Negative Investor Returns: Despite Impressive Fund Performance

During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, Forehand, and Carbonneau discussed Negative Investor Returns: Despite Impressive Fund Performance. Here’s an excerpt from the episode:

Tobias: To some extent, Ken Heebner had the CGM focus fund, which is, famously one that– It returned something like 17% a year for a decade. He was Morningstar manager of the decade in 2011 or something like that. But if you look back a decade before, the average cash on cash return in his funds was like negative 11%, because people sold at the bottom and bought back at the top, and it was– [crosstalk]

Jack: Yeah. And the actual return was like significantly positive, right?

Tobias: The funds were something like 17% compound. The average investor was negative 11%. You probably find the same thing in Ark. The money flows in exponentially as the funds go up. And part of that creates some of the performance too. But equally, it means that the investors cash on cash returns are always negative, because when you take a header, you’ve got the bulk of your money has come in at the very top and it all gets– [crosstalk]

Jack: Fair holding CGM focused. A lot of those same idea, like, they all had the same thing. But it creates a conundrum as a manager, because have those funds added value for people or not? On one hand, the fund could argue, “Well, here’s my actual returns. This is what I put up. If you stayed the course, this is what you got.” On the other hand, do you acknowledge the fact that people are going to do what they do and I’m going to have a 30% investor return less than my actual return, I got to change the strategy, because this is not doing anyone a good. It’s hard. That’s the balance as a manager is, how do you think about those people–? [crosstalk]

Tobias: It’s outside of your control.

Jack: Yeah. No, it is.

Tobias: Got to be worried about it.

Jake: I think it depends on the structure too. If you’re managing an ETF where it’s somewhat easier come, easier to go, I think it’s harder to do. If you’re running SMAs and you have more of a relationship with the investor, I think you have a better chance of bringing everyone along with you to the finish line, maybe fund even more so. I don’t know.

Tobias: You can’t throw up gates. Nobody likes gates, and I don’t think you can justify them either.

Jake: I know.

Tobias: But it probably does lead to better performance.

Justin: Well, it is interesting. It’s funny you’re bringing this up, because for some reason, I heard somewhere else, I was like, “What is going on with those funds?” Actually, those funds liquidated at the end of 2022. So, CGM focus fund doesn’t even exist anymore.

Tobias: Wow.

Justin: I don’t know if the assets tra– But you go to the site and it’s like, CGM focus funds have closed, and it’s like there’s an unclaimed state property link to click on to claim your—

Jake: For everybody. [laughs]

Justin: Yeah. [chuckles] For people that didn’t redeem their shares, if you’re listening, you can still go and get your money, or at least some of it. [chuckles]

Jake: Yeah.

Tobias: Charles asks, “Is that a good argument for closed end funds, despite those funds immediately trading at a discount?” I think you need some ability to buyback your own stock as a closed end fund, which managers don’t want to do because it shrinks their assets, but equally, it gets rid of that discount. And I think that’s one of the reasons why– It’s one of the advantages that Buffett has that he’s got– When the market goes down, all anybody can do is sell Berkshire. They can’t pull money out of Berkshire. And so, Berkshire can trade at a discount, which creates an opportunity for him to buy back stock which as long as the stock is bought back at a good time that generates better performance in the future.

Jack: And to Jake’s point, I think it is a case that running these focused things in SMAs to some degree is good, because you can talk to the end investor on a regular basis. You can help them stay the course. And the other thing is, Eric Balchunas has talked about this a lot. I think you are seeing people use these things maybe a little bit better than they used to in the past. Like, they have the core and satellite thing. So, they’ll have their core portfolio and they’ll take something like Ark and they’ll size it smaller. And so, when it’s sized smaller relative to the rest of your portfolio, you’re going to do a better job of sticking with it.

One thing you can say for Ark is, they should have gotten a lot more redemptions than they did, given how bad the performance was coming off the peak. So, they have gotten buy in, I think, from their investors.

Tobias: Yeah, very much so.

Jack: Whether you like the strategy or not. A lot of these other funds in the past that have had those kind of performance numbers have had much bigger redemptions than Ark did. So, they have gotten buy in, at least.

Tobias: Yeah, I think that’s the most impressive thing about those funds is that even as they fell over, they were still getting positive flows for a long time. I don’t know if they’re still positive, but now they had a good year last year, had a great year last year.

Jake: Hell of a marketing machine.

Tobias: What do you think is the most survivable factor for outside investors?

Jack: [chuckles] [crosstalk]

Tobias: I think it’s got to be something that’s pro cyclical. It’s got to be momentum. When money’s flooding in and you keep on doing really well, and then you have a 2009 where everybody’s just running for cover and everything’s bombed out, so it doesn’t work for you then. But it didn’t work for anybody anyway. But then you go back into a booming bull market and you’re back into momentum land.

Jack: One of the cool things about momentum that a lot of people don’t think is a lot of people might think value is a more consistent factor than momentum, but that’s actually not true. If you look at the consistency of five-year periods producing a positive premium, momentum is actually better than value. It’s more consistent in terms of not having the long, long periods of struggle than value is. So, it’s good from that perspective.

But my big takeaway from value and momentum in my career has always been– [coughs] Excuse me. Sorry. They work really well together. It’s something where people tend to get in these camps and they tend to say, “Well, I’m a value guy, so that I shouldn’t use momentum in any way, or I’m a momentum guy.” When you do the look at the data on them, they work really, really well together. And that doesn’t mean you have to use them 50:50. Value people can use momentum for entry and exit. There’s other ways you can use it. I think they work really well together, and I think they’re great compliments. So, I try not to pick anymore between them.

Tobias: Is that long-short, or just the long only versions of them?

Jack: Just the long only. They work really well together.

Justin: There’s a really good chart by Larry Swedroe. You can google it to find it. You got to dig it up. I think it might be maybe on like– He writes for a lot of different places. So, you got to look around. But it’s like, Larry Swedroe factor persistence, maybe or something like that. He’ll show like value momentum, and then periods 1, 3, 5, 10, 20, the percentage of underperformance in any given year. When you combine the factors percentage, those periods of possible underperformance fall significantly. It’s a really powerful visual that’s out there that Larry’s done work on. So, that’s pretty cool to see, I think.

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