I routinely receive a number of press requests via email during the course of the week.  I delete the vast majority of them because I either do not feel qualified to comment or I’m just not interested in being quoted.  However I did receive one today to which I did send a few thoughts to the reporter seeking input.

He was seeking comments on:

“….financial planners who are surprised or have an opinion on some of the mutual funds that decided to buy Facebook stock in its first two weeks of trading. The monthly portfolio holdings for some fund families have been released in the last couple weeks.

Is it expected for some core mutual fund holdings (including those in 401ks) to participate in a volatile IPO like Facebook? Should Value or Dividend funds (have) picked up the stock, as a few did? Some funds have as much as a 5% to 7% allocation to the stock, is that worrisome?

Some of the funds that bought the stock between May 18 and May 31 include: …” 

My email response to this reporter was:

In the case of actively managed mutual funds such as the ones mentioned in the press request below, for better or worse you are buying into the judgment and skill of the manager or management team.  I would tend to evaluate the fund’s performance over time, their expenses, risk, adherence to a style, and other factors.  I wouldn’t necessarily look at their having bought Facebook during the IPO phase or any other singular holding.  Managers make some good bets and some that aren’t so good.  At this juncture it is a bit early to judge these purchases; however my focus would again be in the aggregate.  Have they made far more good bets vs. poor ones? 

The point of my response was that if one purchases an actively managed mutual fund (or separate account, annuity sub-account, closed-end fund, ETF, etc.) they are buying that manager’s skill and their ability to achieve some expected result.

There is a whole other debate about whether an investor should stick with lower cost index funds and ETFs vs. actively managed funds and that is not the point of this article.  For the record I am a fan of both, I use a high percentage of index products in my client portfolios but I also use a fair number of active funds as well.  As an advisor I have one advantage that many individual investors may not have in that I have access to institutional and other lower cost share classes for a number of the funds that I use both active and index.

In my opinion if you are looking at an actively managed fund you should evaluate the “whole picture.”  Typically when evaluating a fund, the starting points of my analysis include:

• Track record relative to its peers.  It’s useless to compare a mid cap growth manager to one who invests in foreign large value stocks.  Note a stellar track record may not indicate success going forward so it is incumbent upon you to look further and understand what is behind that track record.  For example, how did this fund do on a relative basis in both up and down markets?
• Expenses, how does the fund compare to its peers?
• Alpha and Sharpe ratio.  These are measurements of the fund’s risk-adjusted return and to me are indicators of the value (or lack thereof) added by the manager.
• Management tenure.  It is not uncommon for a successful fund manager to move on to greener pastures, especially if wooed by a competitor.  If the manager(s) who compiled the fund’s great track record are gone this is a big red flag, though not always a deal killer.  A number of years ago the long-time manager of a foreign fund that I like left.  Two of her underlings took over and frankly I think they have done an even better job.  Investing is about people, but it’s also about process.
• Gain or loss of assets.  This is huge, especially if the fund invests in small or mid cap stocks.  Many funds have compiled a great track record with a low asset base.  One of the truisms of investing is that money chases performance.  Once a fund does well, new money can often poor in.  It can be tough for the manager to find enough good ideas in which to invest this new money.  Case in point is Fidelity Magellan.  This fund was managed by the legendary Peter Lynch and posted some fantastic numbers.  Money poured in, Lynch left, and the fund has been decidedly mediocre for a number of years.

These items are a starting point when researching an actively managed fund.  Overall my job is to develop portfolios for my individual and institutional (retirement plans, endowments, and foundations) clients that fit their needs.  Mutual funds and ETFs are the tools that I use.  I rely on the managers of these funds and ETFs and I judge them on their overall performance, not on any one individual holding or transaction.

If you need help evaluating your investments or with your financial planning  please feel free to contact me to discuss your situation.