The Globe & Mail recently ran an article on rebalancing, featuring comments and opinions from some industry giants.   The article ends with advice from John Bogle, who suggests that rebalancing is a personal choice.  He discourages the practice because of the costs involved (i.e. brokerage fees + taxes).  But perhaps it’s worth adding some context to this often-discussed topic.

The rebalancing challenge

The question of portfolio rebalancing presents a significant challenge.  When a financial asset rises in price in the short-term, that asset has tended to continue rising for a period of time.  (The same effect has persisted on the downside.)  This is called the momentum effect and it has persisted for generations.  Since stock and bond markets tend to spend more time going up than falling, this momentum effect can be a significant benefit over time.

Rebalance too frequently and you risk cutting off the benefits of this momentum effect.  Failing to rebalance enough could result in overexposure to certain asset classes or sub-classes.  The challenge, then, when faced with developing a rebalancing method is to capture as much of this momentum effect while keeping risk within a range that is suitable and reasonable.

Developing a rebalancing philosophy

Two years ago, HighView Financial Group tackled the task of formalizing a firm-wide philosophy around rebalancing.  Our process began with a discussion of how each of our partners had previously implemented rebalancing for client portfolios.  We then debated the pros and cons of various methods.  And our goal was to agree on a given method and take it away to back-test the method – along with a couple of other alternate methods that we thought might be equally valid.

Never did we seriously consider rebalancing based on some pre-determined time frame.  We quickly concluded that rebalancing should be triggered by deviations away from the target allocations of investments held in client portfolios.  But how wide or narrow should we set these tolerance bands?  And should they be based on a set number of percentage points away from the target or should ranges be relative to the size of the target allocation?

Finally, we concluded with an agreement on a methodology that we thought made the most sense.  We thought that allowing an investment to move a full 20% from its target allocation struck the right balance.  In other words, if you invest 70% in A and 30% in B, investment A would be allowed to fluctuate between 56% and 84% of the portfolio ( low:  70% x [100%-20%];  high:  70% x [100%+20%] ) while investment B would be allowed to fluctuate between 24% and 36% of the portfolio.  And the ranges could be wider for taxable accounts to reduce the tax cost of rebalancing.

Rebalancing analysis

We quickly discovered that rebalancing is not a long-term return enhancer.  And this makes sense.  If the momentum effect persists over time and markets rise over time, the highest return is achieved by never rebalancing.  But in practice, where investors are sensitive to risk this is not a realistic option for the vast majority of investors.

It’s important to understand that what works in the long-term doesn’t work in all periods.  For instance, rebalancing every month didn’t fare as well longer-term but did work for the five years through February 2009 (the recent bear market bottom for most markets using monthly data).  Using a five-component 60% stocks/40% bonds portfolio, not rebalancing at all resulted in a 5-year return of -1.3% per year through February 2009.  Monthly rebalancing produced +4.5% per year.  And yet longer term, not rebalancing produced the highest raw return for the thirty years through 2009.

For those who can tolerate higher risk and are comfortable underperforming for years in exchange for the benefit of outperforming over the long-term, perhaps no rebalancing at all is best.  But for the rest – which make up the vast majority of investors – prudent rebalancing that strikes the right balance (between risk control and return potential) is key to achieving long-term investment goals.  Just understand that it’s a risk-control strategy that may or may not boost returns.

I recently received an e-mail about a blog post questioning the validity of DALBAR’s annual study of investor returns – Quantitative Analysis of Investor Behaviour.  The blog post – DALBAR study overstates investors’ bad timing – takes aim at DALBAR’s methodology.  And while it makes some good points, the blog actually misses the bigger hole in DALBAR’s methods.  But more on that in a minute.  DALBAR and other similar studies compare the published (i.e. time-weighted) returns of indexes or funds with an estimate of how investors actually performed (i.e. dollar weighted returns or IRR).

