Shooting Stars

William Ehart

THEY WERE GURUS and gunslingers. Market mavens. Stock pickers and sector bettors. Over in the bond market, there was even a king. They were star fund managers—but most were shooting stars, destined to crash.

Yes, we’ve had managers like Peter Lynch, Will Danoff and Bill Gross, whose long-term returns did indeed beat the indexes. But for every winner like them, there have been—statistically speaking—seven who failed. Between 74% and 93% of funds in a variety of broad categories—small-cap, large-cap, growth, value and so on—lagged behind their relevant benchmark over the past 15 years, according to the latest research by S&P Dow Jones Indices.

On top of that, there’s no way to predict whether a manager’s run of outperformance will continue. Just because a manager shines in any given period doesn’t mean he or she will remain top quintile.

Lynch, former manager of Fidelity Magellan Fund, and Gross, former manager of PIMCO Total Return bond fund, ended their careers with great 10-year-plus records. Danoff, who has been at the helm of Fidelity Contrafund for 30 years, still outperforms the S&P 500 index—though he trails the Russell 1000 growth index, which is arguably more relevant. How much is skill and how much is luck? Index fund progenitor Jack Bogle, founder of Vanguard Group, praised Lynch—along with former Vanguard Windsor manager John Neff—as among the few consistent market-beaters who have demonstrated skill.

I’m not discounting their achievements, but the fact that a few investors—maybe including your annoying neighbor—beat the averages over the long term is just a statistical necessity. Someone or something has to be top decile in any data set. Flip a group of quarters repeatedly: One or two of them are going to come up heads a whole lot more than the others. Almost as inevitably, above-average readings are likely to be followed by a losing streak, possibly wiping out the winning margin. It’s called reversion to the mean.

Among the fund stars whose outperformance didn’t last: Bill Miller, Ken Heebner, Mark Mobius, Bill Berger, Wally Weitz, Garrett Van Wagoner and Donald Yacktman. My point isn’t to cast aspersions on these managers. Many others fell by the wayside—and some funds never shone at all.

Celebrated managers justified their high fees for retail investors with the promise that they were proven market beaters. But they had plenty of help in their self-promotion. From about 1990 through the 2000s, star managers shared a symbiotic existence with the financial press.

To publicize their track record and attract more money from investors, such managers needed the limelight, their names in big letters, their faces on the cover of personal finance magazines and their prime airtime on Squawk Box. When they gathered more investor dollars than they could handle, their PR people sometimes stopped making them available for interviews. Other times, they just kept raking it in until the funds were too bloated to follow their original investment strategy.

Meanwhile, the finance magazines needed to sell copies and the cable networks needed to keep eyeballs glued to them, with the tantalizing but dangerously flawed prospect that readers and viewers could profit from star managers’ favorite stocks and strategies, and even from their economic and political prognostications.

I recall what a highly regarded but somewhat media-shy small-cap manager at T. Rowe Price told me 20 years ago: When talking to the press about the stocks he likes, he needed to avoid touting those he was actively buying. So what a magazine might have called his “top stocks to buy now” were not exactly that, though they certainly could have been good investment recommendations. This reality didn’t stop the press and the more attention-seeking portfolio managers from playing the game.

The triumph of index mutual funds and exchange-traded index funds, along with the internet’s devastation of the print media, have changed the game. Money magazine is now exclusively online. It used to be a fat, glossy publication filled with ads for mutual funds that did nothing more than beat their category averages. It’s now a virtual shell of itself. The devastating bear markets of 2000-02 and 2007-09 also seem to have soured retail investors on the star manager parlor game.

That was the game I played when I was cutting my investment teeth. I pored over many a mutual fund table, subscribed to many a magazine, invested in many funds and often changed my mind, buying high and selling low. Today, I’ve learned my lesson—and many other investors are older and wiser, too.

A game is always afoot, however, as Sherlock Holmes would say. What are we playing today? Cryptocurrencies? Robinhood? Smart-beta ETFs? The handful of mega-cap tech stocks that are the only things holding up the S&P 500 this year? All we know for sure is that years from now we will look back, give a rueful laugh and shake our heads at the money we might have made—or, in most cases, saved.

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles include Different StrokesNeeding to Know and Played for Fools. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart.

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10 months ago

One of the best and honest articles I’ve ever read.

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