Yesterday, I posted about why I chose against investing in most actively-managed funds. I actually do hold one actively-managed fund right now, the Bridgeway Ultra-Small Company Market Fund (BRSIX). Why did I choose this fund? It turns out that many of the warnings against buying an actively-managed fund can be flipped to find the best mutual fund managers. Here are several things to look for, as well as some of the companies that many of these characteristics.
Do They Have A Clear, Consistent Investment Strategy?
In order to beat the market, by definition they have to have substantially different holdings from the market and stick to their guns. Also, is it clear enough that you really believe in their strategy? If not, you might bail out yourself during a rough patch and miss out on the fund’s long term returns.
Do They Charge Reasonable Fees
To start, one would hope to see no front-end or back-end loads. If they are “to discourage excess trading”, then any fees should be directed back into the fund shares, not into the manager’s pockets. Otherwise, look for below-average fees, and for those fees to decrease as the amount of money under management increases. For example, the Vanguard Windsor II fund is one of the largest mutual funds available with $52 billion in assets, and has an expense ratio of only 0.33%. That’s more than many sub-par Large-Cap index funds.
Do They Limit Asset Bloat?
Depending on what the fund invests in, once they start realizing that they have more money than can be optimally invested, the ideal mutual fund manager will close to new investors until more opportunities arise again – even if this means less profit for them. This becomes more critical for funds that invest in smaller markets.
Is It Privately-Held?
While this is not a guarantee of bad management, when a financial company is publicly-held it will always be pressured by owners to put profits first (and perhaps properly so). A privately-held and smaller company, while obviously still motivated by money, at least has the chance to place other things like the fund shareholder’s value and ethics on the same level as straight profit.
Does the Manager Also Invest In the Fund?
Having a substantial amount of their own money invested in the fund will help align interests between the shareholders and the managers. It can be hard to figure out what a “substantial amount” is, though, as these figures are not required to be disclosed.
Is There Transparency With Shareholders
Do you read all the prospectuses and shareholder reports for your mutual fund holdings? I don’t either, but try it sometime. They can differ wildly. I always read the one from Bridgeway and am always impressed by their honesty and straightforwardness. When they lag, they admit it and state why. Others that I have read are more defensive or even dismissive about their losses, even though they are quick to point out good returns.
What Are Some Example “Good” Fund Companies?
I’m sure there are a decent amount, but here are just a few with brief supporting attributes. An example held in Unconventional Success* was the Longleaf Partners Funds. They only have three funds, and all of them close regularly to new investors. Right now only the International Fund is open. The Partners Fund once closed with only $1.8 billion in assets. Employees are also the fund’s largest investors.
I mentioned Bridgeway already. They have a history closing their funds early as well. In addition, according to this Barron’s article, the company donates half of it’s net profits each year to charity. The CEO even limits his compensation to seven-times that of his lowest employee. Name one large publicly-traded company that does that!
Other companies that I’ve read positive things about include Dodge & Cox, Oakmark, TIAA-CREF, Tweedy Browne, T. Rowe Price, and Vanguard. I’m actually scheduled to pick up some Dodge & Cox Stock (DODGX) this week from my limited menu of 401k choices, even though it’s closed to retail investors.
* This topic was discussed in detail in the book Unconventional Success by Swenson and is a big source of information and ideas for this post.
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And DFA.
Also, I continue to support Vanguard’s Wellington Fund as the no-brainer, do-all default option for actively managed funds; at the very least, it is a great place to park funds as your spool up your research efforts.
BRSIX can’t really be considered an actively managed fund. As per morningstar it, “attempts to mimic the CRSP Cap-Based Portfolio 10 Index’s market cap, investment style, and sector weightings”. It’s only not officially an index fund because “its tracking error is larger than the SEC thinks an index fund’s should be”.
Well, yes, but it’s his attempt to be LIKE the index, not his attempt to BE the index.
It’s passive (like an idex) in that he has his own computer model – but he will make changes to it.
The definitions of index funds are getting a bit blurred. Wisdomtree is a great example.
Agree with ASM above. All the print references I’ve seen (including Larry Swedroe’s Winning Investment Strategy book) refer to BRSIX as a “passive” fund.
