The most boring article about falling in love with a mutual fund

5 minute read

Yes, you read that right. Someone actually fell in love with a mutual fund.

And that moron is me!

Before you give up on the weird me and move on, do me a small favor and spend just another few minutes to listen to my love story.

Flashback: Exactly a week back..

I had worked my a$# off for almost 2 weeks to put together this marvelous piece of creation (or at least that is what I thought..naive me! )

https://eightytwentyinvestor.com/2017/04/16/know-your-fund-manager-sankaran-naren-the-contrarian/

And then I got a few responses from my friends which go like..

“WTF..Why do you spend so much time researching a fund manager..are you mad??”

And then reality struck me!

The million dollar question: Why take so much efforts? 

Aristotle to the rescue..

While I do have my reasons, let my try and convince you by using the technique of ancient Greek philosopher Mr.Aristotle..

https://anabelmoncada.files.wordpress.com/2015/06/pathos-ethos-logos-ii.jpg?w=843&h=635

Logos – The logical angle..

Just like in a cricketer’s batting career , even the best of funds (read as fund managers) eventually go through intermittent periods of under performance.

There is an interesting study conducted by Vanguard (one of the world’s largest investment companies) where they looked at the 15-year records of all the actively managed U.S. domestic equity funds between 1998-2012.

Here are some interesting findings..

Out of the universe of 275 long term out performers (i.e funds which outperformed the benchmark over the 15 year period)…

  1. 97% experienced at least 5 calendar years of under performance!
  2. 6 out of 10 funds had 7 or more bad years!
  3. Two-thirds experienced at least 3 consecutive years of underperformance, the point at which many investors will throw in the towel

Even the best funds underperform

The takeaway – A path of a good fund is a bumpy road ..

Image result for bumpy road ahead

  • The road to long term out performance is bumpy
  • Even the best of funds experience numerous and often extended periods of under performance
  • Investors should be extremely careful about using short-term performance as the primary criteria for investing or selling out of a mutual fund

Thus, as investors wanting long term outperformance, we not only have to identify winning managers, but historically we have had to be very patient with those managers to benefit from their returns

(Now if you are wondering whether this applies to the Indian context. The simple answer is  “Of course, it does!”. We shall explore that in detail in the coming weeks)

Now with short term performance being so lumpy, your ability to stick on with a fund to a large extent will depend on your belief in the fund manager.

Think about this – if your money was being managed by Warren Buffet – isn’t it a lot less difficult to stick to the fund even during bad times.

Hence, if we as investors need long term outperformance, we need to start understanding the fund manager in terms of his investment philosophy, style, strategy, experience, track record, investment process etc.

This will allow us to put a “context” to the fund manager’s performance and improves our ability to to stay the course (especially during periods of under performance).

Pathos – The emotional angle..

So, we have narrowed down our problem.

We need to stick to good fund managers over the long term.  But How?

Solution: To fall in love! (err with the fund of course..to use “fund manager” doesn’t sound right 🙂

But how the heck do I fall in love with a fund..

No worries we have yet another expert to our rescue..

Dan Ariely – A pioneer in the field of behavioral economics

Image result for dan ariely

In the 1950’s, when the instant cake mixes were introduced, their initial sales were pathetic.

While investigating, Betty Crocker, the instant mix cake maker, noticed a strange thing.

The mixes actually made baking too easy and the homemakers were feeling undervalued.

All they needed to do was add water to the mix before putting it in the oven to make the cake ; it actually gave them a feeling of not working enough to show their love and care for their family.

So what did Betty Crocker do?

A History of Baking with Betty Crocker

It made the cake making process a ‘bit more complicated’. Betty Crocker changed its recipe in such a way that it required the homemaker to add egg as well!

Result? The mixes began to get sold like hot cakes!

The secret?

It was found that the consumers liked the new cake mixes better, because the slightly ‘complicated’ process (of adding an egg) made them feel that they were actually contributing something to the meal. 

