Market Philosophy and Mutual Funds

[J_V]

Before I start, I'd like to begin with a disclaimer that while I have a bachelor's in Finance, I learned a lot more about poker in college, than I did about anything else. I am a punter, when it comes to the details of the market.

That said, I am looking to invest a good portion of my overall net wealth within the next few months. I am hoping someone here would help me. I need to find something in line with my financial goals and my overall market view.

I do not believe the market is particularly efficient. In college, I held pretty firmly to the Random Walk Down Wall Street mentality (suprise, suprise) of market efficiency, however, I no longer believe in such efficiency. I believe there are people capable of beating the markets. Most importantly, however, I believe these people are few, and I certainly am not one of them. I agree with Ray Zee, on most of his market views, and believe the average person should be happy with a captured edge of something a little more than inflation. Thus, I am not looking to become rich in the market.

I am looking to invest in a well-diversified mutual fund, capable of withstanding most market conditions with low management fees (if such a thing exists). I would like to do this myself, but I think it might be too time consuming and I'm not sure I could be confident in my end result. Heaven forbid, I have to do beta calculations again.

Does anyone know how I might go about choosing a mutual fund and/or does anyone have any recommendations for me?Feel free to comment on any part of my post that may seem in err. I would appreciate all advice.

JV

[ericd]

Research the fund managers. They are the key. Ultimately, they are the reason for a fund's performance. Of course, there are exceptions like many Fidelity funds but over time the top managers outperform. After that it's how much risk and volatility you can live with.

[J_V]

I remember reading that most of the top managers felt hampered by the regulations of mutual funds. It seems to me that if I were gonna go with the highest reward/risk ratio, you'd have to look at hedge funds, not mutual funds, that is, if you believe managers can outperform the market.

[DesertCat]

[ QUOTE ]
you'd have to look at hedge funds, not mutual funds, that is, if you believe managers can outperform the market.


[/ QUOTE ]

It's true that actively managed mutual funds are poorly constructed to beat the market, and I'd recommend never investing in one. Choose an index fund and you'll beat 95% of mutual fund returns over time.

Hedge funds are another, tricky, topic. There are certainly managers who can beat the market. Buffett is the prime example, he pretty much disproves the efficient market theory by his very existence. He started with a private investment partnership, which is basically what hedge funds are (the term hedge fund originally refers to funds that are hedged by combining short and long positions, but it seems today that any investment partnership is referred to as a hedge fund, whether it's hedged or not). Hedge funds are much better designed to provide higher returns, the managers are directly compensated for beating indexes, they have limitations on inflows and outflows so they can concentrate on putting money to work and not meeting redemption requests during a falling market (or worry about market timers), and typically have a wider range of investment opportunities. My biggest concern about private investment funds is that I don't feel I can trust their performance claims. There are too many ways to value illiquid investments, which is why I think VC funds are the worse.

The other problem is that all good money managers have a glaring achilles heel, it's called success. It's much easier to beat the market with a $10M portfolio than a $10B portfolio, and anyone who consistently beats the market ends up with a $10B or higher portfolio. Buffett is investing around $100B, and while he's still beating the market, he's not trouncing it like he did 30 years ago.

If you really want an actively managed fund, I suggest you look for funds with ten and twenty year records of outperformance. In investing, anyone can have a multi-year hot streak when the market just happens to fit their "style", someone who's managed through bear and bull markets successfully shows they aren't a one trick pony and can adapt to different conditions. When you come up with your short list, make sure that the management that created the sterling record is still there. Also, look at the fund size, if it's grown rapidly and the fund has recent trends of lower performance, they might have gotten too big.

Lastly, compare your short list's expense ratios. A high expense ratio is like a marathon runner carrying weights, he may be the fastest runner, but may not be able to beat the competition carrying that burden. Based on this you should be able to pick one or two standouts. I'm partial to value firms like Sequioa (unfortunately I think they are closed) since there are a long list of value investors who've beaten the market consistantly for decades, and usually they are very frugal with fees. Good luck...

