There are some well demonstrated propositions about mutual funds and about retail investor behavior:
- Most mutual fund managers under perform their indexes, with the number ranging from 60-70%, depending on the study.
- The top performing asset class (high yield bonds, Treasuries, large cap equities) in a given year generally doesn't show up as the top performer in the following year. Even with randomness in returns, runs of top performance do occur, as with international equities were the top performaing asset class from 2004-2007. As they say in the boiler plate mutual fund disclosures, "Past performance is no guide to future performance."
- All things equal, it's immensely more difficult to achieve stellar performance with a jumbo pool of assets than with a small pool of assets, assuming the manager stays within investment policy guidelines.
- Retail investors rarely know why they are buying an individual mutual fund, and they almost never look at an asset class in the context of their total portfolio risk and return.
- Since they don't know why they bought a fund, they usually sell when there is a period of under performance relative to the market, even though their fund manager might be pursuing a proven, consistent strategy which historically wins over time.
- When they sell, they chase performance and pile like lemmings into the hot performing mutual fund based on historical, not expected returns. This is what happened with the Fairholme fund.
- So, individual investors sabotage themselves and benefit only their brokers with high turnover, usually incurring fees.
Fidelity had two funds worth noting, for different reasons. Magellan, which was the original mutual fund darling of the financial press from Peter Lynch's tenure, returned -2.70% per annum for the five years, with $12.9 billion in assets. This fund, once the core of Fidelity's offerings, has gone through too many manager changes, along with significant instability in the portfolio strategy, design and investment process. NYU Stern's Antti Petajisto, used a measure called "active share" to identify fund managers he called "closet indexers," who charged high fees in relation to index funds for essentially mimicking the index. Magellan under a previous manager had been a closet indexer for several years, a far cry from its history as a growth fund with a value orientation and strong stock selection.