When the Underdog Fights

I was born in a foreign country where sports fans have infamous reputations for home-team loyalty. Their fanaticism has even caused deaths. In 1985, international authorities banned the country’s soccer teams from playing in mainland Europe after a sporting riot cost thirty-nine lives

Where were the fans from? Jolly old England.

Most British sports buffs aren’t thoughtless hooligans, however. And a few of my English friends enjoy supporting the occasional, plucky underdog, even if they’re opposing their own athletes.

Supporting a Jamaican bobsled team, a tiny African country in a World Cup soccer match, or an aging tennis player in the twilight of his Wimbledon career can even be fun. They’re the world’s Davids, challenging Goliath.

Perhaps my affinity for this kind of battle is the reason I scoured bookstores looking for an investment author claiming to defy the odds and achieve–what academics presume– is nearly impossible. I wanted to find someone (other than a mutual fund salesperson) suggesting that they could identify actively managed mutual funds that could beat the market index.

With so many smart money managers watching the economy and trading stocks, it’s sometimes tough to imagine that we can’t find a top money manager who can beat the markets for us. After all, some mechanics are better than others; some surgeons are better than others; and some teachers are better than others. Can’t we identify a few stellar money managers who can produce reliable market-beating returns?

Strangely, after reading more than 300 money books, I couldn’t find a single author claiming to know how to beat the market with mutual funds.

Fortunately, my luck changed in 2008. I discovered Louis Lowenstein’s book, The Investor’s Dilemma. He claimed that, with a few fund-seeking criteria, he could find market-beating funds.

No, I wasn’t going to bet money on his forecasting picks, but I still cheered him on.

I was intrigued by Lowenstein’s assertion that stellar mutual funds could be found. He asked Bob Goldfarb, the chief executive of the legendary Sequoia Fund, to list 10 champion Value funds. Lowenstein then sang their praises; these were among the top funds to buy, he suggested.

Coining them the Goldfarb 10, he then revealed a startling rear-view mirror revelation: each of them had crushed the stock market’s return.

“The ten funds showed positive average annual returns for those five years [1999-2003] of 10.80 percent, or about 11 percentage points per year better than the index...”

Many of Lowenstein’s readers, I figured, poured money into these funds in 2008, when his book was released. But could these actively managed Davids really beat the passively managed Goliaths? Could someone really choose ten mutual funds that, as an aggregate, would beat the returns of the market?

Since The Investor’s Dilemma was published, the U.S. stock market has plunged, then recovered. Overall, Vanguard’s total stock market index rose just one percent from January 2008 to January 25, 2012. This kind of investment climate, according to Lowenstein, is perfect for actively managed Value fund managers: “Value funds are likely to outperform the index when the market is falling, or even treading water…”

But David, unfortunately, got his butt kicked by Goliath. Of the ten super funds listed in Lowenstein’s book, seven of them underperformed Vanguard’s total stock market index since his book’s publication.

The underdog’s supporters are feeling that pain. As a group, the touted funds fell 6.1 percentage points behind the U.S. market.

Their performance also paled when compared to Vanguard’s balanced index fund, with the index beating the Goldfarb 10 by more than 15 percent since 2008.

You can see the funds and their results below, based on Morningstar’s data:

When Many Davids Fail To Beat Goliath

Funds Total Investment Returns: January 2008- January 25, 2012
Vanguard Balanced +10%
Vanguard Total Stock Market Index +1%
Goldfarb’s/Lowenstein’s Ten Value Funds  
Clipper Fund -15.6%
First Eagle Global Fund -12.9%
FPA Capital +38%
Legg Mason Value -31.8%
Longleaf Partners -11.9%
Oak Value (now RS Capital Appreciation Fund) 0%
Oakmark Select +14.3%
Source Capital -21.8%
Tweedy Browne American Value +5.3%
Average Total Return for the touted Value Funds -5.2%

Perhaps one day, somebody will write another book suggesting how to find market-beating mutual funds.

But I wouldn’t put money on their predictions.

Supporting underdogs is one thing. Losing money, because of them, is an entirely different issue.