Transcript
Paul Winkler: All right back here on the investor coaching show, Paul Winkler, along with Anne Sawasky. Okay. So things here, there was a fund company. And you may have heard me talk about this a couple of weeks ago. If you’re a regular listener to the show. What’s going on is fascinating. The article says while the world has been mesmerized by the crazy gyrations of a handful of stocks over the past couple of weeks, Kathy Wood has kept on minting money for her investors as few money managers ever have. Now, number one, if you read that, you’re thinking, man, this fund is continuing to make money, right? You would have missed the fact that they significantly underperformed the market in the month of January, because the article is talking in present tense, right written yesterday.
Be Careful of Being Misled
So number one, right off the bat, we look at this and go, Whoa, already investors reading this article would have been misled. Now it says such success for managers. However, it often carried the seeds of its own undoing. It’s almost inevitable that when funds get too big, too fast, they can’t sustain their performance. And this is the problem. You know, when you think about it, people go like this. They go, wow. This fund has really, really done well. I want to have this person manage my money. I want my money in this mutual fund. And then when you go and do that, when you buy that fund, now they’ve got more cash. They got to figure out something to do with that cash. They can’t just sit on it. They’ve got to invest in it in something, what are they going to invest in?
What’s the next greatest idea? And literally you have a ton of money and now you have to buy stock. And literally when you buy stock with a ton of money, what do you do to the price of that stock? Drive it up.
You drive it up. You’re literally Desire to drive, to, to own that company and the money that you have to buy the company. There’s only so much supply. And now you’ve created a lot of demand with the amount of cash that you got flowing in from investors who put money in your mutual fund and you literally drive up the stock. And what happens is the money makes it really hard for fund managers to maneuver. As the article says, as nimbly as they did when they were small. And then you have this other problem, you have other people that perceive that this person is a really good fund manager. And when you look at somebody and say, Hey, you know what?
What Success Looks Like in Investing
This person is really good at what they do. And I don’t care what career it is that you’re in. You typically do what you watch, what other people do in your field and go, who is getting results. And you may make them, I mean, you want to, you want to be good at what you do. You want to get success at what you do look around. Who’s doing well in your field. Do what they do. You can get the same. Well, it works in other areas. It doesn’t work as well in investing because what happens is when you mimic other people that are getting success, you water down the very success that is possible because all of a sudden you’re actually doing the same thing that they’re doing.
And you’re all chasing particular companies of which there is a limited supply and this is exactly what’s going on. So you have copycats out there, mimicking her every move and all of a sudden what happens is that when it’s going up, everything’s great. But when it comes down, it comes down hard. And that is the problem that you see. And I’ve seen this over and over in my career, watching people do this and just shaking my heads going, this is not gonna end well. It never does. So what happens is that arc managed a total of $11.4 billion at the end of March, 2020, by the end of the year, they had swollen to $58.2 billion.
Liquid Investments
Ooh, oh my goodness. And then it becomes its own impediment because what happens is you got all of this money and you have a few companies. And once you have billions, you’re going to have to spread it across more and more. And here’s the secret. You can’t buy the small companies that brought you to the dance anymore. You know, may have been small companies that she was buying that actually had the great returns. But now, because she’s dealing with huge sums of money, you can’t do that. You can’t invest in small companies anymore. You got to invest in bigger companies and those bigger companies are going to be more liquid. So if all of a sudden you’ve got to sell out, you got to own something that’s fairly liquid.
So now you have another problem. Not only do you have too much money, but you’re investing in companies that it’s a very limited, you know, marketplace, but then you have to go and invest in bigger companies where it’s not as limited so that you can have cash to sell out when you’ve got to make a move. And of course, those bigger companies wouldn’t have as high an expected return. Right? Right. And what happens is, as the Wall Street Journal pointed out, they said, if arc ever needs to sell one of his who will buy enough bulk to keep prices from collapsing in an interview, Ms. Wood says that as markets rise arc diversifies into larger companies, here’s the problem.
Then they formed the kind of war chest that is contaminated during downturns. When less liquid stocks will be hit disproportionately giving us better bargains. Well, you know, Warren Buffet ran into the same problem in Berkshire Hathaway. It’s gone for a very, very long time without matching market returns. And it’s because every time Warren Buffet does something, he sneezes people are watching and they copy what he’s doing. But, you know, I looked at the average PTE, every average price of the stocks compared to earnings in these funds. And I just took an average of all these ETFs. And I took an average price to book average for the market historically is 16, right?
Yeah. It’s, you know, the valuations that are up there and 6.5 price compared to book. And like I said, if you look at the performance in January, it’s actually under the, the market it’s at underperformed, the S&P, which is by far not anywhere near the highest performing area of the market in the month of January. So not only has it underperformed, one of the lower performances is Lamar, but it’s underperformed. Let me think about that. Wow. You know, it’s kind of, kind of a tough thing to go. So that’s one thing I see people do. Another thing that people do is, and this was an email that was sent to me, that somebody had sent me an email about somebody looking at putting money in a fund family.
