My advice to anyone starting out is to read the main value investing texts and understand them, but then put them aside. Then go read the CANSLIM book by O’Neill (How to Make Money in Stocks) and then figure out why these stocks, which seem to be the polar opposite of “value” stocks, tend to do very well once they are included in the IBD 50 (and before, in order to get into the 50). Then try to reconcile the two approaches. A blended approach like that would be far better than just value investing and would help you avoid some common mistakes in new value investors make.
I think you answered my question very well, bromion, so thank you for that. I still don’t understand how the whole “groupthink” industry (95% of mutual funds) survives. Kudos to those salespeople that can still get investors to put money in a mutual fund that just does the same thing that all other funds in that specific class do. They all essentially become index funds with higher fees.
If there’s one thing I’ve learned in my brief (5 years) of investing/trading, it’s that there are many, many approaches to make money in the markets. They just don’t always work at all times. So why not have a more diverse skill set (FA and TA) that can help discover what is currently working.
There are people here more qualified to answer your question about mutual funds (like maybe Sweep, who is probably familiar with these through his RIA experience) but I’ll give it a shot.
I think mutual funds exist because:
They have existed for a long time. This isn’t a good reason but it’s a factor – everyone is familiar with mutual funds.
They are time efficient for retail investors. If you are a small investor with limited time who has a diversification mandate in a relatively small capital account, your options are somewhat limited. It is easy to get into a mutual fund, and far easier than picking 30 stocks by yourself, especially if you lack investing experience.
They spend a lot on marketing and branding.
I personally don’t really understand mutual funds because many MFs have a lot of restrictions around what they can and can’t do. Most are long only, have market cap restrictions, and price per share restrictions (no buying sub-$5 stocks).
Given the large capital bases, they also seem to have to “reach” into a lot of, in my opinion, sub-par investments. I frequently see Fidelity and Black Rock, for example, as the largest owners of broken growth stocks now in the “grave yard” of microcap stocks – I started tracking this out of interest and found that F and BR were often investors in the IPO or shortly after it based on some “story” about the supposed growth prospects of the firm. I think (but don’t know) that these large mutual funds “have to” invest in so called growth stocks if they want small cap exposure because they will almost certainly move the market – Fidelity can’t really buy into a $200 million stock in size (5-10%) if they think the stock is actually worth $250 million, they have to think it is worth some huge amount, like maybe $600 million or something to justify that kind of capital deployment. They also do not want to take a smaller position – say, 0.5% – because there is no scale in that for them.
That kind of behavior – getting bagged at the IPO – is probably rampant at mutual funds. I read a study a while ago that attributed MF underperformance to that as a factor, among others. It’s good for the chuckles to read Seeking Alpha where the paid stock touts are (likely) pumping some scammy stock back up and say that Fidelity owns it (wow!!!) and then you go and look and Fidelity’s investment has lost 2/3rds of its value and they probably just haven’t tax loss harvested it yet.
Most of my business model is actually built around finding pockets of inefficiency related to the behavior of large mutual funds and the waves they create in the market. I think it’s appalling that people point to mutual funds as some sort of supposed evidence that the market can’t be beaten because mutual funds are basically designed to underperform the index, which means the argument is circular. If you want to talk about market efficiency, you would need to measure process-oriented funds that lack these restrictions. There are many that can and do beat the market. Not a huge number, but enough that it’s not a coincidence.
I’m not exactly sure what I’m responding to here, but I’ll just throw this out. The world of retail investing - that is either a civilian directing their own investments or an advisor directing it for them - is overwhelmingly geared towards mutual funds and they’re gaining even more market share.