The blog author makes a fair point in that it’s not completely fair to attribute the entire difference between time-weighted rates of return (TWRR) and dollar-weighted rates of return (DWRR) to poor investor timing.  Indeed, some of that gap is simply the product of volatility and people investing when they have available cash.  In other words, TWRR equals DWRR for investors who buy at the beginning of the measurement period and hold through the end of the measurement period – with no transactions in the interim.  Once you introduce any ‘flows’ into or out of the investment with even modest volatility, you will see a gap between the TWRR and DWRR calculations.

Isolating investors’ poor timing

The blog author takes the reasonable step of comparing DWRR based on actual fund flows against a DWRR based on dollar-cost-averaging a fixed amount.  While there are challenges with this approach too – i.e. how large are the flows relative to actual flows and relative to the starting and ending values – it’s arguably a better comparison when attempting to isolate the pure effect of poor timing.

Indeed, the first academic paper I recall on this topic did just that.  Stephen Nesbitt authored Buy High, Sell Low:  Timing Errors in Mutual Fund Allocations in the Fall 1995 issue of The Journal of Portfolio Management.  Using data from December 31, 1983 through August 31, 1994, Nesbitt found investors lost about 80 basis points annually due purely to bad timing.  (That is, the DWRR for an investor dollar cost averaging into all U.S. mutual funds exceeded a composite DWRR with actual fund flows by 0.8% annually.)

Given that holding periods of U.S. funds have, in my estimation, fallen since Nesbitt’s study I wouldn’t be surprised to see that gap widen.  My past calculations on Canadian-domiciled funds suggests that this timing error is somewhere between 1% and 2% annually.

DALBAR methodology

To give credit where it’s due, DALBAR deserves kudos for having begun its annual QAIB studies as far back as the mid-1980s.  But for nearly a decade, I have suspected that DALBAR’s methodology was flawed.  I contacted DALBAR recently in an effort to confirm my understanding of the finer points of their calculations.  Their lack of response left me with my original interpretation of DALBAR’s 2001 QAIB report, the only full version I’ve reviewed.  And it reveals what may be a questionable methodology.  I suspect that DALBAR calculates what it calls investor returns by applying dollar-weighted fund redemption rates to benchmark returns – rather than applying a DWRR calculation directly to the funds.  And if they’re doing that, they’re not calculating investor returns.  In its 2001 report DALBAR says this about its methodology:

Based on these retention rates, DALBAR then calculates cumulative real returns for investors in the various fund types during the period studied.  DALBAR applied investor retention rates to the returns they could have earned (the market index returns) to determine what investors actually earned – real returns.

If I’m right, it’s not clear exactly what they’re calculating.  But this explains why their figures show such staggering gaps of several percentage points.  My research on this topic over the past 13 years is more in line with figures I’ve seen from Morningstar.com.  In the U.S., Morningstar calculates what they call “investor returns” using the same method I have for more than a dozen years – i.e. calculating actual fund DWRR.  (Click here for an explanation of Morningstar’s methodology.)  But even that is an estimate because it’s based on monthly data; and daily fund flows are required for a precise DWRR.  But DALBAR’s reported figures aren’t even an estimate because they appear to blend fund flows with index returns.

Accordingly, DALBAR is probably correct in direction – i.e. whether TWRR is higher or lower than DWRR – but not even close in quantifying the gap between the two measures.  For some true insights into this topic, you can read one or more of the following:

– Advisor’s alpha  (The Vanguard Group Inc., December 2010)

– Volatility measures behavioural risk (The Wealth Steward, October 2010)

– Who are fickler fund investors:  advisors, institutions or individuals? (Morningstar, June 2010)

– Past performance is indicative of future beliefs (Philip Maymin & Greg Fisher; Risk & Decision Analysis, Forthcoming)

Last fall, GrowthWorks launched a very public campaign to win the takeover battle for the VenGrowth family of labour sponsored investment funds (LSIFs).  VenGrowth’s preferred offer was from Covington II Fund but I thought that VenGrowth’s board didn’t look hard enough for potential buyers.  In the end, the deal was killed.