Fund Families
And I’ve talked about these people before I have to name the fund because I have to give kind of details as to what’s going on. But the idea is that people will invest based on what they are. Maybe it’s it’s, maybe the ESG is a big thing, you know, environmental, social, maybe they have a desire to help out socially, or they have governance things that they want to be helpful. They want their conscience bothersome. So they want to make sure that they’re investing in things that they believe in. And you, and I understand the idea. This seems like a really good idea.
As I remember a guy that I actually, I had an office not too far from him, and this is what his, his whole business model was religiously conscious investing. And, and, and what ended up happening is while it didn’t go well, and I won’t get into too much detail as to what happened. Cause it shows it’s actually a pretty sad story. But in this particular case, if we look at these companies and we say, okay, this fund company, I only invest in companies that are doing things that line up with my faith. That sounds good. But the problem that you run into is that you might go and invest in a company and think about, you know, one of the companies you happen to own happens to be a company that owns grocery stores or something like that.
And what are the things that we might walk into a grocery store and see on the shelves that we would go, oh, you know, that doesn’t necessarily line up. You know, liquor is not my thing, or cigarettes are not my thing. Or, you know, you might have a company that actually delivers, you know, is a, maybe they’re a delivery company, or they own vans that deliver things to people’s houses and they happen to deliver pornographic materials, or they happen to, you know, whatever. There are a lot of things that you look at and go, well, maybe this, this drug store actually happens to have abortion drugs in there. And that’s something you don’t like, or maybe they sell lottery tickets, or, you know, I, there are a lot of things that we look at and go, you know, what, at what point do we say this is a problem?
You know, we, we have to look at it and say, well, you know, all have sinned and fall short of the glory of God and realize that there is no way to avoid it. Well, If we look at, for example, one of these funds. So they have a fund that invests aggressively and it invests in stocks and we go, well, what was the performance of the fund? And if we look at it versus its category index, which, which would be aggressive, an average aggressive portfolio, the underperformance was let’s see.
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Where Is Your Money Going?
It underperformed for 15 years by 4.1% per year. Now you may have a person that says, well, you know what, but it’s still because I like what they do. And I like what they’re about what they say, that they’re about investing in faith-based companies and so on and so forth or what they believe lines up with their faith. I can put up with underperformance, but I want you to think about it this way. If you have a fund that underperformed its benchmark by 4.1% per year, and you invested a hundred thousand dollars in it, based on the performance, the amount of cumulation in the fund versus the index or the benchmark, your hundred thousand dollars would have grown by $135,000, less than it should have.
And I want to, I want you to ask yourself this question. If you had a hundred thousand dollars that you were investing in years, you end up with $135,000 less because of underperformance. Maybe you don’t need that $135,000.
Anne Sawasky: And if you can, you could donate it to your causes to support. But the other thing is by investing in those funds, they’re not benefiting those companies directly. Anyway, you’re just buying it from someone else who holds those.
Paul Winkler: Yeah. When you invest in those companies exactly. And your money isn’t going to those companies, your money is going to somebody else that owns the company before you. And, and the reality of it is some of these companies are doing things. And over the years we’ve seen this over and over. You’ve seen companies doing things and you go, well, you know, I don’t really believe in what these guys are doing, and then all of a sudden they start to change their business model because, because people don’t believe in what they’re doing. But what happens is this as well, if you look at the turnover inside the fund and the amount of turnover is when I look at turnover, what that means is if I have a fund with a hundred percent turnover, that means that 100% or all of the stocks are different from what they were the year before.
So if we look at this aggressive portfolio, the turnover over the last calendar year according to Morningstar was 96%.
Investing Shifts
Anne Sawasky: So aggressive stock picking market timing.
Paul Winkler: It is. Now we can look at this one of two ways. I can look at this and say, well, 100% of the companies that were doing the things that were right a year ago are doing the wrong thing a year later. And we had to remove them from the portfolio, or we can look at it this way that the fund manager is possibly gambling with my money. Yeah, yeah. And trading in trading stocks. And do I believe that gambling is a good idea? Yeah, that’s it. So, you know, I would have to ask myself that and then they had, and just, and that was the first, first fund in an alphabetical order. That was, that was a Timothy fund. The aggressive next fund in alphabetical order is go. We have to go to the letter D in the alphabet, the defensive fund.
Now its performance was a, I don’t know what it was for 15 years. I know that for 10 years it was 4.9, 7%. So if I had invested, it’s a lesser period of time. So the difference in accumulation would be different. But if I took a hundred thousand dollars, it grew to $148,000 in the fund, but it should have been $235,000 if I had matched market returns. And we look at that and go, that’s pretty doggone signific again by anybody’s standards.
