December 10, 2009

The Problem with Chasing Performance of Funds

How do you pick a good mutual fund? The performance track record and investment philosophy of a mutual fund and its manager seem like good way to pick a mutual fund. If a fund has been consistently performing for years and their fund manager has a good head on their shoulders then it seems like it should be a good investment.

That is the logic that lead me to buy into Brandywine Blue (BLUEX) a couple years ago in my 401k. They'd been averaging about 13% returns for 20 years and were in the top 10% of funds. They invested with long term value in mind and scrutinized the financials of companies. They purposely avoided Enron because they "couldn't get their hands around" the company's books. Both their performance and philosophy seemed good to me. Whats not to like about them? It didn't take me too long to find out the answer.

Jump forward a couple years... their 1, 3 and 5 year performance is at the bottom 30% in their class. Their YTD performance is 16% below the index and they are dead last among funds in their class. I still don't know if theres anything "wrong" with their investment strategy per se or if something has changed. I really don't know why they are down so far right now. But the fact remains that what was a very attractive looking fund a couple years ago is now a dog.

Consider the fund CGM Focus (CGMFX) which I was looking at in summer of 2008. At that point they were averaging 35% gains for 5 years. They were up a whooping 79% in 2007. But so far in 2009 they've underperformed the S&P 500 by 16% and they're 23% behind the fund category and the year to date returns place them in the bottom 2% of funds in their category. So again we find a mutual fund with fabulous returns for the past few years which then fails to perform after that.

Now these are just 2 semi-random examples. You could also find a mutual fund that performed great for several years and has continued to do so through the recession. But how do you know if any one fund with a good recent performance history will continue to perform well in the future? You simply can't know. You've probably heard it before: Past performance is no guarantee of future results. Brandywine Blue and CGM Focus are two good examples of this fact.

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