[ericd]

I am not recommending for or against Mutual Funds. I am often amazed at all the investment advice offered on this site and done with an air of expertise. I am only pointing out a path for you to pursue if you wish to conduct you own research.

[TGoldman]

With your background in finance, I would suggest reading more on the field of modern portfolio theory. The general assumptions of this field seem to correspond with your market philosophy (Markets are mostly efficient, it is difficult/impossible to beat the market, long term performance/volatility tends to follow past trends). A simple MSN Money article providing a practical low-cost approach to modern portfolio theory is advocated here: Start investing with just $100 (http://moneycentral.msn.com/content/Investing/Startinvesting/P77595.asp). Good luck, be sure to let us know if you discover any gems along the way!

[adios]

FWIW IMO buy SPY and plan to hold long term. It would be nice to side step bear markets if possible with that strategy. Best advice I could give would be to look at the yield curve. A flat yield curve to me would indicate caution at the very least. An inverted yield curve would indicate sell. That's an indicator that doesn't take much time to monitor. I'm sure people will say I'm crazy though.

[GeorgeF]

For non IRA money I suggest www.freetrade.com (http://www.freetrade.com) + ETFs and closed ends.

For ideas:
www.ishares.com (http://www.ishares.com)
www.etfconnect.com (http://www.etfconnect.com)
www.cefa.com (http://www.cefa.com)

[midas]

JV-

1. There is no such thing as a fund that can withstand all market conditions - all funds are situational - equity, bonds, income - the balanced funds are mostly for people approaching retirement.

2. Avoid all but the basic books on the stock market - they're all crap and so are most fund managers. If they could regularly beat the S&P 500 - they'd be on the front page of Barrons every month or they'd make ten times more money running a hedge fund.

3. There is only one theory that I believe when it comes to the stock market - "Over the long-term stocks out-perform every other investment". With that said, buy the S&P 500 (SPY) for large cap exposure and the S&P 400 (MDY) for mid cap exposure. Buy as much as you can every month (dollar cost averaging) and don't worry about the market anymore or spend any more time thinking about stock investments.

[Czech_Razor]

Given that you say that you're looking to invest a significant portion of your net worth in the next couple of months, I assume that the bulk of your investments will be in taxable accounts. For good or ill, this narrows your options, as quant strategies and even rebalancing start to look like bad ideas, given the tax bite.

A few questions to hone your choices:

What's your time horizon?

What's the biggest percentage loss of your portfolio you could stomach in the pursuit of higher returns?

What are your thoughts regarding asset allocation among domestic and foreign equities and bonds?

Despite your belief in market inefficiency, would you be comfortable investing in index funds for their tax efficiency, or are there certain anomalies you feel strongly enough about that you wish to try to exploit them?

Just some thoughts,

@nth

[theBruiser500]

[ QUOTE ]

I do not believe the market is particularly efficient. In college, I held pretty firmly to the Random Walk Down Wall Street mentality (suprise, suprise) of market efficiency, however, I no longer believe in such efficiency. I believe there are people capable of beating the markets. Most importantly, however, I believe these people are few, and I certainly am not one of them.

[/ QUOTE ]

I'm reading a Random Walk Down Wall Street right now, very interesting book. What led you to change your mind?

[theBruiser500]

[ QUOTE ]
I remember reading that most of the top managers felt hampered by the regulations of mutual funds. It seems to me that if I were gonna go with the highest reward/risk ratio, you'd have to look at hedge funds, not mutual funds, that is, if you believe managers can outperform the market.

[/ QUOTE ]

What are hedge funds compared to mutual funds?

[adios]

You didn't ask me but I'll barge in nonetheless. The book is a good book IMO. The markets are effecient but IMO not instantaneously effecient if that makes any sense.

[adios]

Hedge Fund Definition (http://www.investorwords.com/2296/hedge_fund.html)

hedge fund
A fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including selling short, leverage, program trading, swaps, arbitrage, and derivatives. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals. They are restricted by law to no more than 100 investors per fund, and as a result most hedge funds set extremely high minimum investment amounts, ranging anywhere from $250,000 to over $1 million. As with traditional mutual funds, investors in hedge funds pay a management fee; however, hedge funds also collect a percentage of the profits (usually 20%).


