Defense?
Seeking Alpha takes a look at the performance of alternative strategy funds during Tuesday's wipe out:
Many funds have rolled out alternative mutual funds and ETFs recently, and it is instructive to examine how they have performed on Tuesday's big down day.
One in particular, the Claymore Sabrient Defender Index (DEF), was designed to "Defend" against down days. The specifics of the methodology are proprietary, but in general terms, the fund is rebalanced quarterly by looking back at the last quarter and seeing what did well on the down days. So how well did it play on D day?
An awful -3.00%."
Red Letter Day
Yesterday's Dow drop leave you jittery? Relax. This too will pass (and in fact the Dow, as of 12:28 PM EST, has already bounced back a bit today). Chuck Jaffe at MarketWatch puts it in perspective:
If the stock market's big decline Tuesday made you nervous, try the following: Take a red marker and make a big X on Feb. 27 in your calendar. Make no other marks or notations. Then go about your regular business for the next 10 months.
When the end of the year rolls around -- assuming you review your calendar before you either file it or toss it -- see if you remember why you actually made Tuesday a red-letter day.
Chances are the 416-point decline in the Dow Jones Industrial Average will pass, just like so many others before it. And what investors need to keep in mind is that there have been many others; while Tuesday's drop represents the seventh-largest point drop in Dow history, at 3.27% it is just the 37th-largest percentage decline day since 1950. In percentage terms, if you go back to 1900, you'd have another 200 days where the Dow suffered bigger losses.
...The point of marking the calendar is that virtually every big market drop becomes routine in time. Nearly 20 years after the market crash of 1987, for example, there is not a crowd of people claiming that they would be able to retire today, rather than working a few years past age 65, if they had only been out of the market on that particularly bad day. The market plunged more than 22% on Oct. 19, 1987."
We do think that yesterday's drop does mark the end of higher risk or alternative investments beating more traditional ones. From here on out we predict the S&P 500 will outperform emerging markets like China.
Today's Market Drop is Your Fault
The financial press will cook up dozens of reasons why the market fell so hard, so fast today (the Dow was down over 500 points or over 4% before finding some footing). Most will point toward China and tell you that nothing has changed since yesterday, stay the course. But something has changed. High-risk assets are finally done leading the market. The music has stopped, and investors are looking for chairs.
Downplaying risk and focusing exclusively on upside is why fund investors have sunk billions into higher-risk fund categories like emerging markets, Asia, Latin America, and high-yield bonds. It’s why an ETF like iShares FTSE/Xinhua China (FXI) has brought in billions in recent months.
As of 1:17 p.m. today, a China fund, Oberweis China Opportunities Fund (OBCHX), is the fourth most viewed fund page (out of more than 20,000) on MAXfunds.com. This tells you more about the causes of today’s drop than all the financial analysis you’ll read about the rest of the week.
Fund investors have a bad habit of getting most excited about a certain sector or fund category shortly before in sinks. The last time we saw big fund inflows was early in 2006, and in the following months the U.S. stock market slipped, and emerging markets flat out tanked –though both came back later in the year.
This year fund investors have already put around $40 billion into stock funds – most of it into international funds, and a lot of that into emerging markets.
Nobody knows where the market is going in the short run, but it is likely that all the fund categories attracting the most money early this year will perform the worst in coming months. Maybe this isn’t the end of the great high risk asset bull market, but today’s action shows investors the risk of adding new money late in the game. ...read the rest of this article»
Seven Steps to a Better Portfolio
Kiplinger.com's How to Choose Winning Funds lists seven 'simple steps' to building a winning fund portfolio without the help of a broker:
- Determine your objective
- Home in on a specific category
- Watch your costs
- Study past performance
- Consider risk
- Size up the fund
- Know who's at the helm
Any similarity to our own Seven Golden Rules of Mutual fund Investing is purely coincidental:
- No Loads!
- Don't Overestimate Past Performance Figures
- No Fat Funds
- The Younger the Better
- Watch Expenses
- Check Performance Relative To Class
- Know The Fund's Risk Level
Fund Fee Primer
Front-end loads, back-end loads, expense ratios, management fees, redemption fees, 12b-1s. If you're confused by all the fees associated with mutual fund investing, you're not alone. But since the amount you pay to your mutual fund company can make a huge difference to your long-term returns, getting fee-wise is something all fund investors need to do. Doug Roberts at bloggingstocks makes you a little smarter with this brief intro.
