Mutual Funds Try Hard To Hide One Statistic: Maximum drawdowns or the worst-ever losing period for any given investment

Mutual Funds Try Hard To Hide One Statistic

MAMTA BADKAR AUG. 21, 2013, 5:51 PM 4,609

Mutual Fund Companies Are Keeping A Big Secret (Advisor Perspectives)

Gary Halbert of Halbert Wealth Management shared a FINRA quiz on economic and investment basics with his readers and one of the questions many of them missed was on drawdowns. “Maximum (or max) drawdown refers to the worst-ever losing period for any given investment,” he writes. Mutual funds according to Halbert try hard to hide this statistic because “it doesn’t fit into their “relative return” view of the world.” “Mutual funds like to compare their performance to stock and bond market indexes. Think how often you hear commercials for mutual funds bragging that they beat this or that market index. Sounds impressive, doesn’t it?“That is until you realize that a mutual fund can beat the market even if it loses money. In 2008, the S&P 500 Index dropped 37% for the year. Given that performance, a mutual fund could truthfully claim that it “beat the market” by incurring a loss of only 20% or even 30%.

“Plus, revealing drawdown statistics would often show that many mutual funds have drawdowns near or exceeding those of the unmanaged indexes. The sad fact is that many mutual funds don’t beat the market when it’s going up and often match losses when the market is going down.”

The Big Secret Mutual Fund Companies Are Hiding

Halbert Wealth Management
By Gary Halbert
August 21, 2013

Overview

Do you know that most (if not all) mutual fund and ETF sponsors are keeping vital information about their funds secret from you? We’ll start today’s E-Letter with a discussion about what that valuable information is and why fund companies don’t want you to know about it. I’ll also tell you how you can download my latest FREE Special Report entitled, “The Secret That Mutual Fund Companies Don’t Want You to Know.”

Better yet, after you read my latest Special Report, I’ll show you how to beat the fund companies at their own game by learning this secret about the actual mutual funds (or ETF’s) in your own portfolio. This is information you really need to know, and you may be very surprised by what you learn!

From there, we shift our focus to the Fed. As you will recall, Fed Chairman Ben Bernanke first hinted of reducing “quantitative easing” (QE) bond and mortgage purchases in late May, and stocks and bonds took an immediate hit. In late June and July, Bernanke tried to walk-back the idea of “tapering” Fed purchases, and stocks soared to new record highs. However, in the last few weeks, “taper-talk” has become widespread again.

Most forecasters now believe that the Fed will cut its monthly QE purchases from $85 billion to around $65 billion at its next policy meeting on September 17-18. That prediction sent stocks reeling last week, and 10-year and 30-year Treasury bonds plunged to their lowest level in two years.

So, will Bernanke really do it after saying last month that the Fed would not taper “for the foreseeable future?” I believe that Bernanke has the votes to reduce QE purchases – if he so wishes; and I also believe he has the votes to continue as is – if that’s what he wants. If he chooses to taper, that will almost certainly put more downward pressure on stocks and bonds.

Mutual Funds Are Keeping a Big Secret From You

In my July 9 E-Letter, I shared the results of a study undertaken by the Financial Industry Regulatory Authority (FINRA), a major financial services regulatory body. The FINRA study administered a simple, 5-question test on matters of economic and investment basics. The results? The general public bombed on this test, scoring a dismal 58%.

In that E-Letter, I offered my readers a chance to try their hands at FINRA’s five question test, as well as take on seven additional basic economic and investment questions developed by my staff.

As I reported in my July 23 E-Letter, my readers did exceptionally well on both the original FINRA questions as well as the seven additional questions we added. While I expected my E-Letter readers to do better on the original five-question test, I was pleased to see that my readers scored an average of 95.6% on the FINRA portion of the test and 84% on the entire 12-question quiz.

The test did highlight a couple of questions that even stumped many of my readers. One of the most missed questions dealt with basic knowledge about bonds. Most people taking the exam knew that when interest rates go up, bond prices go down. However, fewer were aware that long-term bonds are usually affected far more than short-term bonds by rising interest rates.

In an effort to help my readers better understand how bonds work, we have developed a new “Bonds 101” Video presentation. This informative video serves as a primer on the different types of bonds and how market forces affect each. It’s a very good video and we’ve received a lot of compliments on it, so I encourage you to click on the link above to take a look.

The next question that many of those taking the quiz missed was #7 in regard to “drawdown,” one of the most important measures of an investment’s risk. It’s an investment evaluation tool that we use extensively in our due diligence evaluations. Yet, less than half of those taking the test knew what drawdown is.

 

Maximum (or max) drawdown refers to the worst-ever losing period for any given investment. It’s a measure of how far the investment dropped in the past from its highest peak value to a subsequent valley or trough. For example, the worst drawdown for the S&P 500 Index was 50.95% in the bear market of 2008-2009.

Whenever we analyze a potential investment or investment advisor, one of the very first things we look for is their max drawdown. It helps answer the question of how much an investor could lose in an investment and over what period of time. Max drawdown is a key reading of the downside risk of that investment or money manager. We generally assume that if a max drawdown happened once, the investment could lose that much (or more) again in the future.

To be fair, it’s not surprising that over half of those who took our test missed this question. That’s because the mutual fund industry tries so hard to hide this statistic from you.

As a general rule, you won’t find “drawdown” statistics on mutual fund fact sheets, marketing materials or in prospectuses because it is often a big negative. Instead, they use less telling risk measures such as alpha, beta and standard deviation that are usually meaningful only when compared to benchmark indexes or other mutual funds.

While most investors focus on annualized returns when selecting an investment, you should also pay attention to the worst drawdown – even if you have to pry that information out of the investment’s sponsor.

Why Do Mutual Fund Companies Hide Drawdowns?

I believe that mutual fund companies try to keep drawdown statistics a secret because it doesn’t fit into their “relative return” view of the world. Mutual funds like to compare their performance to stock and bond market indexes. Think how often you hear commercials for mutual funds bragging that they beat this or that market index. Sounds impressive, doesn’t it?

That is until you realize that a mutual fund can beat the market even if it loses money. In 2008, the S&P 500 Index dropped 37% for the year. Given that performance, a mutual fund could truthfully claim that it “beat the market” by incurring a loss of only 20% or even 30%.

Plus, revealing drawdown statistics would often show that many mutual funds have drawdowns near or exceeding those of the unmanaged indexes. The sad fact is that many mutual funds don’t beat the market when it’s going up and often match losses when the market is going down. Don’t believe me? Take a look at the max drawdowns of five very large, well-known mutual funds compared to that of the S&P 500 Index:

 

S&P 500 Index Total Return -50.95%
Vanguard 500 Index Trust -50.92%
Fidelity Contrafund -46.34%
American Funds Growth Fund of America -48.80%
Dodge & Cox Stock -59.22%
Franklin Income Fund -39.07%

 

(Max drawdowns measured as of month-end.
Intra-month drawdowns could be higher.)

Wishing you low drawdowns,

Gary D. Halbert

(c) Halbert Wealth Management

forecastsandtrends.com

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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