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« Some Side Hustles to Ramp up Your Retirement Savings | Main | Financial Rules that Work and Don't Work »

April 23, 2012

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The problem that fund managers that use active management styles face is this. They have very large positions in many of the companies whose stock they hold. If some bad news comes out such as a bad earning's report, a lawsuit, the loss of a key employee or any of a host of other things that are a negative for the company, it is very difficult to get out of their position without driving the price of the stock far lower, particularly if they are a very large fund.

On the other hand a small individual investor like myself is able to sell out of a position completely at any time very easily and have zero effect on the market. In my own case, in my trading days I made my money trading mutual funds which gave me lots of diversification since a sector fund typically owns close to a hundred companies and a diversified fund several hundred companies. I could then use a variety of technical indicators which I have previously backtested over short, medium, and long time periods to determine the values of the parameters that produced the best results for a particular fund. Then it's just a question of checking each of my 5 or 6 funds after the close every day to see if it has given a Sell signal. This is where a fund's volatility is important. The lower the volatility the more time it takes for a fund to change from a a Buy/Hold to a Sell, so you get more warning. I selected funds to buy based upon parameters such as Risk adjusted return, Volatility, and Max Drawdown, over several time periods and avoided the high volatility/high drawdown funds that can turn on a dime.

With this approach you get out of a fund soon after it has formed a major peak but before it has gone too far below the peak. On the buying side you look for a fund that is in a nice uptrend and ride it up as long as the trend continues. When it falters you just jump ship and move the money into a fund that is still trending up nicely. If you can't find a fund whose chart has what you are looking for you have to just wait until one appears.

This process may sound complicated and time consuming but with a great proprietary database that has thousands of funds, grouped into hundreds of categories, and great software, the computer does all the tedious calculations for you. Of course, experience matters a great deal. If you have difficulty finding a fund to buy it generally means that the whole market is doing poorly and if you are like me and don't want to play the short side of the market it's better to sit it out and wait as long as it takes for things to improve.

In my own case I gave up trading in 2007 so now it's just a question of sitting back and reinvesting very predictable interest every month. At 78 and having been retired for 20 years I am very happy to let the younger people go for the capital gains while I am happy to sit back and wait for my interest to show up once or twice per month.

"We strongly suggest that long-only equity managers read, and reread and re-read again Mr. Travaglini’s comment for we fear that this is the death knell for the long-only stock fund manager."

I believe this statement to be true. The stockmarket of today is being heavily manipulated in several ways. Since 2008 the Federal Reserve has had several programs in play in an attempt to stimulate the economy. They do this by funnelling large amount of money at various unannounced times to large investment banks such as Morgan Stanley and Goldman Sachs that can use it to change the daily course of the market at will. These companies also have supercomputers run by some of the smartest computer science graduates from the country's best engineering schools. This way they are able to profit no matter which direction the market is moving, and they are profiting at the expense of both small investors and fund managers of actively managed stock funds. We no longer have a level playing field as existed prior to the Internet and during its early years. This is why at this time in my life I am very happy to purchase individual bonds at or below par and hold them to maturity. Not a penny of the money I manage for my family is invested in the shares of any corporation. Investing "Long" only I wouldn't have any idea how to invest today if I needed to duplicate the 17.24% annual overall return on my portfolio that I have made since I started keeping records on 12/28/1992. For the last few years I have been getting a little under 5% (tax free and tax deferred).

There are so many studies and so much information out there proving that active fund managers rarely beat the market and when they do, cannot do it consistently. The problems are that people simply look at the past performance and think that is the return they will earn. Another problem is that investors do not understand the effect fees have on their investments. They don't get a bill for fees, so they are unaware of them and how higher fees reduce your return as years go by.

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