Investors Chase Returns? Prove it!

by JT McGee

dog running, chasing returns, investingInvestors are apparently performance chasers – people who follow the “hot money” to invest in a particular corner of the market only when it is hot.

This performance chasing is looked down upon by those who suggest passive portfolio management, or indexing, as performance chasers are, by definition, never to be in first place.

Chasing something (investment performance, in this case) literally implies that there must be something you lag behind.

Prove that Performance Chasing Exists

The financial media naturally chases performance. No one wants to hear about the beaten down sectors of the market. Those who consume financial media do so to see where the money can be made. Chasing performance to write about the spectacular performance of an investment is a great way to draw attention, make waves, and latch onto what’s hot just as everyone and their brother talks about how well any given investment has performed at their latest cocktail party.

The media has no vested interest in many of the hot investments, however. Talk is talk – and without investment interest backing a claim, it has no real value.

But what I find absolutely fascinating is that performance chasers are more likely to be indexers, or at least people interested in sectors over management. For example – the recent movement to precious metals. Here, investors moved cash to an investment, and Wall Street played along, giving investors new indexes like the Market Vectors Gold Miners Index (GDX). Investors could own a portfolio of major players in gold mining. You need not investigate the particular operating activities or financing activities of any given firm – access to gold via a proxy (a gold miners ETF) is good enough. Indexing for the win!

Gold was hot, after all – it’s where sophisticated people put their money. (Said in the best Dave Ramsey voice I can muster up…sophisticated.)

Chasing Performance with Portfolio Managers

In an article about the types of passive investors, I criticized passive investors for implying that other investors cannot mimic the performance of Warren Buffett – supposedly the only person who can ever beat the market in the long-run. Interestingly, I’ve yet to find a passive investor who accepts Warren Buffett’s genius as a stock picker put the whole of their portfolio in Berkshire Hathaway stock. Hence, the “look in the mirror” passive investor.

If Warren Buffett can beat the market, and this is accepted by any given passive investor, why do passive investors shun away from allowing Buffett to “actively-manage” his or her portfolio via ownership of Berkshire Hathaway stock?

Or how about the Bruce mutual fund (BRUFX). This fund continues to rank as one of the best mutual funds on the market in a multitude of categories. Its success was highlighted by Forbes magazine last year, yet in the time from publication to present day there have been no major capital inflows. Forbes has a readership of 5.4 million people, of which I would assume a majority is part of a high net worth family.

It is only logical that if investors were in fact performance chasers, Forbes high net worth readers would propel this fund’s assets to new heights. Mutual fund companies spend hundreds of thousands of dollars on advertising their funds in financial publications to attract assets. This was not advertising – it was a well-written piece about the impressive performance of a fund company. It was organic, honest, truthful – everything that advertising isn’t. And yet, despite the 5.4 million people who undoubtedly read that issue of Forbes magazine, Bruce Fund assets remain at a paltry $346 million.

Bruce, a balanced mutual fund with holdings in both equities and fixed-income securities has handily beat the market despite its .82% annual expense ratio, which is larger than almost all indexes:

A Perfect Case to Test the Performance Chasing Thesis

Forbes reporters were the first people the Bruce managers had responded to. The team shies away from media, seeking to let their performance speak for them.

Yet, performance well in excess of their benchmark (and the much riskier S&P500 index as calculated by beta) is not enough to attract assets. This leaves me to believe that investors have a very backwards view of the markets. Investors are much more likely to performance chase with indexes focusing on underlying investments rather than chase the performance of managers.

Passive investors performance chase with the historical performance of the S&P500 index, whereas others performance chase with sectors via targeted exchange-traded funds.

Why is this? Why would investors conclude that a particular investment is inherently better than another without concluding that perhaps a particular manager is better than the field? Why would it be that a gold miners fund built almost exclusively for the purpose of performance chasing a single type of investment attract nearly $8 billion when a mutual fund that has produced long-run performance in excess of every benchmark fail to accumulate even 5% of GDX’s haul?

Is it proof that investors do not actually performance chase where it might matter – by hiring someone most capable of managing their funds? I don’t know, but don’t let me get too comfortable with that thesis.

Tell me what you think in the comments.

{ 4 comments… read them below or add one }

funancials May 30, 2012 at 12:12

I always like to separate investors from speculators. I think investors Chase value and speculators chase what-they-think-are-returns. Really they are chasing what sounds good. True investors don’t doubt people like the average American but speculators do. They are smart enough to have read that most mutual funds don’t outperform the index but dumb enough to settle for the index and too lazy to search for the ones that do (outperform).
Maybe the speculators are haters – ie. Doubting that Lebron James is as good as he is. Maybe its harder to hate on an index.
I can’t guarantee any of this makes sense as I’m typing on my phone and can’t see anything I’m typing and I think I just compared LBJ to a fund mgr.

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JT McGee May 31, 2012 at 08:09

Heh, it makes perfect sense, and I know what you mean. In some way we’ve been left to believe that the index is somehow a better alternative always. But then people tend to just pick an index, rather than select from one or many. It’s like all discussion stops at the word index.

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John | fearlessmen.com May 30, 2012 at 17:23

I agree that we are all “Performance chasers”. Whether passive or not. Or did I misunderstand you? Even while passively investing, they are chasing in one way or another since they are always lagging behind. Good article! Got me thinking.

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PK May 31, 2012 at 11:12

“…shun away from allowing Buffett to “actively-manage” his or her portfolio via ownership of Berkshire Hathaway stock?” – To be fair, there is a massive downside risk with Warren – his age (and I said downside, but it’s actually increasing!). I would expect that to clear up when a successor is named – you know, someone who doesn’t insider trade.

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