Asset Weighted Mutual Funds

Here is the news alert that I placed into the NOTES section.

News Alert: Explosive Article in this month's FPA Journal

Read the following article from the October 2005 FPA Journal. It is exceedingly well done. It is revolutionary. It turns everything upside down. Best of all: it makes sense.

Passive Investing: The Emperor Exposed by Christopher Carosa, CTFA

Passive Investing: The Emperor Exposed

There are enough subtle details in the article to give it credibility. For example, the article included supplemental information on standard deviations and overall annualized returns when data reduction forced the use of averages.

Keep in mind that there are lots and lots of data points related to mutual funds that encourage misleading interpretations. Most of the meaningful data are limited to the last three decades.

The critical difference between this study and others is its use of asset weighting. This study looks at how well investors have invested their money. Other studies have treated all mutual funds equally, whether managing $10 million or $10 billion.

Keep in mind that actively managed mutual funds invest in markets other than stocks. Very few are fully invested in stocks at all times. Mutual Funds vary allocations. This can add to performance when done carefully and properly. It can detract seriously from performance when done recklessly.

This article tells us how well investors select their funds. This article does NOT tell us how well they choose WHEN to invest. Too many investors get excited. They buy too much when the market is too high. Too many investors buy high, get discouraged and end up selling low.

Additional Comments about the FPA Journal’s Explosive Article

1) Actively managed mutual funds contain holdings outside of the S&P500 index such as bonds.
2) Actively managed mutual funds vary allocations in accordance with the market outlook or similar criteria.
3) Weighting by mutual fund assets tells us how well investors SELECT their mutual funds.
4) Weighting by mutual fund assets produces an INDEX. In this regard, it is an alternative to the S&P500 index.
5) Weighting by mutual fund assets does NOT tell us about how well investors TIME their purchases. They still buy high and sell low.
6) Comments about various indexes as benchmarks (as opposed to the S&P500 index) are simply WORD GAMES. I see this with frustrating regularity. People keep coming up with NEW INDEXES to prove that a mutual fund manager has failed to perform well. All that they prove is that they are good at creating new indexes after the fact.
7) Regarding alternative indexes: if you can gain a consistent advantage, you have skill. If you can actually identify a better index than the S&P500 index, you have skill.

Individuals do well in selecting their actively managed mutual funds. In terms of investment choices, they outperform the indexes.

Individuals do poorly in timing their purchases. In this regard, they underperform the indexes (and other benchmarks).

Actively managed mutual funds vary allocations. They include investments other than stocks. In terms of where investors put their money, actively managed mutual funds outperform stocks (i.e., the S&P500 index).

Have fun.

John Walter Russell
October 4, 2005