Early this year, VenGrowth (VG) launched round two of its attempt to sell its funds – charging a subset of its funds’ board members with leading the process.  VG’s special committee hired investment banker Crosbie & Company to vet offers and provide VG’s special committee with a short list.  But GrowthWorks (GW), feeling VG wouldn’t give it a fair shake, has decided to bypass the formal process and has taken its offer directly to shareholders.

I am recommending that VG LSIF shareholders sign the GrowthWorks support agreement.

The bidding process

Effectively, there are now two parallel processes in motion.  Crosbie will sift through the more than a dozen offers and recommend a short list to VG’s special committee, from which one offer will be put to a shareholders vote.

Simultaneously, GW’s offer is now in shareholders’ hands.  If they can get at least 5% of shareholders to sign and remit their yellow support agreements, they will be able to get VG to hold a shareholders meeting.  At that meeting – which can occur up to three months after GW’s request – GW will be able to formally table its offer for a vote.  Those who sign and submit the support agreement are also giving GW’s “independent committee”  the right to vote on their behalf once VG’s special committee puts its chosen offer in front of shareholders for a vote.

To sign or not to sign

A shareholder who signs the GW support agreement is giving GW, and anyone they appoint, power of attorney.  That includes giving them with full authority to act on that shareholder’s behalf with respect to the VG LSIF shares.  While GW chose and will compensate their appointed committee members, powers of attorney are generally seen as fiduciaries.  That definition of fiduciary may or may not extend to this scenario.

The choice of whether or not to sign GW’s support agreement boils down to which party is more trustworthy.  Many advisors and shareholders have developed a mistrust of VG and its board due to last fall’s attempt to sell the funds.  VG LSIFs’ boards owed and continue to owe a fiduciary standard of care to LSIF shareholders but the events of last fall prove that’s no guarantee of a good result.  GW is holding itself out as wanting to do right by shareholders and helped squash what was a bad deal by Covington.  But they have an interest in winning this deal; so can they be trusted to recognize a superior offer should the VG special committee present one?  I think the answer is ‘yes’ which is why I’m recommending supporting GW.

Giving GW power of attorney shouldn’t be taken lightly.  And it’s impossible to know who is more trustworthy, so the decision is largely based on gut instinct.  Even though I’m not crazy about their offer, my guts tells me that signing and sending GW’s support agreement will be better than allowing VG to have full control of the process.  Based on the amount of votes GW was able to control last fall, I doubt that they will have full control either.

But if they can get enough (i.e. 5% – 10%) to shake up the process a bit and keep VG’s special committee on its toes, giving GW enough power just might work out in the end for VG LSIF shareholders.  I wish that I could make a stronger recommendation that is more fact-based but the inherent uncertainties in this case require a larger-than-usual leap of faith.

I was recently asked to comment for an article on a small, top-performing mutual fund – Redwood Global Small Cap.  While the article included a couple of my comments, there was no room for some of the more striking statistics I found when doing a quick review of the fund’s filings.  But the quick review I did could also serve as a guide to where to start when beginning to research a product for the first time.  And such a review can help to ground investors that are seeing dollar signs after a hot run.

Regulatory review

Too many people often overlook very basic steps.  In the case of a fund, particularly where it is managed by a third party, reviewing the information available in the public domain is easy to forget about – but it’s a critical first step.  For Ontario, you can use the OSC’s Registration Check.  For the rest of Canada, the CSA now maintains a national database for use by the public.  The goal here is to verify the status and category of registration along with any terms, conditions or constraints on licensing.

Document review

Next stop is www.sedar.com which is a database of regulatory filings for mutual funds and publically-traded companies.  You can find the full slate of regulatory filings for this fund on the SEDAR website.  Even a preliminary, surface review should include a quick scan of a fund’s financial statements, management report on fund performance (MRFP), the prospectus and annual information form (AIF).

I won’t recount a full review but here are a few tidbits I stumbled on when taking a quick look through a couple of documents.

