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
aretalented, 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
doperform 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,
Reynolds Blue Chip Growth fund (RBCGX), one
of the top performers over the past year with a 34%
return:
Reynolds Blue Chip Growth
Top Holdings
% Net Assets
Apple
3.69
Google
1.56
OfficeMax
1.47
Research In Motion (Nasdaq: RIMM)
1.32
Cott
1.08
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