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. 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 + ETFs and closed ends.

For ideas:
www.ishares.com
www.etfconnect.com
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