Don’t chase past performance: A lesson from CGMFX
With investing, we often say that past performance does not guarantee future results. This is true of any stock, fund, and even the overall market itself. But its especially true for actively managed funds. Passive index investing is likely to beat any actively managed mutual fund over time, no matter how well the actively managed fund performed in the past.
History is full of funds that delivered amazing performance for a year, or even multiple years, only to sputter and fail over time. Currently, the ARK ETFs, notably ARKK, is one of the darlings of the investing world. It’s not hard to see why - as I mentioned in my funds to watch in 2021 article, ARKK delivered over 150% returns in 2020 and has beaten the S&P 500 in 6 out of the past 7 years.
While ARKK deserves all of its recent success and may very well remain a great investment in the future, it is still unlikely to beat the market in the long term. So don’t feel bad if you missed out on ARKK last year, and if you decide to invest in ARKK today, you should do so only if you’ve researched the fund, like what you see, and believe in their investing philosophy. Don’t do it if you are trying to chase its 2020 returns in the future.
One of the best recent examples of not chasing past performance can be seen in a fund called the CGM Focus Fund (CGMFX). This fund was created in 1997 by legendary manager Ken Heebner. Heebner has often described himself as a contrarian investor, someone who tends to ignore the prevailing market sentiment and marches to the beat of their own drum. He did not get caught up in the crazed run-up of tech and dot-com stocks prior to 2000. Thus, his fund underperformed the S&P 500 from 1997 to 2000. He quickly proved to be correct, however, and when the dot-com bubble burst, his fund not only emerged unscathed, but thrived. CGMFX became one of the hottest and most talked about funds on Wall Street. From 2000 to 2007, it was the top performing fund, period. It didn’t just beat the S&P 500 - it beat every other actively managed mutual fund in existence. Here’s how it performed from its inception in 1997 up to 2008, normalized to the S&P 500:
Data from Yahoo Finance.
The fund’s assets under management (AUM) swelled during this time, as investors flocked to it. And why wouldn’t they? The performance was too good to miss. The S&P 500 didn’t just seem pedestrian in comparison; it looked outright awful. Heebner’s contrarian strategy was clearly working. He was featured in numerous financial publications. Awards came rushing in. Other fund managers idolized Heebner. Investors in the fund were ecstatic. Investors outside wanted to get in. Why would anyone invest in a boring index fund when you can trust your money to high-profile managers who actually know how to beat the market?
You probably know where this is going. The investing world was already aware that actively managed funds, in the long run, do not tend to beat the market. Whereas in 1998, actively managed funds had over 6.5x in assets under management compared to passive index funds, the tide was already turning. Investors were increasingly pulling money out of active management and putting it in index funds. By 2007, this tide became a tsunami. By 2019, passive funds beat active funds in total assets under management for the first time. Spectacular performance can make an active fund palatable, but as with many actively managed funds, CGMFX has a staggering expense ratio at 1.66%. Furthermore, active funds like CMGFX also have incredibly high turnover, making them far less tax-efficient than index funds. As soon as CGMFX starts underperforming, its cost becomes difficult to swallow.
So was CGMFX able to maintain its performance? Unfortunately not. Contrarian strategies might work incredibly well, or incredibly poorly. One way or another, a fund like CMGFX is not destined for mediocrity. It either soars or crashes and burns.
How does this story end? Let’s see the full picture of how the fund performed after 2008, up to present day:
Yikes.
Now, investors who “stayed the course” with CGMFX since 1997 have done fine. Even after its dramatic losses in 2008 and 2017 - 2020, these investors still received decent returns on their money. And if they got out of the fund in 2007, they would have realized some very handsome gains. The irony, however, is that when the fund is doing well, people are flocking to the fund, not pulling out of it. The real cautionary tale is for all of those people who got in late, not early, by “following the herd”. If you entered the fund late (say, 2007 or 2008) chasing its prior performance, you ended up losing your shirt. Over the long run, you’re probably better off just investing in the S&P 500.
Of course, not every fund follows the extreme trajectory of CGMFX in either the ups or the downs. But Heebner’s fund is not alone. Many funds and fund managers have beaten the market for long periods of time, only to end up in the doghouse. CGMFX is a good lesson in why chasing past performance is a fool’s errand. The future is unknowable, and investing for retirement is a marathon, not a sprint. In this race, index funds are the turtle, and the best performing investment fad of the day is the hare. And we all know who wins in the end.
Happy investing!