• Redwood Global Small Cap had $723,372 in assets at the end of 2008, by which point the fund had lost 55% of its value.  The fund grew to $1.3 million by mid-2009 but more of that growth was from performance than from inflows.
• By the end of 2009, when the fund posted a sizzling 150% return, it boasted $4.9 million in assets.  Then in the first half of 2010 – after the 150% return had been made – investors invested a net $2 million into the fund.  At the end of September 2010, assets stood at more than $8.2 million.
• Its reported management expense ratio (MER) for the first half of 2010 was 3.66%, which includes an estimated 0.78% accrued performance fee (which is only paid at year-end).  Trading costs added another 5.63% annually, bringing the total costs of holding this fund for the first six months of 2010 to 9.3% annualized.  Trading costs have added an average of 7% annually to the MER since the fund’s 2008 inception.
• Of the 27 long positions held by the fund at June 30, 2010, 17 were warrants – most of which show a zero cost and most of which were showing a big accrued gain at that date.
• I was quoted in the Globe & Mail article as citing the fund’s average turnover at about 700% annually.  In fact, the average turnover is much higher.  Two of the three years – 2010 and 2008 – were partial years.  Annualizing the reported turnover rates for those years results in an average of 1,040% annually from mid-2008 through mid-2010.
• This turnover is nicely illustrated by the fund’s wild swings in asset mix.  At June 30, 2010 the fund’s cash position (net of that required to cover shorted securities) was 72%.  Three months later, at September 30, 2010, cash was a lean 6% (and all short positions were closed).  By January 31, 2011 cash was back at 25%.

To buy or not to buy

I have not come close to doing proper due diligence on this firm or fund.  Accordingly, neither I nor our firm has an opinion of the fund.  Given that this fund is very hedge-fund-like, it requires investors to do a lot of homework to assess the quality of this fund and its suitability for each investor’s particular circumstances.

One good sign revealed in the Globe & Mail article is the firm’s stated intention to cap the fund’s size at no more than $50 to $60 million.  The high turnover combined with the fund’s focus on small and micro cap stocks requires a small asset base to have a hope of continuing the fund’s apparent strategy.  Even then, however, triple-digit performance figures are simply not sustainable over any meaningful period of time.  And time will tell if the firm actually caps this fund at the stated asset level.  Plus, the wording around the fund’s performance fee is not as tight or complete as I’d like.

Whatever the case, I hope that investors don’t get lured into this volatile fund at the wrong time and for the wrong reasons (i.e. with unrealistic expectations of repeating its brief record).  Canadians’ investing history is filled with such examples that have ended badly for investors.  Don’t be another dubious entry in the investing history books.

Valentine’s Day is a day to celebrate love.  But on February 14, 2011, I wasn’t feeling the love from the mutual fund industry.  On that day, the Investment Funds Institute of Canada announced that it would cease reporting company-specific sales data every month to the public.  It will, however, continue making this information available to members and statistics subscribers.  Some fund companies will also continue to release their own data.  Recent examples include RBC Asset Management and Scotia Asset Management which recently released January sales data via press releases.

This event, in itself, isn’t such a big deal.  But when viewed in the context of the industry’s decreasing transparency, it’s a bit troubling.  Five years ago, mutual funds in Canada stopped providing Statements of Portfolio Transactions (SPT).  When National Instrument 81-106 (Continuous Disclosure) came into force, the SPT disappeared.  In this 2007 Investment Executive article I explain why I think this resulted in worse transparency overall.

Ironically, mutual fund transparency has generally deteriorated over the past several years while the raw volume of information has significantly increased.  More information does not equal improved transparency.  IFIC isn’t to blame for this development; some of this is due to regulatory reform.  But one fund company quoted in this article offers a reason that just doesn’t hold water.

Still, [CI Financial’s] Mr. MacPhail argued there is no need to hand out monthly numbers when firms in the United States and elsewhere don’t do so. “Canada was unique in evolving into this monthly reporting of sales,” he said. “It was never intended to be that way when IFIC started collecting data.

“Somehow, it migrated from confidential internal data amongst IFIC members to public information. No other industry in the world would report this type of information, especially on a monthly basis.”

