Following is an excerpt from Chapter 6 of the BetterInvesting Mutual Fund Handbook, written by Amy Buttell and recently revised by Danielle Schultz:
Fund Managers in Action
When you buy fund shares, you hire a portfolio manager. How that manager runs the fund determines whether you make or lose money. Managers determine which companies to buy and sell. They use different criteria to evaluate companies and manage the fund’s portfolio.
The media, individual investors, and institutional investors constantly scrutinize the performance of portfolio managers. Many fund managers fail to outperform market indexes. BetterInvesting’s tools are designed to help you find outstanding funds that meet your investment objective.
Choosing Management
Examine the record of portfolio managers during the past 30 years, and it’s clear that many fall short of any definition of superior performance. Studies have shown that index funds outperform portfolio managers 75% of the time over the long term.
First, we’ll analyze how active portfolio managers select companies and what you’re paying for when you invest in an actively managed fund.
How Fund Management Operates
Although every fund is different, some common features apply to the operations of most actively managed mutual funds. All funds have a manager or managers who are supported by researchers, analysts, a trading desk, and brokers.
Researchers, analysts, and managers access sophisticated financial data about many thousands of companies. They employ certain criteria, which varies from fund to fund, to sort through these companies.
Most fund companies espouse a fundamental approach to stock selection. Fundamental analysis refers to the practice of examining a company’s management, results, and methods as opposed to technical analysis, which refers to analyzing overall market trends. BetterInvesting also espouses a fundamental approach to evaluating funds in terms of examining their portfolios, management, and costs.
Managers rely on researchers and analysts for basic research on a promising company. Analysts from some fund companies roam the globe, interviewing company management and observing company operations. In the office, they scrutinize financial statements, looking at such elements as a company’s profitability, cash flow, lines of business, market share, and competition.
Portfolio managers themselves devote a significant amount of time to research, examining financial statements and visiting companies or talking to CEOs on the phone. At many fund companies, analysts and managers engage in lively debates as they discuss the merits of various industries and companies.
Once a manager or management team decides to buy a particular stock, the focus of the operation moves to the trading desk. Management decides how much of a particular stock to purchase, but the trading desk figures out how to make that purchase at the lowest possible cost common in the fund industry.
Outside of the drama of what to buy and what to sell, fund managers devote time to staying on top of the businesses of their current holdings, talking to large shareholders, and participating in meetings, conference calls, and media interviews.
Management Changes and Blunders
Should you succeed in finding a top-notch portfolio manager with a superior track record, keep in mind that there’s no guarantee that manager will stay with a particular fund. A manager may quit, be fired, or be reassigned.
In a recent study of the 30 largest fund families, Morningstar found that the average tenure of managers was 5.2 years. If you choose actively managed funds, BetterInvesting recommends you seek funds whose managers have a minimum of five years’ experience managing a particular fund. A manager with less experience isn’t responsible for the fund’s long-term historical track record.
Some fund families frequently reassign managers, moving them around from fund to fund like players in a game of musical chairs. Others lose managers who leave to pursue more lucrative opportunities elsewhere.
Despite the limitation of fund objectives, managers in some fund families enjoy considerable latitude in running a particular fund. This can lead to considerable success or failure. Although the legendary Peter Lynch beat the S&P 500 in 11 of the 13 years he managed the Fidelity Magellan fund, the fund has flailed since then, with five changes of management.
About the ‘Mutual Fund Handbook’
The Mutual Fund Handbook, originally written by Amy Buttell, is $15 for BetterInvesting members ($20 for nonmembers) via the BetterInvesting online store. To get your copy, click here. Or download a free sample chapter of the Mutual Fund Handbook and also try out BetterInvesting’s free mutual fund resources.
About Danielle Schultz
Learn more about Danielle Schultz and read her blog.
About BetterInvesting
BetterInvesting is a national nonprofit organization that has been empowering individual investors since 1951. Founded in Detroit, the association (formerly known as National Association of Investors Corporation) was born out of the conviction that anyone can become a successful long-term investor by following commonsense investing practices. BetterInvesting has helped more than 5 million people become better, more informed investors by providing webinars, in-person events, easy-to-use online tools for analyzing stocks and mutual funds, a monthly magazine and a community of volunteers and like-minded investors. For more information about BetterInvesting, visit its website at http://www.betterinvesting.org/investing/landing/openhouse/blog/index.html or call toll free (877) 275-6242.
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