Lying By Omission: Mutual Funds, Track Records and Departing Managers
- Joshua M Brown
- March 27th, 2012
In November of 2008, after a fifteen-year wait and numerous false starts, the sixth album from Guns n’ Roses, Chinese Democracy, was finally released. And it promptly flopped, having cost $13 million to record, spawning precisely zero hit singles and having sold only a paltry 640,000 copies here in the US to this day.
Why did the band behind Appetite For Destruction, G N’ R Lies and Use Your Illusion, three of the most beloved rock albums of all time, find such difficulty gaining traction with the new album? It’s very simple - the fans knew that, other than singer Axl Rose, the group was no longer comprised of the players who had made the earlier records so magical. Izzy Stradlin, the co-writer of such hits as Sweet Child O’ Mine, Paradise City, Patience, Don’t Cry and You Could Be Mine was no longer with Guns n’ Roses. Neither were propulsive bassist Duff McKagan or iconic lead guitarist Slash. And so even the diehard fans stayed away from the new album - because although Guns n’ Roses had racked up an amazing track record in the past, the men responsible for it were no longer in the band.
Axl’s split and subsequent battles with his old bandmates were very high profile and well-documented; when the new album came out, everyone knew what the deal was. The same cannot always be said for mutual fund investors, unfortunately. One of the biggest mistakes fund investors make is buying into a track record without realizing that the managers behind that track record are no longer at the helm. Even worse, in many cases new managers come with new investment philosophies and styles - this means that all the previous performance and historical characteristics of the fund’s “behavior” in different market climates should be discarded. But this concept does not get emphasized at the fund ratings firms - investors are left to dig for manager tenure when a simple asterisk next to the historical returns data would suffice.
And in some cases, an old track record is even played up in the marketing - with no (or vague) mention of the fact that this record has become a non sequitur now that someone else is in charge of the fund. I bring this to your attention because there is a very excplicit example of this type of thing occurring right now that all fund investors should be aware of.
I’m sure that Tad Rivelle, CIO of the TCW Total Return Bond Fund (TGLMX), is a nice and handsome man. I’m also sure that he is smart and doing his very best at the helm of the fund. But in my view, he has no business making the following statement in a press release about his fund’s performance:
“Less traditional fixed income asset classes have delivered strong returns for long-term investors and our outstanding track record in the areas of mortgage-backed securities and emerging markets is reflected in these awards.”
This is because Tad and his team had almost nothing to do with delivering these “strong returns” to the “long-term investors” in TCW Total Return Bond.
Before we dig in here, please be aware that I am not making any recommendations for anyone with this post - I’m simply pointing out another dimension of performance research that often gets overlooked by investors who are “chasing the hot dot.” So please don’t act on anything I say here without doing your own homework.
Anyway, the quote above from Mr. Rivelle is about the performance that resulted in the fund company accepting a Lipper Award on March 9th for five- and ten-year performance. The problem with this - and the thing that investors need to know - is that these award-winning results were actually generated by Jeffrey Gundlach and his team, about 30 of whom departed TCW in December of 2009. Anyone who had been given trading authority by Gundlach or had worked closely with him, learning his process, has already followed him to his new shop, DoubleLine.
Leaving aside all of the lawsuits and ugliness between TCW and Gundlach upon his departure, if we focus solely on the portfolio management and returns since, we see that the Lipper award and TCW’s attendant PR announcement might be very misleading to investors.
Now its not Tad Rivelle’s fault that Lipper decided to bestow an award upon the fund for long-term performance. But it is very surprising that TCW’s press release makes no mention of the fact that its current team had little to do with it. In fact, Rivelle’s first full year running the TCW Total Return portfolio without any of what Gundlach’s team had put in place construction-wise was 2011, a year during which TCW badly trailed almost all of its rivals in the mortgage backed securities fund space with a stubby 4.1% return. This places them in only the 14th percentile of the category according to Bloomberg and below the Barclays Capital US MBS Total Return Index benchmark of 6.2%. So not only did the new team not add to the fund’s long-term performance numbers, so far it has actually subtracted from them.
Is there any rule saying that they have to mention this? No. There are the standard "past performance" disclaimers and that's all. Which is why it's so important that investors look past the track record and try to understand how it was generated and by whom.
In the mutual fund world, it is said that the manager doesn’t own his track record, the suits own it, and that’s all well and good. But investors need to be aware that an actively-managed mutual fund’s track record is only valid if the same people and processes are in place. Whether or not historical performance will mean anything at all in the future is a separate issue of course, but let’s not pretend that 99 out of 100 investors don’t look at past performance before just about any other available metric out there (because I can assure you that they do).
The key is to understand that this happens all the time, with various responses by the fund families in the wake of a departing manager.
Take for example, the departure of Paul Hechmer from Nuveen Investments in June of 2009. Hechmer was managing $14 billion in assets for Nuveen at the time including the high profile Tradewinds International Value fund. After beating 96% of his peers over five years, Hechmer had a falling out with Nuveen over the company’s direction and quit, taking the knowledge and skills that built his fund’s track record with him. But a glance at Nuveen’s marketing page for the fund would never tell you that, although it proudly displays the record itself.
Sometimes the fault lies with lazy journalism, one example comes from the high ratings accorded to Harbor International in US News & World Report’s “Best Funds” rankings. The magazine, aimed squarely at relatively unsophisticated investors, makes no mention of the fact that lead manager Hakan Castegren passed away in 2010 after putting up great numbers for the fund since 1987, making up the majority of the fund’s long-term performance.
In contrast to these examples of obfuscation, we can point to some scenarios where the transition was handled in an orderly way. Superstar equities manager Chuck Akre (13% annual returns from 1996-2009) left FBR in 2009 to start his own Akre Focus Fund. Akre had built up quite a reputation as a value guy who was able to find faster-growing value stocks in the haystack and the FBR fund he ran soon topped a billion in assets. But eventually, he wanted to do his own thing. The good news is that two of Chuck’s top research lieutenants who had been schooled in the Akre methodology were given the reins. So here we have an example of some continuity, some sense that although the manager was leaving, his process would live on lending some legitimacy to marketing that track record.
Another positive example can be found at First Eagle Global, a fund I own for almost all of my clients and one that exemplifies how the torch should be passed from one manager to the next. It was obvious that the legendary Jean-Marie Eveillard (a track record spanning decades) couldn’t run the value-oriented fund forever and that sooner or later a younger manager would have to take over. The relationship between Eveillard (pictured at left) and his replacement Matthew McLennan at the $30 billion fund is said to be one of mentoring and frequent communication. This is helpful to me as an advisor in understanding how the historical values and performance of the fund make the transition.
TCW is not the only fund to lie by omission in its marketing - managers jump to new funds all the time after all and even the long-term superstars have to retire at some point. Often the journalists and fund-rankers make no mention of these changes so it is very important that advisors and investors take this upon themselves. Because there are more examples like TCW Total Return Bond out there than there are examples like the Chuck Akre or the Jean-Marie Eveillard case.
While band names and fund families may keep the same names, finding out if there are different players behind the scenes can mean a very different final outcome.
Full disclosure: The author is currently invested in DoubleLine and First Eagle Global mutual funds for both clients and personal accounts.
Disclaimer: Any discussion here of historical track records and performance data for products sold under a prospectus is solely for the purpose of exposition. Past performance is not a guarantee of future results. Investors should not rely on the opinions of the author as statement of fact or make investments in any of the funds mentioned without first pursuing their own course of research and determining whether their own risk tolerance and goals align with the stated objectives of the products themselves.
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.