Monday, June 6, 2016

The worst mutual fund in history

Successful investing is simple. You live within your means, save money regularly and invest it. You buy a collection of quality businesses and hold for decades. You know that time in the market trumps timing the market. You ensure a slow and steady accumulation of net worth and income to live off in retirement, by focusing on things you can control such as:

- The amount you save
- The type of investments you make
- The time period you hold onto them
- The investment costs you pay ( taxes, commissions, advisory fees)

In my review of the Corporate Leaders Trust, we saw how a fairly static portfolio of blue chip companies performed miracles to shareholders over the long run ( even beating the S&P 500 over a period of 80 years).  I am personally mirroring my investment strategy to include a static portfolio o blue chip stocks, with limited turnover.

In order to prove my point that investment turnover, high costs are dangerous to your wealth building, I am going to profile an investment that did terribly over the long run.

In my reviews of investment strategies, I stumbled upon the worst mutual fund in history. It was called Ameritor Security Trust. The fund was started in 1961, and was closed down in 2011. A $10,000 investment in the fund at the end of 1961, with dividends reinvested, turned into $1,325 by the time the fund was liquidated in the end of 2011. A regular investment compounds assets and dividends over time. This investment seemed to have compounded error, after error, over a period of 50 years.

Source: Morningstar

The fund family was originally called Steadman Funds, and was started in 1939. The funds were popular for the next 20 or so years, until Charles Steadman took a hold of the family in the late 1960s. These were called “Dead man’s funds” because they were always in the bottom performance chart. Yet, some investors stuck to those funds for decades. The amount of assets under management went from $100 million in the 1970s to $8 million by the time of the death of Charles Steadman’s death. In the late 1990s, the fund was renamed Ameritor. Due to high costs to run the funds, they ultimately failed. The fund managers used those funds as a lifetime annuity, by collecting their generous fees on top of dwindling assets. When the SEC went after the funds, Charles Steadman passed those fees onto unsuspecting investors. By the time of the 1990s and 2000s, many of the fundholder accounts were deemed "legally abandoned", because they were owned by dead person's with unsettled estates or elderly investors who had forgotten about the investment.

The mutual fund chart you see above, is the only data I could find today, which lists the information on any funds from the Steadman Group. All of the other Steadman mutual funds performed terribly over prolonged periods of time as well. As a result, they were consolidated into other funds, or were simply discontinued. This Ameritor Fund is the last one for which data is still widely available ( thanks to Morningstar).

This mutual fund failed because of two key factors that go against the tenets of successful investing listed above: high turnover and high fees. Based on the limited information I found in my research, the problems were also compounded by a rather concentrated portfolio.

The fund manager constantly bought and sold stocks, which resulted in high commission costs and taxes on capital gains. Because the fund manager constantly timed the market, they did not let their investments compound at all. They were constantly chasing hot stocks, which usually results in buying high and selling low. If you constantly try to pick the top or the bottom, you are doing yourself a disservice, because you are not letting your investments compound on their own.

The other mistake with this fund was the high expense rate. Towards the end of the study period, the amount of assets had dwindled, while the amount of expense remained the same. As a result, the fund charged investors something like 40% fee in assets under management in its final year. When Charles Steadman died in the late 1990s, his daughter took over. The funds were not shut down, because they generated the double-digit management fee. The investment managers had treated the funds like a personal annuity, up to the point where it bled the fund to death.

The sad point is that this mutual fund did not make investors any money. They had put their hard earned money to work for 40 – 50 years, and at the end of the day had nothing to show for it. The investment manager was the only person who made money off those poor investors.

There were times where the fund made some money. If we cherry pick start and end dates, the period between 1974 and 2000 resulted in a 6 fold increase in total values. This was still lower than the 60 fold increase in the S&P 500 ( all of those comparisons include reinvestment of dividends) However, given the huge risks taken with investors’ money, they didn’t generate the amount of return they could have generated by sticking their money elsewhere. After all, a $10,000 investment in the average Large Blend Mutual Fund at the end of 1961 would have turned into a cool $452,892 50 years later. It is very sad that during one of the greatest bull runs in the stock market, an investment manager could manage to lose money.

In a few years, the data for this mutual fund would be impossible to obtain, because it is no longer quoted. Once a fund or an investment fails, you would not be able to obtain its past performance information from the databases of places like Morningstar or Yahoo! Finance.
Worst of all is the fact that this failed fund will likely be removed from mutual fund industry stats, which compare the historical performance of various fund groups. This bias would make the results of the group of surviving funds much better as a group, than they should be.

Therefore, investors would not have the data to learn the important lessons from the failure of this fund.

So, what is the point of this story?

Well, the point is to reiterate the point that you should not be timing the market. Over the past 8 years that I have been writing on Dividend Growth Investor blog, I often read about someone who is selling their stocks and raising cash, because they think that shares are overpriced and want to buy them cheaper. As I check the records of these people, they end up missing out on all the upside potential of stocks in terms of capital gains and dividends over an average holding period of 20 – 30 – 40 years. They miss out on all the upside potential, because they do not want to suffer any decline in their net worth. In the end, they end up increasing their transaction costs, taxes. These people are very dangerous to listen to, because they always sound very smart and convincing. Yet they cost the investors who listen to them a huge amount of money. Please remember that your downside is limited, but the upside is always unlimited.

Investors need to remember that buy and hold should mean buy and monitor. It is important to check on the investments you own at least once per year, even if you do nothing about it in the end. The second important point is that you need to keep investment expenses low.  If you notice that you are spending more than 1%/year on costs ( management fees, commissions, taxes), you need to take corrective action.

Relevant Articles:

Dividend Investors: Stay The Course
Successful Dividend Investing Requires Patience
Buy and Hold means Buy and Monitor
Time in the market is more important than timing the market
Time in the market is your greatest ally in investing

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