By Jason Zweig | August 14, 2017 8:40 p.m. ET
Image credit: J.P. Morgan blowing “A Dangerous Bubble,” J.S. Pughe, Puck Magazine (Oct. 22, 1902), Library of Congress
Asset managers have more ways to manipulate returns for marketing purposes than most clients can even imagine — above all, by pretending that sheer luck is the product of skill. Here’s an old column looking at a fund family that combined several of these promotional techniques at once, luring in billions of dollars from investors who never seemed to understand that the funds’ returns were partly lucky, partly gamed and completely unsustainable. Stories like these led me to formulate one of my central rules for thinking about investing: No matter how cynical you are, you aren’t cynical enough.
Looking Out for No. 1
Money Magazine, November 1999
With fund returns, what you see is not always what you will get.
To see why so many investors are growing frustrated with mutual funds, you need look no further than the Chase Vista family. In promoting this 14-fund, $10 billion group over the Internet, banking behemoth Chase Manhattan claims that “our portfolio managers count on a disciplined investment process developed and proven over many years” and declares that “nothing can replace consistency.”
Well, almost nothing. Chase Vista recently announced that the funds’ entire management team, 32 investment professionals led by veteran David Klassen, was being replaced to “strengthen our asset-management capabilities and to better serve our clients.”
Klassen and his team, whose track record had been decent but not overwhelming, will be replaced by another group of Chase portfolio managers, based in Houston and led by Henry Lartigue, whose record is outstanding but is built on a different approach to picking stocks.
From their inception to this latest switcheroo, the Chase Vista funds have been a textbook example of how mutual fund track records are not always what they appear to be.
A few years back, Chase Vista’s flagship fund, Growth & Income, was extremely hot. In fact, from its inception in September 1987 through June 1992, Growth & Income was the No. 1 stock fund in the country. In its ads, Chase Vista boasted of the “unmatched consistency” of Growth & Income’s returns.
Thanks to the fund’s performance and the media blitz — plus the fact that in late 1990 Chase began paying brokers a 4.75% commission to push its funds–Growth & Income mushroomed from just $19 million in assets at the end of 1990 to $1.5 billion by the end of 1994. Today it’s around $2.1 billion.
But there’s more to the story. While a string of good managers helped, the fund was also born lucky. It was launched on Sept. 23, 1987 — right before the crash of Oct. 19, that Black Monday when Standard & Poor’s 500-stock index lost 23%. Since the fund was still in diapers, it was 100% in cash. While the crash pulverized competing funds — the typical small-cap value fund lost 22.7% in the fourth quarter of 1987 — Vista’s cash cushion kept the fund from losing a cent. You cannot lose money on stocks if you don’t own any.
By my math, heading into a market crash with 100% cash accounts for half of Growth & Income’s cumulative edge over the market in the fund’s first five years. Thanks to that cash hoard, not only did the fund dodge the losses of Black Monday, it was also perfectly positioned to profit from what followed.
The fund’s first manager, James Manley, who left Chase in 1991 and now runs $250 million for institutional investors at Manley Fuller Asset Management in New York City, says he intentionally kept the fund out of the market at the start, believing that stocks were overpriced. But it’s hard to believe he’d have gone to 100% cash if the fund had not been less than a month old, and Manley agrees that the fund’s biggest advantage at the start was “having all that cash to take advantage of values right at the bottom.”
Along with good timing, the fund employed several strategies that managers often use to get new money flowing into a fund.
One is to waive expenses. Running a newborn fund can cost as much as 2.5% in annual expenses. When those costs are subtracted from a young fund’s return, as they normally are, they take a big bite out of performance. But for Growth & Income’s first five years, Chase ate the fund’s costs. This temporary giveaway, I estimate, increased the fund’s returns from an annualized average of 30.8% to 32.1% from 1988 to 1992 — just as the fund was building the three-year and five-year track records that are so vital to luring customers.
Second, the bigwigs can keep a fund tiny in its fledgling years, enabling it to invest in hot little companies, to trade rapidly and to sink plenty of the portfolio into the stock pickers’ best ideas. Even after its first two years of spectacular returns — as the fund rose in value by 121% while the S&P 500 was up 54% — Growth & Income still had only $9 million and barely 800 shareholders.
Manley loved the flexibility of running such a wee little fund, because his buying or selling wouldn’t move stock prices and he could always get enough of a stock he liked. “There’s no question that size makes a difference,” he says.
Only in the fall of 1990, when Growth & Income had a three-year track record, did Chase begin to market it aggressively. Nearly a billion dollars gushed in over the next four years; the fund has not beaten the S&P 500 in any calendar year since its assets passed $1 billion in 1993. On the other hand, the fund’s robust performance in its early years has kept it well ahead of the S&P 500 since inception.
When money pours in, many small funds morph into something different. “Our style was small-cap value,” says Manley. “If I had continued to manage the fund, it would have stayed a small-cap value portfolio.” Instead, Manley left in 1991.
His successor, Mark Tincher, who ran the fund from 1991 through 1995, invested in stocks of all sizes, ending up with a portfolio of medium-size stocks on average. “That made sense as the fund grew bigger,” says Tincher.
More recently, Klassen ran the fund as a basket of big, value-oriented stocks. In other words, each manager followed a different discipline.
“We can’t change what the history is,” acknowledges current manager Lartigue. “When [the fund] was smaller, they used small-cap and midcap stocks. For the last three to five years, [the fund] has been implanted in the large-cap value box, and that is where we expect it to stay.”
Perhaps the fund has run out of styles to adopt. Still, even Lartigue’s record gives me pause. No one disputes his ability. Top fund industry headhunter George Wilbanks of Russell Reynolds Associates in New York City calls Lartigue a “wonderful manager with a great track record.” Lartigue’s flagship $156 million Chase Core Equity Fund has returned 19.5% annually since its launch in 1993, beating the average growth-and-income fund by three points a year.
But, as Lartigue concedes, he specializes in technology, health-care and telecommunications growth stocks — not the cheaper, more broadly diversified approach that Vista Growth & Income has been following.
Lartigue hastens to add that his group of 42 managers runs more than $10 billion in large-cap value portfolios, and its Equity Income Fund has outperformed its peers by nearly a percentage point annually over the past decade — showing that his group is amply qualified to run a large-cap value fund like Growth & Income.
But, all in all, this fund’s history shows that “consistency” had little to do with its returns and that figuring out how a fund will be run can be terribly tricky.
So what are the lessons here?
- Luck matters. When portfolio managers look brilliant, at least part of that brilliance may be luck–and good luck rarely lasts very long.
- Size matters. I would ignore any portion of a track record earned before a fund had at least $25 million in assets.
- Cost matters. If you’re considering an investment in one of the more than 2,700 stock funds that are currently waiving some of their expenses, look in the footnotes of the prospectus to find out what the fund would cost if the manager weren’t eating the fees. Trust me: Sooner or later the manager will make you pay up.
For further reading:
Definitions of ALPHA, INCUBATE, MUTUAL FUND, PERFORMANCE, PORTFOLIO MANAGER, and TOTAL RETURN in Jason Zweig, The Devil’s Financial Dictionary
Chapter Nine, “Investing in Investment Funds,” in The Intelligent Investor
The Difference between an Investment Firm and a Marketing Firm