First off you have to look at who controls the money. A shop like Merrill Lynch that controls a couple trillion dollars wants its advisors to buy mutual funds over stocks, ETFs, and SMAs. They’re trying to propagate the image of a wealth manager. They believe an advisor’s time should be spent taking a holistic view of their clients’ portfolio and keeping them on the right track. Not researching individual stocks or making macro calls. Mutual funds are ideal for this type of work as it’s way easier to research a dozen mutual funds than it is hundreds of stocks…obviously. Plus, those mutual funds have already been scrubbed by the home office so there’s an added layer of due diligence. Another reason is that Merrill gets a huge slice of the fund’s fees in the form of revenue sharing. They can pull down as much as 35 bps for equity funds…not a bad gig.
As to mutual funds being too restricted for some folks, it depends on why you’re using funds. For those wealth management advisors, they want funds to behave in a predictable way. If they buy a momentum growth fund they have a good idea when it should perform well and when it should lag, and they can construct a portfolio using complementary funds accordingly. But, if that growth manager decided to go garp when momentum is out of favor you risk adding too much “quality” growth to your portfolio. So, these restrictions are important.
If that’s not your brand of vodka, there are plenty of funds that will go where ever they please (high tracking error funds and/or concentrated portfolios); think Yachtman, Fairholme, Ivy Asset Strategy, etc. At best, you can really only use those in a core and explore type of strategy though. You can’t just own Yachtman and Fairholme. You’d never know what your exposures are on a day-to-day basis.
Anyhoo, while many/most of you all research stocks for a living, it’s just not feasible for the average FA/RIA and especially not pratical for an indvidual investor. I think everyone here pretty much gets that. It’s more a question of why pay a higher fee for a mutual fund than a comparable ETF. That’s a valid question but I’m drifting way off topic…
Mutual funds are cheaper for those that DCA an index, especially if the DCA is at least once a month.
I know a guy that uses DCA once a week. That’s 52 transactions a year and he doesn’t pay a penny in brokerage fees. He pays a bit more in fees compared to an ETF but when you include trading fees, he benefits from being in a mutual fund.
Some brokers are doing no-fee ETF purchases now, I know mine does at least. This creates a situation where I don’t see any value in a mutual fund over an ETF, when indexing.
^ It will, but remember there is a huge segment (I can only speak to Canada, but I’m sure the US is similar) of the population that just allocates into whatever their bank salesman tells them to. These people will still throw 2-3% at the mutual fund manager every year.
I think there are enough of these people who won’t bother to, or simply can’t, read their statements and understand better alternatives for their money. Enough to sustain some of the industry anyway.
Company pension plans are another segment that won’t go to ETFs.
what has worked for me is getting stocks from the IBD top50 since i dont have much time to do FA…then once i narrowed the list down i use TA to tell me when to buy…still a noob compared to some of my friends but i think this approach works pretty well.
What mutual fund charges 2-3%? Sure, some long/short funds do, alternatives, MLPs, etc., but I’d love to see a large growth fund that charges 2.5%.
Most of the money in mutual funds is in large cap equity and core fixed income funds. In general, you’re looking at no more than 1.15% for the former and 45 bps for the latter.
but the size of your fund does matter… good marketing can invite more funds… more funds can be used to build a solid team… better bargaining with brokers… get it?
MF still has a feel good factor in it… an implicit trust… i don’t remember seeing an MF manager being handcuffed in public… or jumping off the roof of his apartment… MF still is my grandmom’s advice…
Welcome to Canada. This is why you should purchase equity in Canadian money managers.
Here is an example so you know I’m not BS’ing you. TD’s US Large Cap Value Fund, MER of 2.56%. That’s a mainstream large cap equity fund offered by a leading Canadian bank.
^ Here, that’s a good deal. There is very little disclosure or education on fees amongst the general population. Bank salesmen take advantage of everyone loading up their portfolios with these while not explaining alternatives (like a 0.5%MER index, which is more appropriate for 99% of investors).
The active/passive argument becomes pretty difficult to defend on the active side when the fee differential starts exceeding 2%. Especially for mom and pop types.
It’s a hugely unethical practice IMO that really bugs me.
YES. Active fund manager should have both Technical and Fundamental Analysis skills. Fundamental analysis is must but to change portfolios actively, the manager should have technical analysis as well.