Mutual fund managers to advisers: Don't abandon underperforming funds

Fund managers, urging financial advisers not to pull client assets out of underperforming funds, painted 2008 as an anomaly at the Morningstar Investment Conference 2009 in Chicago last week. Last year was one of the most “extreme” bear markets ever seen, said David Winters, chief executive of Wintergreen Advisers LLC of Mountain Lakes, N.J., and manager of the $815 million Wintergreen Fund (WGRNX). He made his comments during a panel discussion at the conference, which was sponsored by Morningstar Inc. of Chicago. It was the kind of market that can trip up even the best managers, Christopher Davis, chairman of Davis Selected Advisers LP of Tucson, Ariz., said during a speech at the conference. Mr. Davis, the well-respected portfolio manager of the Davis Large Cap Value portfolios and a member of the research team of other Davis portfolios, ticked off a list of successful investment managers who at some point all underperformed the market.

MEAGER YEARS

The list included such investment luminaries as Charles Munger, vice chairman of Berkshire Hathaway Corp., the Omaha, Neb.-based diversified investment corporation whose chairman is Warren E. Buffett. Mr. Munger — who ran an investment partnership of his own from 1962 to 1975 — was down 32% in both 1973 and 1974, Mr. Davis said. But Mr. Munger's investment partnership generated compound annual returns of 19.8% during its lifetime, compared with a 5% annual appreciation rate for the Dow Jones Industrial Average. Mr. Davis' conclusion is that 1973 and 1974 were anomalies. Active managers can still add value over the long term despite such hiccups, he said. To drive that point home, Mr. Davis suggested that advisers should emphasize to their clients using rolling returns over trailing returns. Unlike trailing returns, rolling returns give an investor a better idea of how a manager performs during multiple market periods, he said. “When you think about what you can do as advisers, that's dramatic,” Mr. Davis said in regard to advisers' ability to steer the conversation with their clients. Class A shares of his $26.9 billion Davis New York Venture Fund (NYVTX) were down 5.88% year-to-date as of last Wednesday, ranking it in the 25th percentile of its large-cap-blend category, according to Morningstar. However, the fund was down 34.46% for the one-year period ended that date, ranking it in the 70th percentile of its large-cap-blend category, and had an annualized three-year return of -9.37% (59th percentile) and an annualized five-year return of -1.46% (35th percentile). Although those aren't great numbers, the fund has outperformed the Standard & Poor's 500 stock index over every rolling 10-year period since 1969. “It definitely makes sense to look at rolling periods if what you are looking for is consistency,” said Stephen Gorman, president of Gorman Financial Management of Hingham, Mass., which has $100 million in assets. “You have to give some consideration to the fact that this past environment was one of the most unique we ever had.” Mr. Gorman didn't attend the conference; he made his comments during a telephone interview.
Investors have to have a long-term outlook, John Bogle, founder of The Vanguard Group Inc. of Malvern, Pa., said during a Q&A session with attendees. If they don't, they are just chasing returns, and that is a losing game, he said. “Trading back and forth doesn't work,” Mr. Bogle said. It is better to stick with a fund, he said in a separate interview, though he suggested that investors stick with passive index funds rather than actively managed funds. It would be foolish to drop a fund based on just one or two years of underperformance, J. Michael Martin, president of Financial Advantage Inc., a Columbia, Md.-based firm with $260 million in assets, said during a telephone interview. But that doesn't mean that the buy-and-hold philosophy makes sense amid volatility, said Mr. Martin, who didn't attend the conference. “What I'm trying to argue is what worked won't work,” Mr. Martin said. “We can't just stay the course.”
Mr. Martin wasn't espousing market timing, but Bill Gross, founder of Pacific Investment Management Co., did tell attendees during a keynote speech at the conference that investors and asset managers should brace for a “new normal.” That means economic growth of between 1% to 2% over the next several years, relatively high unemployment in the range of 7% to 8% and accelerating inflation, said Mr. Gross, who is also managing director and co-chief investment officer of the Newport Beach Calif.-based firm. That will crimp asset manager profits, he said. They won't be able to charge as much as they do now, because they will have to contend with a low-return environment, Mr. Gross said. One of his recommendations was that investors look overseas, particularly at Brazil, India and China. “The growth will be in economies where consumers are a small portion of the economy,” Mr. Gross said. Domestically, he suggested that investors “shake hands” with the government. Investors should look for what government is going to buy, and buy it first, Mr. Gross said.

FRUGAL FUTURE

There is no doubt that the next few years will be tough on investors, Jeremy Grantham, co-founder, chairman and a member of the asset allocation division at Grantham Mayo Van Otterloo & Co. LLC of Boston, said during a presentation. “We're going to have to learn to live with frugality,” he said. Leaders such as former Federal Reserve Chairman Alan Greenspan, and former Treasury Secretary Henry Paulson helped create the market mess, and there isn't much evidence that the current leadership is much better, Mr. Grantham said. “We have been incredibly badly led,” he said. But even the famously contrarian Mr. Grantham said that there is reason to be hopeful. “I do think this is a more optimistic period,” he said. “I find myself smack in the middle between the bulls and the bears.” E-mail David Hoffman at dhoffman@investmentnews.com.