Swedroe: Star Manager Loses Luster

February 29, 2016

Last week, Financial Advisor magazine published a story announcing that one of the mutual fund industry's oldest funds, run by one of its most enduring fund managers, Kenneth Heebner, went out of business when Natixis Global Asset Management liquidated its CGM Advisor Targeted Equity Fund.

According to the article, at its end, the fund had $363 million in assets, dramatically less than the $1.02 billion it had at its peak in February 2010. It finished 2015 with a 3.3% loss, lagging 79% of its peers over the last 12 months. And over the past five years, it lagged 99% of other large-cap core funds. The article further noted that Heebner still runs the CGM Focus Fund (CGMFX), which now oversees $829 million, down from $10.3 billion in 2008.

This story carries an important message for investors who believe that past performance of active managers (and, for that matter, active share, because the CGM Focus Fund has always been a highly concentrated fund) is predictive of future performance. Going back to my trusted "videotape," I found that Kenneth Heebner's CGMFX was the No. 1 performer among diversified U.S. stock mutual funds in the decade ending in 2007.

A Toppled Hero

You could say that his performance put him among the "royalty of fund managers." In fact, in June 2006, Fortune senior writer Jon Birger cited Heebner's "amazing history of making big winning bets on stocks and sectors," adding that, "there's no question Heebner is one of the all-time greats."

His performance was so good that a competitor, Will Danoff, manager of the Fidelity Contrafund, stated in a September 2008 interview with Kiplinger's Personal Finance: "I want to be more like Ken Heebner—he's my hero." As you will see, Contrafund investors are certainly glad Danoff didn't get his wish.

Despite the overwhelming academic evidence that past performance has virtually no value as a predictor of future performance, and perhaps ignoring the SEC's warning not to rely on past performance, investors piled into CGMFX. But have investors been rewarded for their belief that Heebner's performance was the result of skill rather than the result of a random outcome?

CGMFX's performance since 2007 has earned it a one-star rating from Morningstar. The table below presents the results:


CGMFX Return (%) S&P 500 Index Return (%) Morningstar Percentile Ranking**
2008 -48.2 -37.0 96
2009 10.4 26.5 99
2010 16.9 15.1 35
2011 -26.3 2.1 100
2012 14.2 16.0 65
2013 37.6 32.4 9
2014 1.4 13.7 97
2015 -4.1 1.4 85
2016* -20.6 -7.0 99
Last 5 Years* -1.4 10.3 100
Last 10 Years* 1.3 6.3 99

*Through Feb. 23, 2016. **1 is the best rank; 100 is the worst rank.

While one dollar invested in the S&P 500 Index at the end of 2007 was worth $1.64 at the end of Feb. 23, 2016, the same dollar invested in CGMFX was worth just $0.60. Predictably, investors have fled the fund. Thus, even if Heebner's performance turns around, most investors won't be there to benefit.

So, how should you interpret this outcome? Here are two possible explanations to consider:

  • Heebner's pre-2008 outperformance was a lucky outcome and his post-2007 performance was an unlucky one.
  • Heebner was a genius who, on Jan. 1, 2008, took a "stupid pill."

Which seems more likely to you?

A Common Story

History provides us with many instances of other industry-crowned royalty who fell from grace. Two great examples, with a decade-or-longer track record of outstanding performance, are Bill Miller and David Baker. Money magazine named Miller "The Greatest Money Manager of the 1990s." Between 1990 and 2005, he beat the S&P 500 Index for 15 straight years.

His post-2005 performance was similar to Heebner's recent performance. In four of the following five years, Miller's fund ranked in the 98th percentile or worse. He resigned from his role in April 2012.

David Baker is an even better example. In case you are wondering who he is, during the 1970s, his fund, the 44 Wall Street Fund, outperformed the legendary Magellan Fund, and earned a spot as the top-performing diversified U.S. stock fund. Unfortunately, 44 Wall Street ranked as the worst-performing fund of the 1980s, losing 73%. Over the same period, the S&P 500 grew at 17.5% per year.

Each dollar invested in Baker's fund fell in value to just $0.27. On the other hand, each dollar invested in the S&P 500 Index would have grown to slightly more than $5. In fact, the fund did so poorly that, in 1993, it was merged into the 44 Wall Street Equity Fund, which was then merged into the Matterhorn Growth Fund Income in 1996.

Be sure to keep these examples in mind the next time the financial media decides to crown new manager royalty, whether they run mutual funds or hedge funds.

Definition Of Insanity

A well-known quotation notes that the definition of insanity is doing the same thing over and over and expecting a different result. One of the strongest-held beliefs among the investing public is that the past performance of active managers is a reliable predictor of future performance.

Based on this belief, investors adopt one of the following strategies: Either they study the performance of actively managed mutual funds to identify the ones that have had the best performance, or they rely on others to perform that due diligence for them.

Almost inevitably, investors find their choices have underperformed their appropriate benchmarks. They then fire the underperformers and the search begins again, using exactly the same process. They rarely stop and think: "If the process I'm using is the same, why am I expecting a different outcome?"

It seems obvious that unless you do something differently, there's no logical reason to expect a different outcome. Yet that is exactly what active investors do—they expect a different (better) result.

But you do not have to fall into this trap. If you recognize yourself repeating this pattern, you should do what all intelligent people do when they learn they have made a mistake: Change your behavior.

It's better late than never to join the indexing/passive/evidence-based investing revolution.


Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

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