You know? So that’s it. And what was the turnover? That one, turn one this bad, but it’s 50% still. And if you look at the level of risk involved in it, it was tremendously risky, you know, as well. So you didn’t save on risk. It didn’t end up with less risky companies as a result of investing in this part. So you don’t realize that a lot of times these funds are sold. And I look at them as a mortgage. I really do. You know, the investing world is really good at coming up with ideas that you will buy, but not necessarily ideas that you should buy.
Custom ETFs
You know, it’s what can we get people to do? And, and I’ve seen some things. I saw another article and made it to it before the end of the show. It was about another investment idea. Ah, let’s see. Yeah, I got it. I got a second before I got to run to a break, let me hit it right now. So BlackRock’s think a tectonic shift in passive investing is coming. So, you know, here, we’re not dealing with that. It’s active stock picking or market time or anything like that. But you know, this fund company is the CTF provider. You know, BlackRock does a lot of ETFs and, and I’m, I’m fine with some of their ETFs. I don’t have a problem with the company. This is not picking on any particular fund company. Cause I would use them if they have something in an area of the market that they capture well, with this new idea, I would not use it, I would not use this, but basically what they’re doing is this, they’re coming up with ETFs.
That in what they’re doing is they’re saying we are going to put together a custom ETF for you. And it will only hold things that you want to hold. Like, for example, let’s say if you don’t like global warming, we will actually exclude any companies that have a bad carbon footprint or something like that. And you know, and you’re already smiling when I say carbon footprint because of how controversial that whole idea is. But I look at this type of fund as a great way to increase gains for the mutual fund companies because they can charge more. They can attract investors that don’t get the idea cost of capital concept, that there is a cost to use your capital and the cost to use your capital goes up.
If there’s more risk. Yeah. They don’t get the idea that people are sucked in by specious marketing. I mean, it sounds really good. So people will, because it sounds good. It aligns with whatever values they might have and they don’t get, as you said, you know the idea that you’re not really benefiting the company when you buy their stock and doesn’t, it kind of provides an excuse for them to not perform well.
Anne Sawasky: Because you said earlier, you said, sure, well, I can live with lower return because I want to achieve this point. That’s an interesting point. Yeah. Yeah.
Passive Investing
Paul Winkler: Th this tectonic shift in passive investing that’s coming. So the idea being that ETFs that are, have always been historically, no, stock-picking no market timing and what’s happening is they’re starting to shift their there’s this shift coming about. And there’s more of this stuff. It’s Magellan this week. As a matter of fact actually announced, I don’t know if it’s a hundred percent going to ETF, but I was, I thought that was big news, that a big fund company, that was one of the most well-known fund companies of all time, because Peter Lynch did the smartest thing ever as a fund manager, he beat the market 11 out of 13 years. Now that wasn’t the smartest thing ever, the smartest thing ever was retiring.
So then, so then nobody saw what, Oh, that’s smart. You know, if you’re going to do something, you know, go retire after you’d beat the market 11 out of 13 years. And then everybody goes out on the top. I mean, if you’re like Tom Brady and then you win the next super bowl and then you quit and then that would be it. But anyway, so what is happening with ETFs is more of them are becoming actively managed and they’re getting into this pseudo it’s, you know, it’s indexing, but they’re, they’re going in and saying, Hey, you can index your portfolio and you’ll even be able to customize this for yourself. And what we’ll do is we’ll manage this and you got to know that this has gotta be expensive to have somebody customize a portfolio just for you taking out just companies that you just don’t like, yeah.
Emotionally-Driven Investing
You talk about emotionally-driven investing because you’re going to look for companies that do things that you don’t like that just performed poorly recently probably is what’s going to happen. Right? And you’re going to get rid of companies after they’ve done poorly. And then you’re going to buy the companies that are doing things that you think are doing things that are noble. And what will happen is those will be companies that are doing things that you think are noble, but you won’t buy them unless their performance, recent performance has been good.
Anne Sawasky: So you’re buying high.
Paul Winkler: Nobody in their right mind goes and buys a bunch of companies that are doing noble things that have just had poor performance, right? It’s just not going to make any sense. But what happens is, you know, and companies are going to spend money on these things when, and they’re going to have, you know, so let’s, let’s, let’s just take a look at what companies will do. Companies will do this, and we’ve seen this over in China. They will spend money on things that will give a leg up on profitability, on their competitors that don’t blow money on meeting guidelines. So if we look at China, how is it that China got a competitive advantage over every other country around the world?
Well, they said we don’t care if we go and dirty up the atmosphere, we don’t care if we mistreat our employees. We don’t care if you know, so what happened is they get it, and this is the problem. People are addicted to cheap, and it’s not easy to overcome. You know? So What happens is that companies end up outperforming because we still see, we got to change human behavior and that’s not an easy thing to do now. Very, very difficult. So I just look at another gimmick, you know, we can big investment firms make money on trades and money in motion, realize that they come up with products that you will buy, not necessarily that you should buy.
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