Morningstar’s Fund Managers of the Decade…. A Decade Later
Last week while scrolling through Twitter I came across a tweet from Meb Faber, a thought leader in asset allocation (Meb is someone who I’ve never spoke to but have probably read or listened to 50 hours of his content), it read:
In 2010, five US stock fund managers were nominated for fund manager of the decade. Know how many outperformed this decade?
— Meb Faber (@MebFaber) October 29, 2019
Zero.
Average underperformance of the five nominees was 5 percentage points per year.
And the winner? 8 percentage points underperformance per year.
The tweet was referencing a November 2009 article that outlined the nominees for Morningstar fund manager of the decade (2000-2009). Eventually Bruce Berkowitz of Fairholme Funds, won the award in January 2010. This tweet (and more importantly the facts that substantiate this tweet) lit a fire under me, hitting right between the eyes on a few different ideas I have been ruminating on.
In my role at Human Investing I primarily deal with two groups of people:
Committee Members and Trustees of Defined Contribution Plans
Employees who participate in Defined Contribution Plans via group and one-on-one meetings
Meb’s content sparked ideas around how to facilitate positive outcomes as it relates to creating watchlist and fund monitoring criteria (very applicable to committees) and performance chasing/market timing (especially prevalent among plan participants).
Going beyond the character count
Prior to diving into to each of these thoughts it’s probably wise to present a deeper evaluation of Meb’s tweet. The key word here is “tweet”, as opposed to a white paper or long form article. His 280 characters caught some attention (including mine) and is not factually incorrect as it relates to using the S&P 500 as his benchmarks. I imagine if Meb was having a conversation with the fund managers in a room their rebuttal would probably include arguments like; “compare us to our category peer group and benchmark instead of the S&P 500” and “the objectives of our strategies perform better in a market environments like 2000-2009 compared to 2010-2019”. Both criticisms are fair points that we can flush out later.
The five funds nominated in the Domestic Equity space (let’s call them the fab five) were; Fairholme, Fidelity Low-Priced Stock, FPA Cresent, Royce Special Equity and AMG Yacktman. The charts and tables below illustrate the performance for the last two decades:
January 2000 through December 2009
All five of these funds outperformed the S&P 500 and Russell 2000 from 2000 to 2009.
January 2010 through October 2019
In contrast to 2000-2009, these fund managers underperformed compared to the S&P 500 and Russell 2000 since January 1, 2010. Some lagging significantly more than others.
For Committee Members
So What?
“Okay Andrew predicting which active manager will be the best performer is hard, but I already knew that. All our committee has to make decisions around data points like historical returns or if the fund manager got fired/retired.”
I hear statements like the one above a lot. Ultimately, I think about that statement and the data presented above through a scenario like the following.
Imagine it’s Q1 2010, you’re on a committee and are looking to replace the Large Cap Value manager. My guess is Fairholme (FAIRX) might have been at the top of your list (I don’t blame you!). However, now that we are almost 10 years after the fact, it’s easy to see that FAIRX would have not only been the worst choice of the 5 managers of the decade, but it also happened to be one of the worst performing funds in the Large Cap Value category. In other words, you bought a lemon.
So how do you implement and maintain a process that avoids decision making like this? There’s no “right way” but a few thoughts are:
Have a quantitative and qualitative approach to fund monitoring and selection. It shouldn’t surprise us that a fund manager thrived from 2000 to 2009 and struggled from 2010-2019 or vice versa in the US equity markets. This would be like expecting a world class marathoner to also win the 100M dash. Historical returns obviously matter when evaluating a manager, however utilizing other quantitative metrics that account for risk-adjusted returns and utilizing qualitative metrics to truly understand what the fund is trying to accomplish essential to an excellent monitoring process.
Have watchlist criteria that does not force your committee to be market timers. An article a few years ago references bottom quartile funds actually having better performance than top quartile funds on a forward-looking basis. By implementing monitoring criteria that are too strict, committees can handcuff their decision making process forcing fund changes that may be short sided and harmful to the plan.
Do you want to have active managers in your retirement plan menu? Remember, as a plan committee member you are making decisions on behalf of all plan participants and giving them an opportunity for excellent outcomes. By deciding to remove active fund managers you remove decision structures like Q1 2010 example above. Sites like SPIVA make a fairly compelling case for this approach.
