Sunday, June 12, 2011

Handicapping Mutual Funds the “Belmont Way”

As many of our blog community members and readers of my book, MONEYWISE already know, I credit the US Marine Corps and the racetrack as my two great educational experiences; as distinct from Columbia University, from which I graduated. What little I know about security analysis and mutual fund selection is based on what I learned at the race track.

For those who have a detail orientation and are comfortable with basic arithmetic, the task of analyzing races is a great challenge and a pleasure. Just some of the items to take into consideration are the track records of the horses, their parents, the trainers and the jockeys. These factors are vital in terms of the winning results, but more importantly, the conditions under which the records were produced. The objective of all this study is to pick net winning bets, (winning more dollars than losing). Note by setting this goal I am accepting the reality that a number of the bets will be losers. I do not expect to win with every bet. I carry this expectation into my investing in funds and individual securities.

The Belmont

Belmont Park is America’s longest dirt race track. Each year in June it conducts the Belmont Stakes, which is the so-called third crown of the Triple Crown for three year old colts and fillies. Linking the three races into an overall result is a public relations/media concoction and has very little to do with the development of racing and perhaps more importantly, breeding results. No single horse has won the three races since 1978. Out of the last twenty-three years there have been eighteen years (including this past Saturday) that neither the winners of the Kentucky Derby nor the Preakness Stakes have won the Belmont.

As a kid who grew up in New York City, I have always taken the attitude that the Belmont was the real test of champions. Further, as the race normally has the fewest horses and the longest distance, it is the truest race. (Most of the horses will not run again at a distance of a mile and a half in the US.)

The Analytical Bridge to Fund Selection

Picking winners at the track, called handicapping, involves a great deal of intensive research and analysis. With all of this effort, the odds are that I will come up with more losers than winners; but by limiting my wagers to selected races and appropriate odds, I will come out dollars ahead. Many of the same techniques that I use in the search for winning horses I use in selecting funds for my clients and myself. There are two big differences in investing in funds. The first is that a losing race ticket is worthless, but when a fund goes down all is not lost. The second is with a race the most important result is at the predetermined finish line. With investing it is a continuous race which ends when the investor chooses, except if it’s a forced sale due to external circumstances, e.g., better bargains, change of objective, a margin call or similar involuntary termination.

Belmont Lessons and Fund Selection Applications

I have spent almost my entire professional career of more than fifty years thinking about investment selection. I use many different inputs for my analyses. The purpose of the following exercise is to show the application of the lessons observed from this year’s running of the Belmont Stakes to fund selection as well as examining the use of specific past performances to correlate to future results. The objective of the exercise is to improve the odds of avoiding losers and picking some better than average results. The following list outlines the lessons from the Belmont Stakes, and their applications to fund selection as a point of departure for deeper analysis:

Belmont Lessons matched with Fund Selection Applications

  • The 2011 Belmont race was very slow by historical standards. Fund winners in a given year have had gains of 100%+, to losers of (-50%), with the norm of 8-12%.

  • Too many horses crowded the favorite from the gate. Too many investors plowing into the same names at the same time makes it difficult to get a distinctive advantage.

  • Racing luck=Derby winner losing early contact with its stirrup. Anything that distracts portfolio managers in their personal or professional lives could be a factor.

  • Change of equipment: first time use of blinkers by the winner. Some PMs need to focus more

  • Winning change in strategy from stalking to being near the lead. Adapting to change conditions

  • Performance records not useful. Managers of the year or decade can lose

Ten Past Bull Market Winners

Each week I look at lists of funds that are of interest to our clients. They either own these funds or are considering them. We compare the funds with their own specific peers and array them in quintiles. Recognizing that often fund performance fits into a bell-shaped curve, we include funds that are in the three highest performing quintiles. The following is a list of funds of interest for one of our clients. The list includes funds that performed in the top three quintiles in the rally between March 31, 2003 to September 30, 2007. Next to each fund name is its quintile performance in the current rally which started on March 9, 2009 and continued through June 2, 2011.


  • Mutual Global Discovery - Fifth quintile. Portfolio Management changed

  • Templeton Institutional Foreign Investment - Second quintile. Good in down markets

  • CGM Focus - Fifth quintile. Poor in down markets

  • Longleaf Partners - First quintile. Poor in down markets

  • T Rowe Price Growth - Second quintile. Third quintile in down markets

  • Dodge & Cox Stock - First quintile. Poor in down markets

  • Vanguard Mid-Cap Index - First quintile. Poor in down markets

  • Thornburg Value - Second quintile. Poor in down markets

  • Fairholme - Third quintile. Financials lag this rally

  • Vanguard Small-Cap Index - First quintile. Poor in down markets

The superior performance of the two Vanguard index funds suggests that the index funds are not structured or own the same securities as their actively managed peer funds.

One of the lessons from observing the Belmont Stakes is that some of the participating teams of horses, jockeys, and trainers change their equipment and strategies. Sometimes the changes are beneficial. Further, track records are a guide, e.g., in the Belmont, roughly 80% of the time the winner is neither the Kentucky Derby or the Preakness winner.

How do you pick winning investments? Please share.


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