Perhaps you've heard that roughly three-quarters of all mutual funds lose to the market over the long run. The question is why -- why do presumably smart and talented managers serve you worse than simply buying an index fund? Believe me, I've met plenty of fund managers and the vast majority of these folks are talented and responsible and hard working -- they're not bad stock pickers.
The best explanation I've found comes from a recent study by professors Cohen, Polk, and Silli. Their study, "Best Ideas," provides pretty convincing evidence that the rules are stacked against smart fund managers. Their few very best ideas do perform well -- beating the market and their other picks by approximately 1% to 4% per quarter (which is significant). However, the very nature of a mutual fund requires managers to pick dozens -- perhaps hundreds -- of stocks.
Who can pick 100 good stocks? No one, really ... and having to load up a fund's portfolio with all these second-tier ideas seriously harms returns.
But what if ...
The knowledge that fund managers' best ideas tend to outperform might be profitable for us individual investors if we knew with certainty which stocks they most loved. One proxy for determining a fund's favorite ideas might be to look at its largest holdings. Take, for example, the giant American Funds Growth Fund of America , headed up by James Drasdo:
Growth Fund of America
Top 10 Holdings
% Net Assets
Microsoft (Nasdaq: MSFT)
3.28%
Google (Nasdaq: GOOG)
3.23%
Oracle (Nasdaq: ORCL)
2.94%
Apple
2.12%
Cisco (Nasdaq: CSCO)
1.63%
Phillip Morris International (NYSE: PM)
1.37%
Bank of America
1.30%
Medtronic Continued... |