Thursday, April 30, 2009

On Mutual Funds and GM Stock

The Mutual Fund community likes to sing their own praises when it comes to managing your money. The way the story goes, a team of professionals has a much better chance of finding good investment opportunities. After all, they have lots of advantages over the inexperienced layperson. For instance, they are trained in Accounting and Finance which allows them to navigate the increasingly complex slew of reports.

In addition, most investment houses have their own research teams. That way, they don't have to rely on "biased sell-side research geared towards investment banking" (they actually say this in their presentations). Naturally, these teams have full access to top management as the companies know who their actual and/or potential large investors are.

With these resources at their disposal, you would think professionals should have been able to avoid bad investments like GM stock. Oddly enough, a list of GM holders as of 12/31/08 (the closing price was $3.20 which was an all time low for the stock except for a few weeks last year so most of these were under water) shows that professional funds owned a big chunk of shares of an essentially bankrupt company. Many even added to their positions in 4Q08. Granted that a few of the names below, like Vanguard, manage indexed portfolios and, thus, expressed no opinion on the matter, but the point is why would an active manager own ANY shares of GM as late as December 31st?

I am sure that all of the portfolio managers responsible for investing your money (theirs is in the stream of fees you pay) in GM stock as of December 31st, 2008 will tell you that it was too late to sell. I may even be persuaded to think that they believe that. However, no matter how they try to explain it, the truth is that, for all their advantages, they acted no differently than a gambler on his last chip hoping for a recovery when the writing was already on the wall in neon lights.

As you may already know, most active managers underperform their indices over extended periods. Also, they do not see themselves as asset allocators so they never hold much cash nor will they tell you to redeem their funds so that you may hold cash when the time is right. They don't seem to catch the most egregious reporting misrepresentations (Enron, Worldcom, Bear Stearns, Lehman, and GM were all widely held names). The question is why do people still pay 1-2% for bulk institutional management? I suppose it is because that is the way we have always done it.

caveat emptor

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