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Wednesday, November 18, 2009

Another Terrible New Product From The Mutual Fund Industry

And another example how the mutual fund industry is dedicated to producing "products" in reaction to past market actions which appeal to investors tendency to extrapolate future events from what has happened in the immediate past.

What is particularly sad (or aggravating) is that the marketers clearly have read up on behavioral finance and clearly (in the marketers jargon) "frame" the marketing pitch of these products to hit the hot buttons of the worst foibles of individual investors.

I posted already about how the Putnam group appeals to investor nervousness by offering a fund that purpors to guarantee stable returns in both up and down markets.

Here's another one guaranteed to appeal to the nervous investor. A mutual fund that not only will be able to succeed in stock picking, it will also be successful in market timing.

As I have pointed out numerous times about actively managed funds that concentrate stock picking. Such funds dont reduce risk they just add what I call "manager risk" to an investment portfolio in addition to market risk as opposed to a portfolio of index instruments where there is only asset class. With funds described below there is the additional "manager risk" of the portfolio manager's skill in market timing.

While the fund companies may sell these funds as an increased opportunity for the fund to beat the market (add alpha) statistics for actively managed funds have shown us adding manager risk (in this case stock picking and market timing) makes it more not less likely the fund will underperform the relevant index.

from the WSJ my bolds and comments in italics


More Mutual Funds 'Time' Market
By ELEANOR LAISE

In an effort to lure back investors still wary of stocks, more mutual-fund managers are playing a risky game: timing the market.
Many of these funds promote their ability to avoid big losses by trading in and out of the stock market at just the right time.(what else would their marketing material say ? that they sometimes get in and out of the market at the right time and sometimes fail to do so ?)Some are labeled "tactical allocation" or "dynamic" funds. But even funds that don't openly tout such strategies are moving in and out of big cash stakes, betting that they can outsmart the volatile market. Quaker Small-Cap Growth Tactical Allocation Fund, launched late last year, now has about half its assets in cash, down from as much as 95% last year. The new John Hancock Technical Opportunities Fund had about 12% cash at the end of October and is managed using a strategy that devoted roughly 90% to cash early this year.

Hmmm....seems like the market timing of these funds was less that perfect for these funds.

Almost as important as difficulty of successfully timing the market when using the funds is the lack of transparency. This lack of transparency makes it particularly difficulty to constuct a portfolio. To give a simple example: if one's portfolion target is 65% equities, how can one be sure that the allocation is on target if one of these funds is held. When a fund can got from all to zero cash it is impossible (particularly when there is no requirement to even give that information on a real time basis.)


So no suprise that like many of the "exotic" products sold to investors by the mutual fund industry the results are disappointing:

These and several new funds from firms like Legg Mason Inc. and Morgan Stanley's Van Kampen Investments have leeway to make swings between cash and other investments. But funds attempting to time the market often deliver erratic performance, charge high fees and rack up big trading costs.


But of course from the point of view of the mutual fund industry disappointing results for investors don't make them a loser as long as they can be sold:

These funds are something of a bright spot for the fund industry, which has seen billions flow into bond funds but little cash go to more-profitable stock funds
.

Of course I cant deny that some of these funds can do well over short periods of time but experience tells us there will be little persistence among the outperformers.:

Some of these funds have beaten the market in recent years. Ivy Asset Strategy, for example, gained an annual 14.9% in the five years ending Nov. 10, compared with less than 1% for the Standard & Poor's 500-stock index. But they can also give investors whiplash. The Encompass Fund fell 62% last year, landing at the bottom of its world-stock category. This year it's leading its world-stock category with a nearly 110% gain
.

And here is the marketing strategy peddle products that can be marketed as "would have should have" holdings during the recent market turmois. Of course a simple long only index strategy would have produced returns of 25.6% in the US S+P 500 in 30.3% in developed international and 74.7% in emerging markets.


Fund companies say investors spooked by the recent market turmoil are demanding more-flexible products. Many investors have been frustrated "with investment products that were not able to react to the environment that we just went through," says Joel Sauber, head of U.S. products at Legg Mason. The firm's new Legg Mason Permal Tactical Allocation Fund can stash up to 40% in cash.


In fact as behavioral finance teaches us those "spooked investors" would have run to the market timing fund and the precise time they should have been in a low cost globally diversified indexed portfolio,

I certainly agree with the more critical views here"


A study from New York University's Stern School of Business suggests market-timing can work for some mutual-fund managers. The best stock-pickers during economic expansions also show some market-timing ability in recessions, the study found.

I am more in agreement here
But academic research raises doubts that the typical fund manager can successfully time the market over the long haul. Anders Ekholm, adjunct professor at Hanken School of Economics in Helsinki, (says).
There are a couple of reasons why the deck is stacked against market-timers, Mr. Ekholm says. Market-timing requires more trading, and transaction costs hurt performance. What's more, while a manager may relatively easily dig up some unique information that gives him an edge in selecting an individual stock, it's difficult to get such superior information about the overall market.

In a real triumph of marketing over good sense the fund companies apparently are not even touting the funds as a "side bet" for a small portion of a portfolio. Then again why would they ? the more money in the fund the more money for them.


Though some fund companies are promoting their new tactical-allocation funds as core holdings, analysts are skeptical. If the manager makes a wrong call, like plowing into cash before a market rally, "that could really hurt the investor," says Karin Anderson, mutual-fund analyst at Morningstar.

Funds dodging in and out of the market also tend to be quite costly. The A shares of Quaker Small-Cap Growth Tactical Allocation Fund charge annual expenses of 2.59%.



Once a new and creative product for the fund companies is a poor investment choice,

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