Most individual investors understand that Wall Street is designed to sell you a product with the occasional ancillary benefit of adding value.
That is especially true in the mutual fund business where there are now thousands of mutual funds exchange traded funds, and other packaged products. The choices are immense.
Not surprisingly, there is an entire industry that has developed to help you, the fund connoisseur, pick and choose the best of the best for your portfolios. At the top of the list is Morningstar and its fund rating system.
Over time, Morningstar’s system has become more and more complex. To help make it less so, Morningstar offers investors a plethora of articles and other information to help you better utilize their information and research.
One of the standard gimmicks used by Morningstar and others in the business is the so-called “Hot Fund” feature. The idea is to identify those mutual funds that have the “hottest” performance record. Theses are the funds that offer the highest returns, usually one, three or five years. The idea behind the feature is to highlight the cream of the crop in fund management.
That is a bad advice if you ask me.
Riding on the Coattails of a Hot Fund Manager? Don’t Do It.
Riding the coattails of a hot manager may sound like a good idea in principle, but in practice, the results of such a strategy fall far short of expectations. One could argue that in many cases the hot manager will start lagging the market right about the time he becomes a hot manager.
How do I know this? Well for starters, I have been that hot manager in the past, and I know firsthand how difficult it is to stay on top, especially in the short run.
See, markets are a funny thing. At some moments your approach may be on top, at other times…> on the bottom. The key trait is long-term outperformance. By winning in the long run, you have the ingredients for successful investing.
Too many investors follow a hot manager only to be disappointed. Then, they jump ship when things don’t work and run to the next hot manager. Not a sound strategy and one that Dan Wiener, editor of The Independent Adviser for Vanguard Investors, has spoken out against for more than 17 years.
Find a Fund Strategy You Believe In
Indisputably, Dan is the expert on Vanguard funds. He’s been tracking Vanguard’s performance and management talent since The Independent Adviser for Vanguard Investors published its first issue.
Dan and I both agree that investors need to follow a more disciplined approach to investing in mutual funds. Namely, find a manager who sticks to a strategy you believe in–not the other way around.
(In fact, Dan Wiener recently interviewed two titans of the fund trade, Vanguard Selected Value’s Jim Barrow and Mark Giambrone to get their take on the industry’s ups and downs. Here’s what they had to say.)
Stay Away From the Hot Hand
I would recommend following a more disciplined approach. Find a manager who follows a style that you believe in and make sure that manager has a long-term track record that has beaten the market consistently.
If you really need to follow a gimmick, I might suggest that you follow the manager who has the cold hand. In many cases, that cold hand becomes the hot hand. Of course there is risk that manager stays cold, but if the basics of good management philosophy and long term track records are in place, such risk is low.
In Dan Weiner’s The Independent Adviser for Vanguard Investors, he discusses a fund with a cold hand, Vanguard U.S. Growth. This might be the place to implement a buy-the-cold-hand strategy.
At a minimum, stay away from the hot hand.
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