A Change in Scenery

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Aug 10, 2015
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I wanted to start off my article today by announcing a relatively significant change in my career. As many of you know, Nintai – which was a management consulting business with its own internal fund – has been winding down operations and will shortly be nothing but a memory. Any assets in the firm will likely be fully dispersed by the time of publication. The only remaining part of the business will be my own managed portfolio of the newly created Nintai Charitable Trust. Accordingly, any mention I may make going forward referring to “Nintai” will be strictly associated with any trades or positions in the Trust portfolio.

Additionally, (and far more importantly!) I am very excited to announce that I will be joining Dorfman Value Investments as Director of Marketing. Some of you may already know John through his writing here on GuruFocus. For those who don’t know, John has a tremendous record as a value investor and has long been seen on Bloomberg, CNBC, as well as a writer and editor at the Wall Street Journal and Forbes. It is an extraordinary privilege to be working with John and his team.

In the inevitable reflection that happens when shutting down operations, I began thinking about other funds that have closed over the years. I began to wonder what made these close and if many ceased operations at the height of their performance or at a trough of underperformance. It should be stated up front that not many professionals retire or leave their profession in their prime and when success is assured by their past record. In the investment world the most obvious cases are Buffett’s Partnerships,

Joel Greenblatt (Trades, Portfolio)’s Gotham Capital, and Julian Robertson (Trades, Portfolio)’s Tiger Fund. Unfortunately most portfolio managers – or at least those considered real stars such as Bill Miller at Legg Mason – face the inevitable humbling of reversion to the mean. While in no way equating our own skills with Warren Buffett et al, we feel comfortable Nintai is leaving our investors with a more than adequate return over the long term.

Back to the future

In our article “Mutual Fund Survivorship: The Revenge of Abraham Wald” (found here), we discussed a 2013 Vanguard study that looked at fund survivorship from 1997 through 2011. Using this as a jumping off point, we thought it would be interesting to analyze the cause of these fund closures. Since we were knee deep in the data, we thought we might additionally check in to see how the funds that were merged – rather than closed – performed after exiting from the investment stage.

At the beginning of 1997 there were 5,108 active funds. By 2011 2,364 of these were closed/merged or roughly 46%[1].Of these funds that didn't survive the period from 1997-2011, 1,915 (81%) were merged with other funds and 449 (19%) were closed outright. Of the closed funds, 87 (19%) were closed due solely to performance, 261 (58%) were closed due to insufficient AUM, 101 (23%) due to an aggregate of both, and exactly 1 fund was closed due to a fund manager leaving. Of interest, this fund was the only one to have beaten its respective index over the previous 5 year period. Of the merged funds, 1,115 (58%) went to the mutual fund pearly gates due to lack of AUM, and 800 (42%) were closed due poor performance[2].

Of the 2,364 funds that didn't survive the measured period, exactly one was closed that had outperformed the market index S&P500. For the vast majority of the remaining funds, the story was unfortunately one of past underperformance and future underperformance. The active fund is dead. Long live the active fund.

With friends like these …

It turns out that it really doesn't mean much to underperform and its impact on investor returns. The inability for a fund to be profitable to the fund’s mutual fund company is the seeming driver for closing or merging away a fund. How do we know this? Actual fund return data show us the priority of many mutual fund companies.

We see this when we look at the 958 funds merged into surviving funds. This includes both equity and fixed income funds. Of these, 87% or 834 funds were underperforming against their respective index by a median 2.3%. We would expect this as their records were nothing to crow about. Certainly more distressing is the fact that post-merger roughly 73% or 747 funds still underperformed their respective index. Seen below are the results by category.

Category

Number Merged

% Underperform Before Merge

% Underperform After Merge

% Underperform Entire Time

Median Excess Return Before Merge

Median Excess Return After Merge

Equity

           

Global

55

78%

59%

69%

-1.61%

-1.07%

Developed

79

72%

65%

68%

-1.43%

-0.50%

Emerging

29

62%

72%

69%

-0.82%

-1.74%

Large Blend

122

96%

88%

99%

-2.75%

-1.88%

Large Growth

163

88%

88%

90%

-3.00%

-2.47%

Large Value

108

77%

57%

73%

-1.90%

-0.78%

Mid Blend

24

100%

88%

100%

-5.63%

-5.24%

Mid Growth

104

100%

72%

100%

-8.52%

-2.20%

Mid Value

16

100%

94%

100%

-3.74%

-0.80%

Small Blend

24

96%

79%

100%

-3.06%

-1.89%

Small Growth

64

86%

69%

87%

-4.2%

-1.30%

Small Value

15

87%

73%

84%

-3.10%

-0.13%

Sector

16

44%

69%

44%

+0.43%

-3.07%

Fixed Income

           

US Gov

45

98%

47%

89%

-1.04%

+0.18%

US Corporate

75

96%

69%

99%

-1.20%

-0.76%

US High Yield

16

88%

94%

100%

-1.42%

-1.89%

             

TOTAL

958

87%

73%

87%

-2.30%

-1.45%

Conclusions

We all know it’s extraordinarily difficult to outperform our respective indexes over time. Managers who outperform are diamonds in the rough. More importantly, managers who either close their funds or are merged after a period of outperformance are even more rare birds. The ability to willingly go out on top is at odds with nearly every emotional aspect that assisted you (and me) getting there – confidence in your ability, a healthy ego to place substantive bets against the general markets, patient and understanding investors willing to invest for the long haul, and a remarkably intelligent support staff that assists in everything from keeping you from making poor decisions to getting you to a meeting on time. Of equal importance has been all that I’ve learned here on GuruFocus from all of you who have taken the time to read and comment on my ramblings. Although it was never stated, each of you helped make Nintai the success it was over the years. Leaving all this behind is painful from a personal, emotional and professional level. My time at Nintai was a fantastic experience as well as a profitable venture for our investors. However, I look forward to the next phase of the journey with intense delight and great expectations. I hope you will join me on the trip.


[1] Information for this article was from another outstanding Vanguard report entitled “The Mutual Fund Graveyard: An Analysis of Dead Funds”, by Todd Schlanger and Christopher B. Philips, January, 2013.

[2] There is a question about whether lack of AUM or poor performance is the lead reasons for closure. There aren’t many fund companies that will say “our lack of AUM was driven by poor performance”, so much like the chicken/egg dilemma it’s difficult to state an exact cause. We chose the reasons as stated by the mutual fund company itself.

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