The Perils of Chasing Performance

I recently read an article that intrigued me. It is an older story reported by Eleanor Laise, of The Wall Street Journal on December 31, 2009; it told the story of the best performing mutual fund of the decade which ended that day. However anecdotally, it is a ringing validation I’ve ever yet seen of the core principle of the value of good advice – the knowledge & discipline of putting a plan together and sticking to it. As Warren Buffett says – it’s the “sticking to it that’s so hard.”

The champion fund was the $3.7 billion CGM Focus Fund and according to the WSJ, citing research by Morningstar, it returned (through December 29) 18.2% a year for the decade just then ending. This achievement (in a flat to down market) is all the more remarkable because the fund totally whipped the second-best performer by an astounding 340 basis points. (The second-place finisher was Lord Abbett Micro Cap Value I, at 14.8% per year.)

But you must not be remorse for missing it. So did literally everyone else, including—and especially—the CGM Focus Fund’s average shareholder during these ten record setting years.

For you see, Morningstar calculated the average shareholder return in the fund during the decade—based on the fund’s critically important “dollar-weighted return” —managed to rack up a LOSS of 11% per year. That’s Morningstar saying that!!

How did such a thing happen? You see, in 2007—the all-time top of the equity markets —the CGM Focus Fund returned a roaring +80%. Then performance-chasing "investors" poured $2.6 billion into the fund during the following year, even as the fund went down -48%. Followed by "Investors" pulling out three quarters of a billion dollars by November 30, 2009. So, the bulk of “investors” money was only in the fund during the dramatic sell-off of 2008 & early 2009.

High performance always brings in huge amounts of not-so-smart money, forcing the purchase of most of a fund’s assets at the worst possible prices, and thus insuring that whatever is drawing all that hot money must underperform in the next block of time. (Is it happening to the gold ETF right now??)

There is no statistical evidence for the persistence of performance. No trusted advisor allows (that is, enables) his clients to chase performance. You pay for customized financial advice – not “follow the herd” advice.

Through December 31, 2009, the story of the best performing fund of the decade proves one thing, and one thing only. The dominant determinant of real-life, long-term investment outcomes is not investment performance; it’s investor behavior.

Clients should hire advisors for 1 good reason – the value of good advice – the knowledge & discipline of putting a plan together and sticking to it. As Warren Buffett says – it’s the “sticking to it that’s so hard.” Now, where have you heard that before?

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