no I think we’ve all learned, since you guys learned your lesson from the last mess we had and I think, gosh there’s where all the growth is, if you will. But it did notice, there’s one more thing. I don’t mean to hog up here, but one more thing is I notice finally got online. Your website is expanding. I like the ability to look at the returns various time frames. Absolutely outstanding. I noticed last year from the amount that we were collectively I guess vested in equities, ok, made some unbelievable returns. I’ll give you a real good example like just equities, even though it was maybe 30%, 20%, it returned 83%! Ok, that this is my portfolio as an example, ah, and ah, for small amounts so is that going to be the ongoing philosophy for the portfolios being to mitigate risk go in with the more aggressive type stuff, well you just say, “Oh well but let’s just follow the supply and demand system.”

Yeah, well for everybody, it’s gonna’ be different. It’s gonna’ be individualized. But from the standpoint of you know, yeah, we always want to be able to mitigate risk and, I guess, from an investment standpoint, Mike, you know the overriding factors are gonna’ be how much risk is there in the market, how much, you know, what are the long term trends showing. There’s a lot that goes into, you know, how much are we invested in the market for someone individually? So, for you specifically, I’d rather talk with you off line.

Absolutely, thank you, very good.

Absolutely

Guys, let me just jump in. The, I guess, from a big picture point of view, really our supply and demand system is really, number one, it’s been around for decades. I mean it dates back to Charles Dow. You know, Dow Jones, the creator of the Dow Jones industrial average, so, it’s nothing new in that regard. The gist of it is, we want to identify areas of the market that appear to have increasing demand. Economics 101. We want to, the more demand increase for anything, price tends to go up. It also helps us to identify areas where demand is weakening and those are areas that we want avoid, or, under the right circumstances, those would be areas that we would short the market. In terms of risk reward, all that kind of stuff, over time, what we’ve experienced I think a broad generalization would be we’ve tended to on a big picture, clients probably capturing or end up experiencing the return of the market in a good year without having all their money at risk. Usually, know you, only 50-60% of the money is at risk. So you’ve got experience in the returns the (coughing) generates is 40-50% lower risk, just because we don’t have all your money in the market to a capture the returns.

Great, thank you.

OK. Next question? … No other questions. … All right. Here we go, last warning. Anybody have a question. Questions going once. Going twice. Last call for questions. All right everybody. Thank you for joining us today. We’ll be here next week. We’ll have another Coffee Club call. If you have a particular question or concern that you’d like to see us address on these calls, just send us an email or give us a call. We’ll be happy to cover any topic that is important to you. Otherwise have a great week and we’ll talk to you next week same time. Bye now.

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