I always thought the reason they didn’t call it an index fund was because the mathematical rules guiding the fund not to buy or sell funds that waffle on the edge being included in the CRSP-10 (for tax efficiency sake) keep it from precisely tracking the index.
(I think I read this in some correspondence from Bridgeway, but I can’t remember well enough to cite it here.)
I really appreciate you giving example fund companies. I think that a lot of articles would leave this intentionally out, as they don’t have anything real to back up their story.
Thanks!
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I?ve owned T Rowe Price mutual funds since the mid 90s and the bias that I?ve always maintained is to select fund managers who went to good schools. For example, T Rowe Price?s Brain Rogers (PRFDX) and Henry Ellenbogen (PRMTX) both received their degrees from Harvard. There?s also Rob Gensler (PRGSX) who went to Penn and Stanford. In addition to reasonable fees and performance, going with Ivy Leaguers usually make good picks. Of course, these criteria didn?t help much when I owned a few Janus funds back in the day. Morningstar usually gives Stewardship grades and analyses to help out with that. I can’t say that all funds that I own are run by Ivy League grads. But, I’d add that an MBA and investing experience are definite must haves. I?ve also read somewhere that small cap funds have superior performance if actively managed compared to the indexed ones. However, the small cap mutual funds tend to close rather quickly. The two small cap funds that I?ve owned in my investing experience (PRSVX & NBGNX) have been closed for some time now.
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Yes, I forgot DFA. It will be interesting to see how they deal with asset bloat as well in some of their funds as they keep gaining popularity.
I think you can argue BRSIX either way. Since it’s managed by a company of quant funds, and the tracking error can be (and has been) pretty large at times, I’m hesitant to call it a true passive fund. It is true that they don’t try to beat the index, but it seems like they don’t go about it in the same way as other index funds. Also, the previous name for the fund was something like “tax-managed” to suggest that it was sort of a tax-managed version of their other micro-cap fund.
I get overwhelmed with all the different mutual fund and ETFs… There’s SO many!
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I’d throw Oakmark funds and Sequoia (SEQUX) in that list of active managers as well… They are often mentioned in the same breath as Mason Hawkins at Longleaf. Both of those funds are available via the 401K plans of at least one of Buffet’s companies.
In fact, for a who’s who of managers with the qualities you talk about, I’d suggest checking out OID. (Outstanding Investors Digest.)
Any thoughts on when BRSIX will close… it is getting awfully big for a micro-cap fund.
One other quick comment… John Montgomery (Manager of BRSIX) was fined for a pretty egregious error in the way they were doing some accounting down there at Bridgeway. In his case however, it was an oversight, and not an attempt to take advantage of investors.
I believe Montgomery was one of the managers who testified in Washington on ways to make the mutual fund industry better not too long ago… All around great guy. His quarterly letters are fantastic reads.
Not Fair!!! I don’t have DODGX in my 401k!!!!
DODGX is a GREAT fund…although it’s having a crappy year so far this year…it should be great for the long haul though. I’d load up on that fund if it was in my 401k.
I have DODFX (International) and it has done great…although this year just average….but I’m not selling!
I just looked on Schwab’s web site, and the mutual fund you mentioned (BRSIX) was in the bottom 25% (performance-wise) of all similar funds, both for 2006 and for 2007 year-to-date. This is not a mutual fund to recommend, IMHO.
“This is not a mutual fund to recommend, IMHO.”
Only if you believe recent past performance is an indicator of future long-term performance.
“(BRSIX) was in the bottom 25% (performance-wise) of all similar funds”
Huh? There’s about a total of 5 microcap funds — almost all closed to new investors to day of opening because they hit their max money cap immediately. What’s Schwab comparing BRSIX to? I suspect Schwab may be miscategorizing this fund as a regular smallcap. Much better comparisons would be against PZI, IWC and RZV+RZG. Of course, all these ETFs are quite new so there’s not much to compare against.
The micro-cap ETFs are all lame… IWC is mostly small cap. In fact, 80% of the weight of IWC is from stocks that are also in the Russell 2000. Russell sold out to Barclays so they could make an investable product. You are essentially buying the bottom half of the Russell 2000 with a few extra small regional banks thrown in…