If You Trade Mutual Funds…
The
last two days have not been good for the stock market. Yesterday was
a distribution day for the Nasdaq, and today was a distribution day for the S&P
500. In addition, I’ve seen a good number of stocks that have broken out in the
last week-and-a-half, return to their bases. So far I will treat this as a
normal correction. Traders should watch carefully to see if additional
distribution occurs and also monitor the action of leading stocks. Should the
market worsen, you don’t want to be the last one to leave the party. I wouldn’t
take action too quickly, though. This very well could be a pullback that
provides additional buying opportunities. The quick jump in the VIX today leads
me to believe that even after the long run-up we’ve had, there may still be
skittishness among investors, which is good. A further move northward in the VIX
would be helpful.
Last week, news broke that four
mutual funds were in cahoots with a hedge fund in allowing market timing and
after-hours trades. While there is nothing illegal about market timing trades to
try and take advantage of price discrepancies in overseas markets, the mutual
funds involved were acting unethically, without the best interests of their
shareholders in mind, and contrary to their own guidelines as outlined in their
prospectuses. They gave preferential treatment to one large shareholder in
return for kickbacks.
The second activity, allowing
after-hours trading in their funds in return for kickbacks, is blatantly illegal
as well as detrimental to shareholders. The mutual funds involved were run by
Bank of America, Bank One, Janus, and Strong. If I were invested in any of these
companies’ mutual funds, I would be out of them already. There are plenty of
mutual funds out there, and these guys don’t exactly have the best returns on
the Street, anyway.
Mutual funds are sold to people
as long-term investments. Buy and hold. Most of the time when someone says to
you “Remember, this is a long-term investment,†that means in the short-run they
are losing you money.Â
As traders, I would suggest
that TradingMarkets members not treat mutual funds as long-term
investments. There are very few mutual funds that do even a half-decent job of
running their portfolios. One of the biggest scams on Wall St. is that mutual
fund companies all compare the performance of their equity funds to the S&P
500. If they beat the index, they want you to think that they are doing a good
job. The S&P 500 is still down nearly 35% from its March 2000 highs. If I put
money with someone 3½ years ago, and they told me they were doing a good job
because they’d only lost 30% of it so far, I’d be irate. This is what most of
these firms want you to believe, though.Â
The S&P 500 is an unmanaged
index. It’s just a basket of stocks representing the US stock market. If you let
10 monkeys run portfolios, five of them should beat it. Yet rarely do five out
of 10 mutual fund managers beat the index for any length of time. Fund expenses
are no excuse. Expenses go to research, which should improve stock-picking to a
degree great enough to more than compensate. I do not know the results of Larry
Connors’ 5-years-old-and-under stock-picking contest yet, but I would be very
surprised if the average contestant didn’t beat the average equity fund.
There was a fund manager I saw
on TV a couple of weeks ago that posted his returns of nearly 40% since the
March bottom. He talked about how smart he was, and all the great stocks he was
invested in. I checked his company’s website and it was obvious why he only
showed returns back to March. Anything longer was horrific. One fund’s
inception date was last November and even with the huge run-up, he bragged about
since March he was still losing money since inception. This is typical.
Many of these people are paid
big dollars to manage large sums of money and they add less value to their
clients than the average monkey or 5-year old would.
For the most part, I would say
that traders who use mutual funds should learn how to use them as trading
vehicles. This may be necessary if you are invested in a 401k or other
retirement plan where you are forced to use mutual funds. TradingMarkets posts
intermediate-term timing models that could help you with this endeavor. Mark
Boucher has several timing models in his book “The Hedge Fund Edge†that could
be applied to mutual funds. Another resource I would recommend is the book “How
I Trade For A Livingâ€, by Gary Smith. Gary trades heavily in mutual funds and
has several interesting strategies than can be utilized. Take an active
interest in all your money, not just your trading account.
That said, there are some
fund managers out there who have done a good job in both up and down
markets, have beaten the averages consistently, and have added value to their
clients. If you still want to own mutual funds as a long-term investment, find
one of these to invest in. And make sure they are not with one of the companies
involved in last week’s scandal. Who knows what other schemes the sleazeballs
at these companies have concocted to the detriment of their shareholders?
Best of luck with your trading,
Rob Hanna