IKEA Effect

“Things seem a lot better and more valuable if you have to work for it. “

Dan Ariely calls this behavioral quirk the IKEA Effect. It describes notion of love in our own labour. This phenomenon derives its name from the love affair, IKEA’s customers apparently have with their self-assembled furniture, even when it’s badly assembled.

If interested you can read his entire paper here and also listen to him here

You can see this phenomenon in a lot of products like,

Thumps from the heart - Quotes for Royal Enfield, by REians #RoyalEnfield #Biker #Riding

Happy Cook.jpg

Now hang on. What does it have to do with analyzing a mutual fund?

The simple idea is to use this behavioral hack, and make sure we attach a lot more pride, ownership and value to the otherwise “lifeless” and “boring” mutual fund. This means we need to put in some effort before we pick the fund.

What better way than to put some effort and start analyzing the fund manager for his investment process, philosophy, style, strategy, track record etc.

But the trick is to find the right level of effort.

Too little effort, and there’s no “love” from us; too much effort, and it becomes frustrating.

So I shall take care of the “too much effort” part (and bring you various fund manager analysis in a crisp format), while you take care of the “little effort” part (reading through them) – and there begins our mutual fund love story…

Summing it up..

  • The road to long term outperformance is bumpy
  • Even the best of funds experience numerous and often extended periods of under performance
  • Investors should be extremely careful about using short-term performance as the primary criteria for investing or selling out of a mutual fund
  • As investors wanting long term outperformance, we not only have to identify winning managers, but historically we have had to be very patient with those managers to benefit from their returns

How do we manage to hold on to a fund manager for the long term?

  1. We need to put some effort to start understanding the fund manager in terms of his investment philosophy,process, style, strategy, experience, track record etc.  This will allow us to put a “context” to the fund manager’s performance (especially during bad times) and improves our ability to to stay the course.
  2. This will also bring in the IKEA effect, thus helping us attach a lot more pride, ownership and value to the otherwise “lifeless” and “boring” mutual fund. This hopefully should help us stay the course with a good fund manager.

And the most important part..Happy investing as always 🙂

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For those wondering on the ethos part, I have conveniently ignored it on the assumption that you trust me 🙂

P.S: As always, there is the other side of the problem, that given our additional effort and the IKEA effect we may stick on to a wrong choice of fund manager for too long. But at this juncture, its still too early for worry and let us solve that problem as and when it comes 🙂

Disclaimer: No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments.

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Author: Arun

Hey! I'm Arun and I work for the research team of a boutique wealth management firm based out of Chennai. The idea behind this space is to share my learnings/mistakes and hopefully help people in making better investment decisions :)

2 thoughts on “The most boring article about falling in love with a mutual fund”

  1. Suppose, you’re already invested in a fund that you’ve chosen after thoroughly evaluating all the options, including the fund manager. The fund manager then leaves and joins another AMC. What would you do in that case?

    Loved your blogs, by the way. Subscribed!

    Like

    1. Then the entire thesis goes for a toss. One option might be to wait for the new fund manager. If the new fund manager is an experienced investor with strong track record then you can consider continuing. However if the investment style is extremely divergent from the exiting fund manager, then you may look at exiting the fund as it conflicts with the actual positioning of the fund within your portfolio. For Eg when Fund Manager Kenneth Andrade left IDFC Premier Equity fund, he was replaced by Anoop Bhaskar – who is also a seasoned veteran. But however the investment styles are extremely divergent as kenneth follows a thematic, growth oriented, fairly concentrated portfolio construct while Anoop follows a relative value + diversified portfolio construct..Now if I had positioned IDFC Premier in my portfolio to capture long term thematic trends + early in the curve companies with a concentrated portfolio – the same fund post the arrival of new fund manager won’t be able to play the intended strategy as it is not Anoop’s natural style. I might be wrong on this qualitative assessment but these are obviously nuances which we need to consider on a case to case basis.Hope it helps 🙂

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