Mark Hulbert: Harvard teaches investors a lesson in what not to do Express News
CHAPEL HILL, N.C. (MarketWatch) — Don’t fire your investment manager just because he failed to beat the stock market last year.
I can already hear the howls of protest: If trailing the market isn’t a fireable offense, then what is?
My answer: It’s not that past performance doesn’t count; what’s irrelevant is performance over the recent past. Calendar-year performance, for example, tells you next to nothing about whether your manager is a good bet for future returns.
This is an exceedingly difficult lesson for us to take to heart. Even Harvard University, with the largest endowment fund in the world, apparently is having trouble with it.
The university in late January laid off more than half its investment-management staff. Though the institution’s press release announcing this didn’t mention it, the layoffs come on the heels of a disappointing fiscal year in which the endowment actually lost money, lagged behind its benchmark by 3 percentage points, and trailed the total return of the S&P 500 Index
by 6 percentage points.
Yet the endowment’s longer-term performance remains impressive: Over the past 10 years, it’s beaten its benchmark by 0.9 percentage point per year on an annualized basis, according to its latest annual report. And over the past 20 years, its margin of victory is 3.1 annualized percentage points.
Since the vast majority of all managers fail to beat their benchmarks over the longer term, one would have thought that this impressive long-term record would have given the institution at least some leeway to tolerate its recent loss.
Apparently not. (For the record, I should mention that Harvard says there are other reasons besides disappointing recent short-term performance for its decision to fire its management staff.)
To put Harvard’s recent actions into perspective, I measured the frequency of losing and lagging years among the investment newsletters I monitor that have nevertheless beaten the stock market over the past decade. It turns out that, while not necessarily the rule, such years are most definitely not the exception either.
Consider first the number of calendar years over the past 10 that these market beaters lagged the overall stock market: This number averages 4.8, believe it or not, or only slightly less than half the time. (Please see the accompanying chart.) The number of calendar years of the past 10 when these market beaters actually lost money was 2.3, on average, or about one of every four.
And note carefully that these numbers reflect the performance of the very best advisers at the top of the 10-year rankings.
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Lest you conclude that the investment-newsletter industry is unique, let me assure you that they are not. Consider a Brandes Institute study from 2007 in which the frequency of mutual fund losses and benchmark-lagging returns was measured. It found that each and every one of the mutual funds in the top decile for 10-year performance through 2006 was nevertheless in the bottom half of the ranking in at least one 12-month period. And three-quarters of those top decile funds were in the bottom 10% for performance during at least one 12-month period.
In showing us why it’s premature to get rid of a manager for short-term underperformance, these studies also illustrate why picking an adviser in the first place is so important. You need to give your chosen manager the benefit of the doubt even if he or she lags behind the market for a year or two along the way.
If the relationship to your adviser is not exactly a marriage, it’s far closer to it than most of us think. And yet most investors view their relationships with their advisers as something akin to a one-night stand.
For more information, including descriptions of the Hulbert Sentiment Indices, go to www.hulbertratings.com or email firstname.lastname@example.org.