There are two types of mutual fund fees and expenses -- the single shots and those that are ongoing. The single shots generally consist of one-time charges, like sales fees and redemption fees.
Sales fees or commissions, often referred to as a "sales load," may be charged when you enter the fund (front-end) and when you exit it (back-end). They are usually paid to the mutual fund company, the broker or salesman.
I strongly urge you to avoid investing in funds that charge a sales commission. When a sales commission is charged, possibly 4% to 5%, this means that you must outperform a similar fund without a commission by that amount just to match its performance. This is usually not an easy task. Furthermore, a sales load locks you into the fund. You need to stay in it for a long time to cover this cost and still get a competitive rate of return. When a commission is charged, you never know if your broker or advisor is favoring the fund that is best for you, or the one he stands to profit from the most. Often, if you do some detective work, you can find a similar fund without the commission, sometimes with the same manager.
Redemption fees usually refer to fees charged for early redemption in order to discourage short-term trading and "market timing." These fees are not bad for the long-term investor, as long as they are reinvested into the fund and not pocketed by the fund managers, brokers or salesmen.
With redemption fees, the key is to ensure that the fee is paid to the mutual fund itself. In general, I prefer funds that do not extend their redemption fees longer than three to six months, unless they offer superior performance for their category with a very low expense ratio.
In addition to these one-time charges, there are ongoing fees that are charged every year and impact the performance of the fund, even for the long-term investor. These include the expense ratio and brokerage costs.
The expense ratio is the total annual expenses of the fund, expressed as a percent of assets in the fund. It includes the management fee paid to the mutual fund manager, operating and administrative fees paid to run the fund, and 12b-1 fees used to market and distribute the fund. The general rule with expense ratios is "The lower the better." New funds sometimes have high expense ratios because of their small size. These funds should make every attempt to lower the expense ratio as they grow. This indicates a cost-conscious environment and a desire to put shareholders first."
Diligent fund investors need to look for (and avoid) level loads as well as front and back end loads. Level loads are 12b-1 fees in excess of 0.25% per year. Funds with such ongoing sales commissions will be categorized as "LOAD" on our website (red LOAD graphic) and will not come up in screens if you exclude load funds - even though these funds have no front or back end load
See also:
A Fund Fee We Love
The Worst Mutual Fund Investing Advice Ever
Are You Paying A Sales Load?
New Fund-O-Matic Feature
A quick note to turn your attention to an important tweak we made to the Fund-O-Matic search engine over the weekend.
The new 'Exclude High Min. Investment?' option ('yes'is selected by default) on the Fund-O-Matic search box (the brown area with the toaster-esque object, near the top of each page on the site) gives users the ability to filter out funds with high minimum initial investments - specifically funds that require more than $25K to buy in.
This means that if you search for, say, Large Cap Value funds sorted by Highest MAXrating, your search results won't include mutual funds that are primarily available to high net worth individuals, institutional investors, or only through 401(k) Plans.
We also added the new 'Fund-O-Matic's Most Popular' box to the right had sidebar. It's a fun little piece of code that displays the most searched for funds of the last 72 hours. Enjoy!
Past Isn't Prologue
How about a Saturday reminder, via Blodget at Slate, not to invest in a mutual fund based on its past performance?
Most investors have heard the "past performance" warnings before, but like other common mantras, do not heed them. Why not? Because they defy common sense. Above-average fund managers should have beaten the market, while below-average ones should have lagged it. So, all we need to do, the logic goes, is to look at some past performance—and pick a few managers who have put the market to shame.
The first of many reasons why this logic is flawed is that excellent past performance is often the result of something other than skill—namely, chance. In any given period, a random selection of stocks will beat the market about half the time. Similarly, a random selection of fund managers will beat the market about half the time (before costs). As a result, the difference between a supertalented fund manager and an average one is often as hard to discern as the difference between a .350 hitter and a .280 hitter in baseball. Over many seasons, with the help of detailed statistics, the difference is obvious. Over a few dozen at-bats, however, the hitters often look about the same.
Second, strong past performance is often the result of the temporary dominance of a particular investment style: growth stocks in the late 1990s, for example, or value stocks and small stocks from 2000 to 2006, etc. When a particular fund manager's style is in vogue, the fund can post extraordinary returns. These returns can disappear quickly when the market environment changes, however. (If you could predict the future, you could theoretically switch from style to style, but the whole problem with stock-picking, market-timing, etc., is that most people aren't Nostradamus.)
Third, even if you do manage to find a fund whose excellent past performance is the result of skill, something critical to the performance might soon change—leaving you with a frightfully ordinary fund (and facing a big transaction and tax hit if you decide to ditch it)."
