Bill Miller’s Winning Streak

With just over a week to go in 2005, Bill Miller’s Value Trust fund looks set to beat the S&P for the 15th consecutive year.

Certainly, Mr. Miller’s 14-year winning streak is impressive, especially in the context of professional fund management, an industry in which the average fund manager typically underperforms broad market indices like the S&P 500. Mutual fund screeners (e.g., Yahoo’s, which takes data from Morningstar) show about 11,000 stock funds. Noting that 11,000 sits between 2-to-the-13th power (8,182) and 2-to-the-14th power (16,384), we should expect by pure probability alone to find about one fund manager in 11,000 who has a winning streak of 13 or 14 years (similar to performing 11,000 trials of 13 or 14 coin tosses and finding one streak of all heads). From this perspective, Mr. Miller’s performance is still exceptional (just as a string of all heads is exceptional), but we should not be surprised to find an exceptional performer among the many thousands of mutual fund managers out there. In other words, while Mr. Miller does appear to have a “golden touch,” he is not necessarily a living incarnation of King Midas.

Asset Allocation and Rebalancing

Interesting example of asset allocation and rebalancing in this article, “What the Heck is Asset Allocation.”

He illustrates two cases (over 2 years):

  • Case 1: Investing $100,000 in 4 different mutual funds (large-cap, mid-cap, small-cap, and bonds), 25% each. Sell the worst performer after the first year and buy the best performer. Hold for one more year. This leaves you with $96,535 after the 2 year period.
  • Case 2: Same as above, but rebalancing the funds after year 1, so that each fund was again 25% of the portfolio. This case leaves you with $103,170.

He also could have shown the case where you just buy & hold for the 2 years:

  • Case 3: Using the returns provided in the article, the final value for each fund would be FV=PV \times (1+i_1)(1+i_2) for each fund, where i_1 is the return of a fund in year 1 and i_2 is the return of a fund in year 2. You would end up with $102,660

It just happens to work out this way because of the data he used. Had he rigged his data so that the Bond fund continued to do poorly in year 2 and the small cap continued to outperform the others, then our results would be different. But in my opinion if you looked at past market data you would find that case 2 above is invariably the best thing to do.

My Kind of Fund Manager

ABC Funds’ newest feature article, “Our ABC Response to Client Concerns” reveals Irwin A. Michael’s dedication to his funds and his profession. Basically he was getting questions from clients, asking him if perhaps he was not putting more effort into his newest fund, NAD-V, and less attention to his older funds. One client asked him,

Recently, however, with the launch of the NAD-V, I’m beginning to get the feeling that you are focusing on the NAD-V and as a result the other three funds that I own aren’t going to have the same results as one has come to expect. I hope I’m wrong but would like to know from you – are you getting distracted from managing the performance of the other three funds so you can ensure the NAD-V does well? Just wondering…

Here is part of Mr. Michael’s reply,

My initial response to this question was one of surprise. Quite frankly, it never occurred to me that I might slight one fund over the other three ABC Funds. I regard myself as a professional, but more importantly, I have too much to lose – my reputation, my own invested money as the largest single individual client of ABC Funds, my Chartered Financial Analyst designation (CFA), an industry code of ethics and the fact that I have dedicated over 32 years to my profession and almost 18 years building the ABC Funds.

Actually, not only is Michael Irwin the largest client of ABC Funds, but this page says he has invested “his own funds (taxable, holding company and full RRSP) as well as his wife’s, children’s and his late father’s estate in the ABC Funds.” Further down in the article he says exactly how much of his and his family’s portfolio is investedin ABC Funds:

As a final point, given that my family and I are the largest individual unit holders of ABC Funds with over 80% of our invested capital in the three open-ended funds it is in my best interest to see that they all succeed. The fact is that these four funds are a large part of my deep passion for my work and I would never compromise my principles. I remain motivated and excited about ABC Funds and the prospects for “deep-value investing”. This will not change. [emphasis mine]

I wonder how many fund managers out there (and their families) have such a huge stake in their funds? (and are as passionate as Mr. Michael makes himself out to be)?