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Mutual Fund Definition (http://www.investorwords.com/3173/mutual_fund.html)

mutual fund
An open-ended fund operated by an investment company which raises money from shareholders and invests in a group of assets, in accordance with a stated set of objectives. mutual funds raise money by selling shares of the fund to the public, much like any other type of company can sell stock in itself to the public. Mutual funds then take the money they receive from the sale of their shares (along with any money made from previous investments) and use it to purchase various investment vehicles, such as stocks, bonds and money market instruments. In return for the money they give to the fund when purchasing shares, shareholders receive an equity position in the fund and, in effect, in each of its underlying securities. For most mutual funds, shareholders are free to sell their shares at any time, although the price of a share in a mutual fund will fluctuate daily, depending upon the performance of the securities held by the fund. Benefits of mutual funds include diversification and professional money management. Mutual funds offer choice, liquidity, and convenience, but charge fees and often require a minimum investment. A closed-end fund is often incorrectly referred to as a mutual fund, but is actually an investment trust. There are many types of mutual funds, including aggressive growth fund, asset allocation fund, balanced fund, blend fund, bond fund, capital appreciation fund, clone fund, closed fund, crossover fund, equity fund, fund of funds, global fund, growth fund, growth and income fund, hedge fund, income fund, index fund, international fund, money market fund, municipal bond fund, prime rate fund, regional fund, sector fund, specialty fund, stock fund, and tax-free bond fund.

[Senor Choppy]

[ QUOTE ]
Research the fund managers. They are the key.

[/ QUOTE ]

The problem is that the sample size for the performance of funds and fund managers is so small it isn't necessarily relevant.

It's true that the managers are the key, but it's impossible, except in extreme situations, to determine who has been smart and who has been lucky.

[zerosum]

[ QUOTE ]
The markets are effecient but IMO not instantaneously effecient if that makes any sense.

[/ QUOTE ]

Your opinion makes perfect sense to me. It's reasonable to believe that the markets are efficient in the long run but that they can be inefficient over short to intermediate time horizons. Hence the old saying that the market is a voting machine in the short run and a weighing machine in the long run. Translation: the emotion of market participant tends to trump their reason in the short term, but not long term.

[theBruiser500]

adios, thanks. also regarding the efficient markets i found the castle in the air stuff interestging, like the tulip craze etc.

[J_V]

From what I have gathered, there are enough people who can beat the market consistently to suggest some degree of inefficiency. You could argue that with millions of investors, some are bound to get very lucky over and over again, but from what I have heard, the academics are no longer pushing efficient market theory in practice anymore.

[DesertCat]

Warren Buffett wrote that efficient market proponents "observing correctly that the market was frequently efficient, went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day." He also wrote an essay debunking the efficient theory called "The SuperInvestors of Graham and Doddsville".

The old joke is that an economist won't stoop to pick up a ten dollar bill because if it really existed someone would have picked it up already. John Kay probably described it best when he wrote "Kay concludes, "The efficient market hypothesis is 90% true, and and you will lose money by ignoring it. The search for the elusive 10%, like the search for discarded $10 bills, attracts effort greater than rewards. But for the very few skilled searchers, the rewards can be large indeed."

The performance of actively managed mutual funds has been used to support EM theory (95%+ trail the market), but it's typically their high costs vs. index funds that hurt them, i.e. many mutual funds do beat the market, but not after deducting fees.

[OrangeCat]

[ QUOTE ]
For non IRA money I suggest www.freetrade.com (http://www.freetrade.com) + ETFs and closed ends.


[/ QUOTE ]

Just curious, why do you say non-IRA money?

[Czech_Razor]

From http://www.freetrade.com/how_to_qualify.html:

"We only offer account types that fit into automated operations; Individual, Joint, and Trust accounts are available. We do not accept other account types such as IRA, or corporate accounts."

I'm not endorsing GeorgeF's recommendation; I was curious about the site, though, and found the answer to your question.

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