$326 Million in Need of a New Home: The High Cost of Blind Loyalty

Opinion: How long should mutual fund investors wait for a turnaround?

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Jun 13, 2016
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The high cost of blind loyalty

Sticking by your friends through thick and thin is an admirable trait. Staying put in chronically poor-performing mutual funds, though, can be extraordinarily costly.

Every fund manager intends to add value while collecting their pay in the form of management fees. Sometimes, though, facts show that their decisions have actually subtracted from returns over long periods of time.

Investment styles (value versus growth, small-cap versus large-cap, etc.) tend to rotate in and out of favor. Knowing that everyone underperforms some of the time, the question becomes…

How long should investors wait before pulling the plug on a demonstrably bad mutual fund?

Muhlenkamp Fund’s (MUHLX, Financial) founder and portfolio manager Ron Muhlenkamp is a highly educated, well-meaning man. His fund’s tag line is, “Intelligent Investment Management.” The question mark shown below was added by me.

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Muhlenkamp hired family members to fill key positions on the fund’s executive staff. That is equivalent to stocking a corporate board of directors with people that are unlikely to be objective towards any of their CEO’s policies or proposals.

Nepotism suggests that positions at MUHLX were not filled based on who were the “most qualified” applicants.

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Nobody would worry about that if MUHLX had posted decent returns. A glance at the fund’s own figures, though, spells out the damage inflicted on shareholders in the decade ended Dec. 31, 2015.

That period was pretty representative as it spanned the manic housing bubble years, those of the Great Recession (2008 to 2009) and America’s subsequent gradual recovery.

In those same 10 years, $10,000 invested in the S&P 500, with dividends reinvested, would have more than doubled to $20,242, for a cumulative net profit of $10,242. That represents a good, but not great, 7.31% annualized rate of return.

Continuous holders of MUHLX would have netted 10-year cumulative total gains of just $639. Ouch. That was a meager 0.62% per year compounded. Having $10,000 in MUHLX, rather than owning the index, cost $9,603 in foregone profit. Those with $100,000 stakes missed out on $96,030. Million dollar investors in MUHLX lost out on $960,300 versus index buyers.

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For MUHLX, 2015 was a disaster relative to the market. It lost 6.21% while the broad market return was slightly positive. Over the three years ended last December, continuous shareholders captured just 54.6% of the S&P 500’s gains. The five most recent years fared even worse, at only 50.4% of the index’s return.

During the full decade ended 2015, those who remained loyal to Muhlenkamp missed out on 84.8% of the S&P 500’s performance.

While fund holders suffered, Muhlenkamp and his family continued to rake in multi-million dollar management fees. In the last five years, the fund averaged a higher-than-industry-average, 1.25% expense ratio.

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The fund likely paid out more than $4 million in expenses last year as 2014 assets under management were about $435 million, before declining gradually due to both negative market action and net withdrawals during 2015.

The Muhlenkamp Fund’s expenses more than wiped out all dividend income collected during the entire three-year period from 2013 through 2015. The year 2011 saw just a 1/10th of 1% net investment income contribution after deducting expenses.

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Was I too harsh in my judgement of the Muhlenkamp Fund?

Investors who sat tight through May of this year hoping for a turnaround are sorry they did. On May 31, the Muhlenkamp Fund was down another 6.50%, while the S&P 500 had gained 3.57%.

The trailing 10-year numbers were 0.25% annualized for MUHLX versus 7.41% for the index. From May 31, 2006 through May 31, 2016, Muhlenkamp captured just 3.37% of the broad market’s profits!

Going back to the trailing 15-year data would do little to ease the pain or change any minds. From May 31, 2001 through the same date this spring, Muhlenkamp’s continuous shareholders missed out on 46.4% of what an index fund like the S&P 500 ETF (SPY) might have achieved.

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A smart guy like Ron Muhlenkamp (BS: MIT, MBA: Harvard) might eventually recover his feel for the modern market. Perhaps his family members will tell him that what he’s been doing is no longer working. Maybe he’ll realize it on his own.

People with money in the Muhlenkamp Fund should be asking themselves why they haven’t pulled it out already. The late, great Martin Zweig said this about the market long ago …

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Disclosure: No position in MUHLX, duh.

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