Wednesday, November 11, 2009

Mutual Funds Know Investors Like Stories

Most mutual funds don't earn their fees, but the great unwashed keep investing in them, the same way the vote for politicians who perennially suggest they can solve problems that the last 10 guys did not solve. Yet ultimately, they sell what the public demands: style funds, index funds, sector funds, analytic All Star funds. They suggest, as always, that talking to an investment analyst to 'meet one's future needs' magically will provide for kid's college, or retirement, as if stating 'I really want $1MM in 10 years' can make it happen. These are part of an inconsistent global view of alpha, or how risk relates to return, empirically, but never mind, the public believes in these stories.

The Wall Street Journal outlines that some funds are adding market timing to their strategy, clearly with hindsight a good idea for 2008:
The 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

Unfortunately, there is less evidence that market timing is feasible than stock picking. Indeed, in 1960s the first tests of mutual funds took seriously the idea the funds added value timing the market, but it was quickly discovered there was nothing there. Considering that predicting the aggregate stock market has major data limitations (there just aren't enough stock market cycles in one's working life), this skill tends to be mainly marketing bluster.
Anders Ekholm, adjunct professor at Hanken School of Economics in Helsinki, recently analyzed more than 4,000 U.S. stock funds' returns between 2000 and 2007. Managers helped their performance through stock-picking, he found, but hurt their returns by market-timing.

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