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Which Funds To Avoid - Cooking Lessons from Americaís Mutual Fund Managers

Which Funds To Avoid - Cooking Lessons from Americaís Mutual Fund Managers
By Ron DeLegge, Editor
October 28, 2008

SAN DIEGO (ETFguide.com) - ďPut your money where you mouth is,Ē was the good advice given by a toothpaste commercial back in the 1970s.

But unfortunately, recent statistics reveal that Americaís mutual fund managers havenít been following that advice.

According to Morningstar, an amazing 47 percent of domestic stock fund managers report no ownership in the mutual funds they manage.

And thatís just the beginning of the valuable cooking lessons being dished out.

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An astonishing 61 percent foreign stock fund managers similarly havenít put their money into their own funds. Managers of taxable bond funds and balanced funds are shamefully worse. A ridiculous 66 percent and 71 percent respectively, report having a zero percent stake in the fundís they manage.

What does all of this mean?

It means a lot of things.

It means fund managers arenít investing their own money alongside of their fund shareholders.

It also means if fund managers have so much confidence in their own financial acumen they sure arenít showing it.

Put another way, it means they arenít eating their own cooking.

Morningstar's surprisingly candid survey indicates that ownership scores from fund shops like Putnam, J. P. Morgan and Vanguard tend to be weak. Putnam's Fund For Growth And Income (Nasdaq: PGRWX) underperformed the Vanguard Value ETF (NYSEarca: VTV) by over 10% for the past 12 months. Here's an idea: How about incorporating fund manager's ownership into Morningstar's fund ratings rather than dwelling on misleading past performance numbers?

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ďIt is obvious that fund managers should invest significant dollars of their own in their funds, so as to align their personal interests with their investorsí,Ē says Louis Lowenstein, author of The Investorís Dilemma: How Mutual Funds are Betraying Your Trust and What to Do About It (John Wiley 2008)

Lowenstein adds, ďManagersí willingness to put their own dollars alongside the publicís may be the single best marker for their credibility and integrity.Ē

Still, for all of the fuss over fund managers eating their own cooking itís still no guarantee that fund managers will be able to consistently beat their benchmarks.

How about Bill Nygren, lead manager of the Oakmark Select I (Nasdaq: OAKLX) mutual fund?

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Even though Nygren eats his own cooking by investing more than $1 million of his own money in the fund, it hasnít helped the performance of OAKLX. Over the past five years, his large cap value fund has underperformed corresponding barometers, like the iShares Russell 1000 Value Index Fund (NYSEArca: IWD).

The same holds true for Wally Weitz and the Weitz Partners Value (Nadaq: WPVLX) and Weitz Value Fund (Nasdaq: WVALZ) along with the Dodge & Cox Funds (Nasdaq: DODBX).

Nevertheless, Nygren, Weitz and Gunn deserve some credit. Unlike most of their cowardly peers, at least they got the stomach to consume their own unappetizing recipes. Good for them.

Since the bulk of actively managed mutual funds fail to consistently beat plain vanilla indexes like the S&P 500 (AMEX: SPY), DJ Wilshire 5000 (AMEX: TMW), and the MSCI EAFE (NYSEArca: EFA) maybe we shouldnít be so alarmed to learn that fund managers arenít eating their own cooking.

Take Boston, MA-based Fidelity Investments, who prides itself on homemade recipes cooked up by its fund managers. Seven of Fidelity's largest ten mutual funds have failed to beat the S&P 500 over the past 3-years and eight of ten are performing worse than that same index. Think about it. Who in their right mind would ever want to eat all of this rancid food? Rotten eggs and old banana peels anybody?

If you observe closely, fund managers through their actions appear to be trying to teach us a valuable lesson.
 
Itís a cooking lesson.

Fund managers are effectively saying, ďSince we donít eat our own junk food, why should you?Ē

And the recipe for investors is as simple to comprehend as a box of Cheerios: Donít invest with mutual fund managers that donít invest in themselves. Can it be any more clear?

Better yet, just stick with investing in index funds or index exchange-traded funds (ETFs) and let someone else eat the rotten food.

Itís doubtful that the typical mutual fund investor will ever pay attention to these cooking lessons, but you never know.

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