Spencer Jakab has a great new book out called Heads I Win, Tails I Win: Why Smart Investors Fail and How to Tilt the Odds in Your Favor. Jakab is currently a columnist at the Wall Street Journal, but also spent part of his career as a sell side research analyst. The fact that he is able to approach the markets from both the media and practitioner point of view offers an interesting perspective on the world of investing.
Jakab does a great job providing some much needed context around some of the greatest investing track records. The numbers he provided on former Fidelity Magellan portfolio manager Peter Lynch, considered by many to be the greatest mutual fund manager of all-time, were eye-opening:
During his tenure Lynch trounced the market overall and beat it in most years, racking up a 29 percent annualized return. But Lynch himself pointed out a fly in the ointment. He calculated that the average investor in his fund made only around 7 percent during the same period. When he would have a setback, for example, the money would flow out of the fund through redemptions. Then when he got back on track it would flow back in, having missed the recovery.
That’s some behavior gap. Mutual fund investors have a history of buying high and selling low, but this type of self-destructive behavior seems to be even more ramped up when you’re dealing with star portfolio managers or the latest fad investments. Considering how well stocks performed in the 1980s, that means investors in Lynch’s fund underperformed the market by around 10% per year. ‘But what if you would have just bought in at the beginning and held on?’ you might ask.
You would have done much better but still had a hard time earning that 29% annual return number.
William Bernstein discussed this problem with Lynch’s track record in his wonderful book, The Four Pillars of Investing:
Although he had worked at Fidelity since 1965, he was not handed the Magellan fund until 1977. Even then, the fund was not opened to the public until mid-1981 — before that it was actually the private investment vehicle for Fidelity’s founding Johnson family.
From mid-1981 to mid-1990, the fund returned 22.5% per year, versus 16.53% for the S&P 500. A remarkable accomplishment, to be sure, but not in the same league as Buffett’s. In fact, not all that unusual. As I’m writing this, more than a dozen domestic mutual funds have beaten the S&P 500 by more than 6% — Lynch’s margin — during the past 10 years. This is about what you would expect by chance alone. […]
It is not commonly realized that the investing public had access to Peter Lynch for exactly nine years, the last four of which were spent exerting a superhuman effort against transactional expense to maintain a razor thin margin of victory.
So even though Lynch took over the fund in 1977, the public could not actually invest with Lynch until 1981. While the roughly 23% annual returns he put up from 1981-1990 are still pretty damn impressive, those first few years when the fund was closed obviously made a difference. And Bernstein also points out that Lynch started with a relatively small amount of assets with around $100 in AUM, which ballooned to over $16 billion by the time he retired from the fund.
I’m not trying to diminish Lynch’s skill as an investor here. He’s obviously one of the all-time greats. One Up On Wall Street remains one of my favorite books on investing. I also think one of his most impressive feats as an investor is the fact that he basically went out on top. He didn’t try to hold on to the spotlight and overstay his welcome while tarnishing his long-term record as so many other well-known investors have done over time. He could have coasted on that track record for years and racked up huge fees from investors along the way. I give him credit for walking into the sunset like he did at the top of his game.
I just think that it’s a little too easy for investors to look back at amazing investor track records and think: what if?
What if I would have just put $10,000 in that fund?
What if I could just invest like Lynch?
What if I could find the next Lynch?
Investors have to remember that historical performance numbers always require context. A few considerations can help contextualize a great (or terrible) track record:
- How large was the asset base when the bulk of the performance was earned?
- Now how large is the current asset base?
- What type of market environment were they investing in?
- What investing style or risk factor worked best/worst during this period?
- How realistic would it have been for me to stay invested the entire time?
Again, this is nothing against Lynch or his legacy. It’s just important for investors to remember that even the greatest track records of all-time are not always as they may appear at first glance.
Should Fund Managers Care About the Behavior Gap?