Topping the charts shouldn’t always earn your hearts
In the mutual fund business, performance forgives all sins.
High expense ratios don’t matter much to shareholders who are showing big returns after those costs are paid. Bad past track records are forgotten if recent memories are of strong gains.
But when investors overlook flaws that would be deal breakers if not for good recent results, they’re headed for trouble. For proof, consider the case of the Berkshire Focus fund, which has some dark chapters in its past but where strong recent results – including the best performance through the first half of 2012 of any technology fund, according to Morningstar Inc. – might suggest it’s a buy.
Performance surfing is always a problem, largely because hot funds with fabulous but volatile short-term performance regress to the mean; investors who buy after the hot streak typically only experience the next downturn.
How long a fund’s momentum will continue is the real question, and if you wanted to bet on which funds would not sustain a top slot in the performance rankings, it’s the ones with characteristics that typically send a fund to the doghouse. Even all-time losers such as the now-defunct Steadman Funds, the American Heritage fund or Frontier Micro-cap – all of which generated massive losses for anyone fool enough to stick with them – had periods where they rose to the top of the charts for a quarter or six months.
What makes the case of Berkshire Focus so intriguing is that it’s tough to sort its recent success from the time when it had all of the earmarks of an all-time stinker.
To see why, let’s dig in the history of Berkshire Focus.
The fund has always had an identity problem, mostly because the public wants to identify it with others. The name “Berkshire” evokes images of Berkshire Hathaway, the company run by legendary investor Warren Buffett; the manager is Malcolm R. Fobes III, which frequently gets people confused, even with the different spelling, that he is somehow tied to the Forbes family, famous for its investing prowess.
Bzzzt. Wrong answer.
The fund’s strategy is a polar opposite of the legends it is compared to, as witnessed by portfolio turnover of nearly 800 percent. That number paints a picture of the whole portfolio turning over roughly every six weeks, but the fund actually is tightly focused on a few stocks, and then trades like crazy around its core holdings.
It’s a strategy that has worked, sometimes. The fund first gained a reputation with triple-digit gains in both 1998 and ’99, a move so strong it even drew money manager and CNBC star Jim Cramer as an investor.
Then the Internet bubble burst, and so did Berkshire Focus’ performance. By 2006, the fund’s annualized performance since the market peak was an annualized loss of 25 percent, one of the worst among all funds over that time despite a 67 percent up year in 2003.
A 2 percent expense ratio – about double what most people pay for a stock fund – plus the transaction costs that come with all that turnover mean that the fund always faces an uphill battle, and made the fund easy to ignore. That has changed.
Over the past five years, according to Morningstar, the fund is in the top 1 percent of all tech funds, the category Morningstar ascribes it to due to huge chunks of Apple and Google while ignoring holdings like Starbucks and Chipotle Mexican Grill. The fund is in the bottom 20 percent of the category over the last 15 years, but that shows just how much it has overcome in the last decade, where it stands just outside the top 10 percent; it now carries a four-star rating. It also is a “Lipper Leader” for total return, ranking atop Lipper’s multi-cap growth category in virtually every time period for the last decade.
A $10,000 investment in the fund in 2006 is worth more than $18,000 today; alas, a $10,000 investment when the fund started in 1997 is worth about $4,150.
Recent success should not make investors ignore what produced the long-term record. It’s a feast-or-famine strategy; consider that Fobes opened a Berkshire Technology fund after the great late ’90s run, but closed it during the bear market having turned a $10,000 investment into $800.
Fund experts say recent performance doesn’t forgive the past; Steve Goldberg of Tweddell Goldberg Investing describes Berkshire Focus as “insanely overpriced, ridiculously high turnover, and strange industry concentration.”
With about one-third of assets in Apple and Google, investors can easily find alternatives to Berkshire Focus that have less risk, lower costs, less turnover and reduced volatility.
“There’s danger in looking at the five-year numbers, the Morningstar ratings and the short-term results without looking under the hood of a fund,” said Matthew King, chief investment officer at Bell Investment Advisors in Oakland. “Any fund can have a good quarter or six months or even a few good years, but what matters is the chance of those good results being repeated, and if you see high costs and conditions that can cause trouble, you don’t want to be fooled by what the fund has done lately.”
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at email@example.com or at Box 70, Cohasset, MA 02025-0070.