Why do we post so many articles warning against the dangers of relying on past performance to make mutual fund investing decisions? Because, believe it or not, past performance is still the number one factor mutual fund investors consider when making buying decisions.
What Not To Do
Marshall Loeb provides the list of five big mistakes mutual fund investors make. We provide the commentary.
- Chasing performance - Don't buy last year's hot funds. Studies show that funds that are currently at the top of the performance heap have less of a chance of beating the average fund return going forward than funds that did less well.
- Paying commission - Don't pay loads. Ever. There are perfectly good no-load alternatives for each fund that charges you 5.75% of your money for the privilege of investing in it.
- Paying excessive fund expenses - When it comes to fund expenses, the cheaper the better. Fund expenses eat away at your returns. It's usually the cheapest funds that make you the most money long-term.
- Buying funds with high turnover ratios - A high turnover ratio is generally bad for a fund to have because excessive trading produces larger commission fee expenses, higher income and capital gains distributions, and might imply a lack of a clear investing focus by the fund manager. The industry average turnover ratio is 102%. We generally prefer funds that don't exceed 65%.
- Having inadequate diversification - Basically, the idea behind diversification is to spread your money among many different investments as the chances of them all going bad at once is pretty remote. Purchasing even a single mutual fund automatically provides a certain level of diversification by taking your money and investing it across all the stocks and bonds the fund owns. The problem is that many mutual funds invest in a single sector or country - technology stocks, financial companies, or Chinese equities, for example - and very often all the companies in a particular sector or industry rise or fall together. Therefore, your best bet is to buy a few different funds that concentrate in entirely different fund categories. And, depending on your risk profile, it is also a good idea to keep a certain percentage of your money in bonds and some in cash.
You can check a fund's performance history, expense ratio, turnover ratio, and whether or not it is a load fund or a no-load fund, by entering its ticker into the Fund-o-Matic. 
(MAXfunds.com is also the only place where you can instantly compare a fund’s expenses to similar funds INCLUDING an adjustment for hidden portfolio-level expenses resulting from trading. Check each fund's MAXrating: Expenses for the complete expense picture.)
See also: MAXuniversity Part III - MAXfunds.com's Seven Rules of Mutual Fund Investing.
Some Gold Fund Managers Wary of Buying Gold
Looks like some gold fund managers are as pessimistic as we are about the yellow metal. Many are hording much of the cash that performance chasing investors threw at them after gold fund's hot run of the last few years.
With gold headed back toward its highest level in decades, why are so many gold fund managers holding so much cash?
Take Frank Holmes, chief investment officer at U.S. Global Investors in San Antonio. His $250 million Gold Shares (USERX) held 16.4% in cash as of Dec. 31, while the $1 billion World Precious Minerals (UNWPX) had 14.5% of its assets in cash at year's end.
While it might seem like a fund with that much money on the sidelines would have missed out on gold's rally of 20% from its low of around $560 an ounce last October, Holmes says it has provided much needed flexibility.
"What happens is that when the stocks really get clobbered, I have the money to buy them," the fund manager says.
Another reason for big cash sake is that hot money fund investors are just as quick to turn tail when gold loses some luster. The manager of a fund inundated with hot money typically has to keep cash around to meet fast liquidations – otherwise the manager would have to sell fund investments which increases fund turnover and trading commissions and other costs. US Global Investors World Precious Minerals (UNWPX) fund currently has a hot money of 5 (the worst).
This needed cash cushion is one reason funds with high hot money ratings tend to under-perform going forward. Hot money in these funds in general is the main reason why our current category rating for precious metals funds is just 25 out of 100 (poor).
Our Favorite precious metals funds:
MAXadvisor Powerfund Portfolios Update
Note to MAXadvisor Powerfund Portfolios subscribers: the First Quarter, 2007 'Our Favorite Funds' report has been posted. MAXadvisor Powerfund Portfolios subscribers can access it by clicking here. Each 'Our Favorite Funds' report reveals what our analysts consider to be the very best no-load mutual funds in each fund category.
The MAXadvisor Powerfund Portfolios is a collection of seven model mutual fund portfolios ranging in risk from very safe to quite aggressive. Each portfolio is made up of a group of terrific, no-load, low-cost mutual funds that are carefully chosen to work together to lower volatility and increase returns. You can learn more about the MAXadvisor Powerfund Portfolios (and sign up for a free trial if you like what you see) by clicking here.