Swedroe: Top Managers Underperform

As readers of my books and articles know, I believe there is an overwhelming body of evidence demonstrating that, while it’s possible to outperform the market by selecting fund managers with long track records of success, the odds of doing so are so poor (and getting persistently worse) that it’s not prudent to try.

Furthermore, the evidence supporting this view keeps pouring in, both from academic research and courtesy of the financial media. The latest evidence is almost too good to be true, at least if you are a believer (as I am) that accepting market returns in the asset classes to which you want exposure is the winning investment strategy. Unfortunately, there are a lot of investors who placed their trust in the past performance of active managers and have paid a steep price for an education on the difficulty of delivering alpha.

Recently, I addressed the fall of a once-idolized fund manager, Kenneth Heebner, and the performance of his CGM Focus Fund (CGMFX). After reading that post, a Boglehead (who goes by the moniker of Nisiprius) pointed me to an article announcing that Heebner had been named the 2007 investment Guru of the Year by GuruFocus readers.

As I originally noted, after being named manager of the year, Heebner went on to deliver abysmal performance. While $1 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.

Virtues Of Multiple Managers?

Fortunately, the GuruFocus article provides us with the names of the four managers (and their funds) that finished right behind Heebner in the reader poll. Perhaps Heebner’s performance after winning this award was an isolated case. And perhaps if you had built a portfolio of the five leading gurus you would have been OK. With that in mind, we’ll analyze the performance of all five gurus named in the poll.

The five gurus and funds at the top of the GuruFocus list were Robert Rodriguez of FPA Capital Fund (FPPTX), Bruce Berkowitz of the Fairholme Fund (FAIRX), David Winters of the Wintergreen Fund (WGRNX), Martin Whitman of the Third Avenue Value Fund (TAVFX) and, of course, the winner, Ken Heebner of CGM Focus Fund (CGMFX). I will note here that Robert Rodriguez stopped managing FPPTX in December 2009. Since it was selected by the GuruFocus readers, the fund has been managed by Rikard Ekstrand from November 2007 to May 2013, Arik Ahitov from July 2013 to the present, and Dennis Bryan from November 2007 to the present. Each of these fund managers is (or were) partners at FPA.

Before looking at the returns achieved by these funds, it’s important to realize this wan’t just some ordinary list of active managers. In fact, when Bob Goldfarb, chief executive of the legendary Sequoia Fund, was asked by Columbia University professor Louis Lowenstein “to select ten dyed-in-the-wool value investors who all followed the essential edicts of Graham and Dodd,” he included Robert Rodriguez, who remains a partner at FPA, on his list. And in 2009, Bruce Berkowitz of the Fairholme Fund was named by Morningstar as the manager of the decade.

The table below shows the annualized returns for our five funds for the eight-year period 2008 through 2015.

Underperforming Gurus

While the GuruFocus readers’ five choices produced an average return of 1.2% per year, the S&P 500 Index was returning 6.5% a year. And not one of the five outperformed the S&P 500 Index, with the average underperformance being 5.3 percentage points a year. That is a cumulative underperformance of more than 51%.

The table below shows the performance of the same five funds for the first two months of 2016, a period when the S&P 500 Index lost 5.1%.

For the first two months of 2016, these funds continued to underperform the market by a wide margin, producing an average underperformance of 4.8 percentage points—although this time, one fund, WRGNX, did manage to outperform the S&P 500 Index.

Apples To Apples
We can also see how these funds have performed relative to more comparable benchmark indexes.

• Morningstar classifies FPPTX as a small-cap value fund. From 2008 through 2015, while FPPTX returned 4.2% per year, the MSCI U.S. Small Cap Value Index returned 7.0% per year, outperforming FPPTX by 2.8 percentage points per year.
• Morningstar classifies FAIRX as a large value fund. From 2008 through 2015, while FAIRX returned 3.5% per year, the MSCI U.S. Prime Market Value Index returned 5.1% per year, outperforming FAIRX by 1.6 percentage points per year.
• Morningstar classifies WGRNX as a global large growth fund. From 2008 through 2015, while WGRNX returned 1.6% per year, the MSCI U.S. Prime Market Growth Index returned 8.3% per year and the MSIC EAFE Index returned 0.9% per year. Even equal-weighting these two indexes would have returned 4.6% per year, outperforming WGRNX by 3 percentage points per year.
• Morningstar classifies TAVFX as a global midcap value fund. From 2008 through 2015, while TAVFX returned 0.4% per year, the Russell Mid Cap Value Index returned 7.3% per year and the MSCI EAFE Mid Cap Value Index returned 2.1% per year. Even equal-weighting these two indexes would have returned 4.7% per year, outperforming TAVFX by 4.3 percentage points per year.
• Morningstar classifies CGMFX as a large blend fund. From 2008 through 2015, while CGMFX returned -3.5% per year, the S&P 500 Index returned 6.5% per year, outperforming CGMFX by an astonishing 10.0 percentage points per year.

Each of the funds chosen for the GuruFocus list went on to underperform their respective benchmark indexes, with the underperformance ranging from 1.6 percentage points to as much as 10 percentage points, and averaging 4.3 percentage points over a full eight years.

The next time you are tempted to invest based on the past performance of even legendary active fund managers, keep this tale in mind. It’s likely to save you from an expensive lesson.

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