When I read this, I immediately remembered the stories I read on car and truck sales every month.  But I’ve never seen the data first-hand so I turned to the internet in search of such data.  In 60 seconds flat, I stumbled on this statistics page from Wards Automotive.  Clicking on the data link takes you to a spreadsheet showing monthly sales by vehicle type and by manufacturer – a layout that is similar to IFIC sales data.  This makes me wonder how many other industries around the world offer monthly sales or performance data.  If I could find one so quickly, surely there must be others.

The industry can keep sales data under its hat but net sales can be inferred, quite accurately, from monthly asset and return data – that is unless asset data becomes more sparse.  Investor have more information available on funds but transparency has clearly deteriorated.  This broader trend of decreased transparency isn’t good for investors, analysts or the industry so I hope it’s not a trend that will continue.

In Tuesday’s Globe & Mail, I shared a couple of suggestions that investors should consider for their RRSPs.  My suggestions covered two themes you’d have read here over the past several months.  One is that bonds remain a vital, albeit boring, portfolio component – hence my recommendation of a bond fund.  The recommendation of a global stock fund touches on a thorny issue today – namely that the better opportunities for the next several years are, in my view, in global stocks not Canadian stocks.

Also on Tuesday, I participated in a noon-hour live chat on RRSP investing.  We covered a lot of ground, including income funds, RRSP vs TFSA, asset allocation, bonds vs stocks and more.  You can view the archived 70-minute Q&A session (during which we covered about two-dozen questions) by clicking here.

I had received a couple of calls this week telling me that Peter Cundill had passed away.  This was confirmed today when another contact today sent me his online obituary.  Peter suffered from a debilitating disease called Fragile X, the symptoms of which are quite ironic given how cerebral and physically active he was.  I didn’t know him personally but by all accounts he was one of the good guys.  And many investors were enriched on the back of his talent for picking stocks.

For most people, this was done through the original Cundill Value A fund.  Started in 1974, the fund was unique in its focus on giving Canadians access to a portfolio of global stocks.  Through his strict adherence to the principles of Ben Graham and David Dodd, he amassed an enviable track record of performance, known for capturing much of the market’s upside while offering great protection in tougher times.  We extend our sincere condolences to his family and friends.  For investors, Peter mentored many talented money managers including Tim McElvaine, Wade Burton, Alan Pasnik and many people who remain at Mackenzie Cundill Investment Management.

It has been a long time since much was heard directly from Peter.  Fortunately, a webpage I bookmarked in 1998 when I began recommending Cundill Value fund is still online today.  So a candid description of Peter’s investment style and its evolution can be found on the Outstanding Investment Digest website’s account of the Cundill Investment Conference.  A more recent piece of work, however, is slated for a February 1, 2011 release.  Prior to his death, a book on his investing style was completed.  There’s Always Something To Do:  The Peter Cundill Investment Approach will be out next week.

I don’t make many bold predictions.  But nearly a decade ago I did just that in this article.  I challenged the most popular monthly income mutual fund of the day, now known as IA Clarington Canadian Income (now called IA Clarington Strategic Income Fund Y).  I stated that this balanced fund’s 10% distribution rate at the time could not be sustained and would have to be cut.  No recommendation has ever caused me such grief.  I received angry phone calls and e-mails.  But I turned out to be right.

Fast forward to 2011.  In today’s Globe & Mail I take readers through a process for testing whether an investment’s monthly cash payout can continue longer-term.  It’s the same process I used to make my Clarington prediction in 2001.  While Clarington and some other firms have adopted more flexible distribution policies, several funds continue to sport unsustainable cash payouts.  And I use a popular big bank fund to illustrate our distribution sustainability test in today’s article.

There was not sufficient space in the paper to provide more specific guidance so below I detail where to find the bond yield data and distribution sustainability estimates on a few other popular funds.

Bond yield data

Some firms post yield-to-maturity (YTM) data for their bond portfolios.  In the absence of such good public disclosure, you can use the asset mix of an income fund to estimate YTM.  ETFs tracking various bond indices can be helpful to obtain timely YTM data.  For instance, many iShares bond ETFs invest in bonds and they post YTM data daily.  Similarly, the ETF websites of BMO and Claymore can also be helpful in this regard, depending on a fund’s bond exposure.