What Now?
Go grab your Plan’s Investment Policy Statement and read it cover to cover. Does your plan currently have the structure and process in place to make prudent and defendable decisions?
Have your plan track the investment changes that it makes to review how the decision worked out 3, 5 and 10 years later. This can often shed light on parts of your process that may be broken.
Make qualitative notes about a fund/managers objectives. Imagine if a fund’s goals is to capture 80% of market upside and 50% market downside. Understanding that strategy should impact a committee’s process vs. a traditional equity strategy.
For Retirement Plan Participants
So What?
When conducting a group or one-on-one meeting with participants, I’m often asked about the investment options for their 401(k). My canned answer to the question goes something like this:
“Asset Allocation based funds, like Target Date Funds for example, are a great solution for many investors as they provide diversification across core asset classes and a glide path that aligns with your age/retirement goals. If you’re someone who is looking to be responsible and at the same time look at this account as little as possible, Target Date Funds accomplish both goals. If you are looking to build your own model or use additional choices there are X number (typically around 10 to 15) additional choices that allow you to accomplish that. If you have questions, I’m happy to be a resource in the fund selection process.”
For the most part, this post won’t be applicable to you as a plan participant if you simply default/select a Target Date Fund. However, if you are someone who is trying to create a more customized portfolio by selecting individual asset classes, consider these thoughts that relate to market timing and fund selection in a retirement plan:
One could argue that someone’s savings rate and tax status of savings rate (Pre-Tax, ROTH, After-Tax) are more important decisions than asset allocation. Granted, being invested in equities over a long period of time matters a lot! Assuming you are invested appropriately, what I’m talking about is decisions like how much to be invested in small cap vs. mid cap vs. international. Stick to the basics and the rest will take care of itself.
Trying to select outperforming asset managers can almost feel like trying to time the market twice. There are numerous studies that speak to how average investors behavior is…. not great and honestly, it’s understandable. Investing is often emotional when you are stomaching short term losses for long-term benefits. If we can stack hands and agree that staying invested through all market conditions is hard, is it fair to say that choosing top performing managers in addition to staying invested adds another layer of hard?
What now?
Have your own personal Investment Policy Statement. If you are going to own active managers in your portfolio have a policy for why you choose to own or remove the manager. For the record, I believe that for certain investors it makes sense to utilize active managers, especially those with specific niches like ESG, specific risk tolerance, etc. While using active managers begs its own blog post, I’d be happy to grab coffee, jump on a call or email to talk further.
Put the right amount of effort and energy into variables that move the needle most. Five years ago I was meeting with an executive of a manufacturing company with an annual profit sharing contribution between 10-15%. We got into a conversation about asset allocation and the ideal ratio of US equity to International equity. About 10 minutes into the conversation I looked at his balance and noticed that all $500k of the funds in the portfolio had been invested by the company. I paused the conversation and said Martin (we’ll call him Martin) have you contributed to this plan before? He responded that he didn’t know he could. This is an extreme example, but an example nonetheless, to make sure you do the necessary due diligence on the items that truly move the needle (savings rate, tax, planning, high level asset allocation) prior to getting into the weeds.
HERE’S THE FULL PICTURE
When I saw Faber’s tweet for the first time my mind was racing with so many questions: where’s the data behind this? How does this factor into my thoughts on active vs. passive investing? Did we ever own any of these funds in our plans (no)? How can committees make great decisions for participants? What were the fund flows associated with this time frame? What’s the best way to write a blog post about this and is Tom Brady the greatest quarterback of all time? Put simply there was a lot going on.
What I’ve landed on aligns with how ERISA requires retirement plan Fiduciaries to think; regardless of your outcome have a process that allows you to substantiate a decision, document that process and make that process repeatable.
The piece of information that I’ve held off until now, is how these funds performed over the full 20-year time period (see below). Does this mean stop everything you’re doing and invest it all in the AMG Yacktman Total Return? No. Point to point returns are ultimately a poor way to judge fund performance. Chart crimes happen all the time because people try to craft a narrative that aligns with their own biases. Don’t fall victim to chart crimes do your own research or engage with someone who is a Fiduciary (all the time) to help you figure it out.
