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When it Comes to Underperforming Assets – Is Patience Still A Virtue?

August 9, 2011
by Jack Reynolds

Here is a link to an intriguing article in the August 8th Wall Street Journal about how long you should be patient with an underperforming manager or mutual fund. I particularly like the author’s (Michael A. Pollock’s) list of considerations that you should bear in mind:

Questions to ask about a lagging fund:

1. If the manager is sticking with a stock or sector that is out of favor, do you agree with that position?

2. Has the fund grown to the point that the manager can’t operate as he or she used to?

3. Did you fully understand the fund’s approach to begin with?

4. If the manager invests very differently from a benchmark, can you tolerate performance that is sometimes much better but sometimes much worse?

5. Do you want to trim your exposure to this type of fund? Or, alternatively, are there competing funds that are more attractive?

6. What has the manager said about the recent results in shareholder reports and other commentary?

7. Has the manager veered away from the strategy described in the fund’s prospectus?

I would add a couple of other factors to his list:

8. Has the manager or fund lost so many assets under management that they may need to reduce their staff, imperiling the viability of their strategy going forward?

9. Have there been any changes in the key members of the investment team (research or portfolio management)?

10.Has there been a change in the controlling ownership of the firm managing the fund or your separate account?

Unfortunately, the questions and answers can be subtle and may vary from one situation to another. It may be helpful to have a Private Investment Counselor to help you sort through the issues.

In support of the view that patience can be appropriate, be aware the nearly all hugely successful funds / asset managers spend a three-year period in the bottom half of their class:

“A study by Tucson, Ariz.-based Davis Advisors, managers of the Davis Funds, found that 93% of 192 large-cap managers who ranked in the top quarter of their peer group for the decade of the 2000s had spent at least one three-year stretch in the bottom half of their category. The analysis looked at managers at a range of fund firms and was based on a ranking by Atlanta-based data provider eVestment Alliance.”

How do you, or your family office, or your private foundation/charitable trust deal with this thorny issue? Many of my readers would like to know your thoughts. Please post a comment on my blog or send me a Letter to the Editor, which I look forward to publishing.