Distribution sustainability of selected funds

If the required return from stocks is under 10% (before fees), the distribution is probably safe.  If it’s between 10% and 15% annually, the distribution is at risk.  For a fund with a sky-high required return from stocks (i.e. 15% or more per year), I would say it’s simply a matter of time before distributions are cut.  I recently applied the method detailed in the article to a handful of popular income funds.  Click on the image below to enlarge the full table of calculations.  If you spend your income fund’s distributions, you’d be wise to spend some time testing using the same process.

The financial media are abuzz about Goldman Sachs’ $450 million common share investment in Facebook for a tiny piece of the popular company.  As I read a few reports of this latest round of financing, it occurred to me that Goldman bought more than a pile of common shares, that this deal could spur new regulations and Facebook’s implied valuations gave me a bout of déjà vu.

What did Goldman really acquire?

News reports like the one linked above note that Goldman paid $450 million in cash at a price that values the social media powerhouse at $50 billion (all dollars in USD).  This implies a 0.9% stake in Facebook.  To put the size of the deal in perspective, consider that Goldman generated more than $9 billion in net income over the most recent four quarters –  twenty times the size of its investment.  But Goldman secured a few side-benefits as part of its investment deal.

First, Goldman probably stands to benefit substantially when Facebook floats its formal IPO.  While typical IPOs fetch underwriting fees of 5% or so of the offering size, it’s likely that Facebook could probably negotiate that in half.  At a 2.5% fee, an IPO of $9 billion would give Goldman fees to cover half of its recent investment.  Post-IPO stock sales to smaller retail clients would trigger lots of trading commissions plus any gains realized from selling from its ‘house account’.

Second, Goldman effectively acquired options or rights to acquire up to an additional $1.5 billion in equity at the $50 billion company valuation.

Third, it struck a deal to acquire these additional shares through a so-called special purpose entity (SPE).  The SPE is being set up to allow Goldman to offer its private clients a way to invest in Facebook shares with the SPE counting as a single investor – regardless of how many of its clients buy units in the SPE.  While few details were provided, I expect Goldman to charge a fee to “manage” the SPE.

Finally, Goldman is likely to leverage the caché of being able to offer clients exposure to Facebook shares for good PR and to persuade private clients to bring more business to the firm.

Will regulators clamp down on secondary private market?

Through the various reports on this latest deal, there was mention of trading in shares of Facebook.  The name that continues to surface is a U.S. broker-dealer called SecondMarket.com, which facilitates trading in various “alternative investments” by connecting accredited investors, professional investors and the like.  But Facebook remains a private company, so I was surprised to learn that such a robust market could exist for private companies without complying with the regulatory requirements of publicly-traded entities.

Goldman’s planned SPE could raise another interesting issue.  It’s one thing for a broker-dealer to organize private placement trades for accredited investors and professionals but it’s quite another for Goldman to effectively offer Facebook shares to hundreds of wealthy clients through this soon-to-be-created SPE.  I wonder what sort of disclosure will be available to Goldman’s private clients given that Facebook remains a private company and is not required to release detailed financial data.

I wouldn’t be surprised to see regulators step in with some views of their own (and perhaps some disclosure rules) since this is really just an IPO in disguise.

Is Facebook valuation a throwback?

One of my concerns around investments in this SPE centres on investor behaviour.  All too often, investors are wooed by a company’s ‘story’, often at the expense of even basic financial due diligence and valuation.  In fact, my conversations with many retail investors over the years has led me to believe that most investors buying stocks don’t know how to value a business.  And I fear that investments in Facebook, via Goldman’s SPE, could end badly.

Failing more details of Goldman’s SPE, the deal appears to lock in a company value of $50 billion.  I found a few sources quoting Facebook’s 2010 revenue at $2 billion (a figure likely to have originated from Facebook).  Assuming that’s true, this latest round of financing implies a price-to-sales ratio of 25 times.  This level of valuation brings back memories of figures I thought I’d never see again.

