Monday, March 28, 2011

Mutual Funds: My love has cooled, but I'm not movin' on, yet.

A few years ago mutual funds were all the rage. The market was the place to make money if you knew what you were doing BUT . . . The big but was "but most of us didn't know what we were doing." The answer was to entrust our investment money to some folks who did know what they were doing. In return for earning us big bucks in the market, these experts would take a percentage of the money to cover their costs and pay them a handsome income.

Well, we all soon learned a few things. First, the experts weren't all that good at making pots full of money. In fact, many of us felt that we could have done as well without them and saved ourselves all the associated costs, called MERs, to boot.

The Management Expense Ratio (MER) is composed of the multitude of expenses incurred by a mutual fund during the year. If you could magically do away with MER, you could up your return by that percentage. On paper some of the expenses that contribute to the relatively high MERs reported by many actively managed mutual funds seem to be expected, necessary evils: research, salaries, marketing.

Yet, in truth, many mutual funds that simply follow an index perform as well as the ones that are actively managed. If an index fund boasts a MER of .5 percent opposed to its counterpart in the actively managed sphere, which may have a MER of 2.5 percent, the index fund is 2 percent ahead of its actively managed competitor right from the get-go. This is a big handicap and most actively managed fund never get over it. A high MER is a killer — for you, not for the managers.

As I first openly confessed last year, during my mutual fund stage I got burned time and time again. One of the funds that I bought wayback when was the RBC O'Shaughnessy US Growth fund. It came highly recommended with lots of stars. Sadly most of its stars fell from the investment sky and today only 2 stars remain dimly glowing.

Last year this fund was perfect, perfectly bad.
When I first talked about my disastrous foray into this mutual fund, I was down 57.07%. Today I am down only 43.56%. Last year I wrote that I continued to hold the fund because nothing in life is perfect. Surely this fund cannot keep its perfect losing streak going forever, I wrote. And I was right. It is now on a tear!

This is an interesting turn of events. Do you recall the book How to Retire Rich by James O'Shaughnessy? I do.

According to Common Sense Advice:  

"Jim set up a set of mutual funds a few years back, promising to use his strategies in the funds. Of O'Shaughnessy's four original funds, only one beat either the Standard & Poor's 500-stock index or its average comparable fund, as measured by Morningstar. And that one, Cornerstone Growth, prevailed by a sole percentage point."

What went wrong? Read what Efficient Frontier has to say:

"Consider the performance of poor Jim O'Shaughnessey, who sliced and diced historical stock returns in a dizzying variety of ways, coming up with impressive excess returns [on paper]. How well have his funds done as a group in real time? Don't ask."

So, why do I hold on? I don't want to make the same mistake on a big scale that I made on a small scale with my block of silver. I held that 100 ounce brick for years. When the price broke free and started to climb, I sold. In just a few months, the price has almost doubled. Oh, I got out with my shirt but I could have gotten out with a full wardrobe.

Check the screen grab below on RBC O'Shaughnessy US Growth. Look at the comparative performance. For the last six months this fund has been on a roll. It has been sitting right at the very top of it's category for the past six months.

I say, don't sell the leader of the pack. But such a herculean effort will not go on forever. The day will come when this fund will tumble from its perch. When it falls deep into the yellow, the green or even dives to the blue depths, I'll dump all I've got, find a good US ETF paying a good dividend and be gone. (This fund makes up part of my U.S. investment allocation. If I sell, I should replace it with another American investment to keep my allocation goals on track.)

Remember, if you click the ScotiaMcLeod Research image, it will enlarge. If you click it again it will be full size and easy to read. Cheers!


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