When it comes to playing defense, most fund managers’ hands are tied.
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After a 10-year bull market, it’s easy to forget how bad things can get. Not long ago, between 2000 and 2010, the S&P 500 lost 5.7% a year. The current bull market is already the longest on record. With Brexit, a trade war, and the 2020 election on the horizon, this is a good time to prepare for the eventual end of this bull market.
The most important question to consider is whether you want your investment managers to do anything differently if the market starts heading down? This may sound like a silly question, but many funds have tied their managers’ hands so there is not much they can do when the market is falling . I know this is hard to believe, so let me explain.
Somewhere in the prospectus for most actively managed mutual funds will be a sentence saying that the fund will always be at least 80% invested in stocks that meet the fund’s criteria whatever that might be — large-cap, small-cap, tech, healthcare, whatever. This means when the market is falling, the managers can be at most 20% in cash.
Index fund managers have even less flexibility. They have to stay 100% invested in the stocks that comprise their benchmark all of the time. They have no flexibility.
The first step in preparing for the end of the bull market is to make sure the funds you are in give their managers some latitude to be less than fully invested when the market heads down.
But a prospectus that allows a manager to take some defensive actions, does not ensure that the manager has the skill to use this flexibility. The best way to measure whether a manager has made good use of a fund’s flexibility is to look at the degree to which the fund has outperformed its benchmark over the past 10 years.
Click here to see the top three mutual fund managers who beat their benchmarks by the largest amounts over the past decade.
Since I know my own managers better than any mutual fund managers, I will use one of them to explain what I look for in a great manager.
Wayne Himelsein started a model fund at Marketocracy in September 2000 to implement his approach to selecting stocks from the S&P 500 that are likely to outperform. Over the next 12 years, Wayne’s model-averaged 11.05% a year while the S&P 500 averaged 1.29%.
If you had put $1,000 a month into your retirement account and invested it in the S&P 500 during those 12 years, your $144,000 of deposits would have been worth $154,669 and you would have paid close to zero fees. Invested in Wayne Himelsein’s model, the same deposits would have grown to $273,384 after fees.
By mid-2012, I had seen enough to start to vet Wayne to become a Marketocracy manager. At this point, almost 7 years later, he has now averaged 11.93% a year for more than 18 years while the S&P 500 has averaged 6.03%.
Wayne’s past returns are impressive, but what can we expect of him going forward?
A manager’s track record is like a student’s grade point average. The student with the highest GPA is not guaranteed to be the best student next year. But, if you had to bet on a student to do better than average in the future, it is smart to bet on one with a high GPA.
When it comes to investing, if you don’t have enough time to recover from another 10 year period when the market loses money, it makes sense to choose a manager who has delivered good results even in bad market conditions and has the flexibility to do so.
Click here to learn more about Wayne, the stocks he has been buying recently, and sign up to be notified when he updates his views.