In the summer of 2000 JDS Uniphase announced a deal to acquire SDL Inc.  I remember being struck by the $41 billion deal at the time because it valued SDL at 50 times revenue (and 371 times earnings).  While Goldman’s investment in Facebook is rather frothy on the surface and brings back memories from a decade ago, this is a bit different.

In 2000, most deals were simply exchanges of overpriced pieces of paper.  For instance, the JDS-SDL deal was inked in July 2000 at a value of $41 billion.  Just five months later, the deal value was cut in half thanks to JDS’ sinking share price.  Goldman’s investment is all cash and Facebook is a younger business on what appears to be a very sharp growth trajectory.  (From various reports, it appears that Facebook’s 2010 revenue growth was in the 300% range but this can’t be verified since no audited information is available.)

Still, 25 times revenue is a very steep price.  And paying with cash is a more expensive proposition than paying with overpriced shares.  The memory of the ridiculous JDS-SDL deal should at least remind investors that many glamourous stories have gone down as costly mistakes.

In the Globe and Mail recently, Shirley Won screened for the best and the worst among U.S. equity funds for the decade through November 30, 2010.  A couple of funds on the list struck me as worthy of further comment, which point to the need to dig beneath the numbers.  The first step in this endeavour is simply knowing a fund’s history.  For instance, among the list of worst performers was Ethical American Multi-Strategy.  The current manager, Manning & Napier, has been in charge of the fund for only the last half of the past decade and it’s a firm that we hold in high regard.

Ethical American Multi-Strategy has stayed ahead of the S&P 500 C$ TR index over the past five years, during which Manning & Napier has been in charge.  But they only entered the picture in May 2005.  Prior to that, AllianceBerstein was in charge of this fund, posting weak-enough performance to drag down the entire decade.  But when I look at Manning & Napier’s performance in Canadian dollars and adjusted for this fund’s 2.47% MER, I find that it outpaced the index by about 1.5% annually, net of fees, over the past decade.  In recent years, Manning & Napier managed to do what so few managers could.

Manning & Napier outperformed the index in both bull and bear markets – an accomplishment that has held up in the total of up and down months in addition to the last two big bear markets, starting in 2000 and 2007.  For example, this fund’s 36% loss during the bear market was much less than the index’s 51% loss.  But then the fund rebounded 39% since the end of February 2009, compared to the index’s 35% gain.

Another fund listed in the article is an example in the opposite direction. Dynamic American Value’s 1.4% annualized gain over the past decade far outpaced the index – a showing strong enough to make it the third best performer in its class.  Similar to the Ethical fund, however, lead manager David Fingold has only been in charge of the fund for about five years.  The difference here is that Goodman & Company, as a firm, has run the fund for as long as I can recall but it’s also a firm where changes in individual lead manager are huge.  So, the fact that David Fingold has been in charge for only half of the fund’s strong decade is more than material.

Dynamic may argue that Fingold contributed ideas to the fund when Todd Beallor was the lead manager, prior to Fingold’s tenure as official lead manager.  And that’s a valid point but it’s not the same as having lead management responsibilities so I wouldn’t count it as equivalent to managing a fund.  And I’m not making the case that Fingold isn’t skilled – just that the numbers never tell the whole story.  But circumstances surrounding him or the fund could change the picture a bit in the future given that Scotia recently appointed Fingold to run the Scotia U.S. Value fund.  Further digging is always necessary and it must be done with an eye on the future.

Even where the same manager has been in charge over a particular measurement period, changing circumstances can make the past record a bit unreliable when looking toward the future.  For instance, a significant rise in assets of a fund can make it more difficult to repeat past outperformance.  The longer the period of measurement, the smaller outperformance is likely to be.  Also, ten years ago was also near the peak of the technology bubble so the measurement period itself may be a bit biased in favour of active managers.  Those are just a few factors to examine when using past performance to pick future winners.

This is the reason that we have long emphasized qualitative factors in our manager research.  This emphasis allows us to gain a better understanding of what was behind the past returns and puts us in a better position to judge whether the fund or manager is likely to outperform in the future.