DRIPs for iUnits ETFs

As a follow-up to my previous post where I quoted a site that said ETF distributions could only be paid out in cash, I just found out from a comment on the that it is possible to have distributions from iUnits ETFs re-invested through a DRIP:

Dividend reinvestment plans let you take advantage of the power of compounding. Instead of receiving cash dividends from the company, you may purchase more of a company’s stock by having the dividends reinvested. Your brokerage firm may offer a dividend reinvestment plan that allows for the reinvestment of cash distributions on iUnits. Cash distributions, in the form of income, return of capital or dividends could then be reinvested in additional units of the same fund. You should check with your brokerage firm to see whether you will be charged for this service.

iUnits (Barclays) lists four companies which offer DRIPs for iUnits, three of which are Canadian big-bank brokerage affiliates. The one that wasn’t, Canadian ShareOwner Investments Inc. states “to enjoy complete dividend reinvestment and the lowest trading commissions in Canada, your iUnits need to be in an account at ShareOwner.”

The website goes on to say that “as demand increases, more firms will likely have DRIPS available on iUnits.”

I still can not see a huge advantage to DRIPs, except that using them would reduce the cash-drag in an investor’s account ever so slightly. I recently talked to my advisor about cash distributions the ETF I will be buying soon and our plan will be just to roll the cash into my regular monthly purchases within my RRSP.

ETFs vs. Index Mutual Funds

I found an informative Comparison of ETFs and Index Mutual Funds. It has some great information about the internals of ETFs and how they compare to index mutual funds. Notably, that “overall, there are few pros and many cons to using ETFs.” This came as a bit of a surprise to me. Much of what the article says is true, although told in a way that is biased towards index mutual funds. Some of the information is out of date such as: “ETFs have poor coverage of foreign style/size indexes. If you wanted to buy a foreign value ETF, for example, you would not be able to do so at present” and “there are few bond ETF options available at present.” I think these two points are no longer true.

One big difference between ETFs and mutual funds is that “they [ETFs] pay out distributions as cash. If you want to then reinvest that cash, you need to take some action to do so (and incur whatever transaction costs apply).” Although I initially found this annoying, it is really no big deal because the distributions can easily be re-invested into no-load mutual funds on a monthly basis along with other cash. Since you SHOULD be dollar-cost averaging on at least a monthly basis this should not be a problem for most people.

With many low-MER index mutual funds out there (and I expect to see even more, with possibly even lower MERs), the low-MER advantage of ETF is not a huge deal. I still think that the best option is to buy index mutual funds (with as low an MER as possible) on a monthly basis and switch them into index ETFs when the cost of making the ETF purchase (from commissions) becomes a small percentage of the total amount to be invested.

Google shares reach $400, still a good value?

Today, Google’s shares reached $400. It seems unlikely that any true value investor would consider Google (GOOG) to be a good “value.” Renowned fund manager Bill Miller seem to think it is. His Value Trust fund (a fund that I am considered for my US portfolio) has a good portion (4.3%) of it’s assets invested in Google. Bill Miller “follows a value discipline in selecting securities” according to Value Trust fund’s Investment Strategies statement.

Just for fun, I wanted to see if Google meets any of Graham’s basic criteria for defensive investors (or rather, how badly it fails):

  • Google’s price/book ratio from the most-recent quarter is 12.64. Graham probably wouldn’t touch Google unless it’s P/B Ratio was less than 1.5, meaning Google would have to trade in the $50 range.
  • Google does have a positive book value, which Graham considered a must.
  • Google’s current ratio from the most recent quarter is 15. Graham looked for a current ratio of at least 2.
  • Google’s growth rate has been phenomenal. About 400% from 2003 to 2004, and on pace to grow earnings about 350-400% in 2005. Graham looked for earnings growth of 33% over 10 years. Google hasn’t even been around for 10 years yet and Graham would probably classify it as a “new issue” and would stay clear of it.
  • Google has never paid a dividend. Graham looked for stocks with uninterrupted dividends over 20 years.
  • Google has not made money in each of the last 10 years. Graham liked businesses which had some earnings in each of the past 10 years. Since Google was a start-up not too long ago, there was a time within the last 10 years when it did not make money. Basically Google fails this test because it is just too new.
  • Google’s revenue was $3 billion in 2004, on pace for more than that in 2005. Graham recommends investments with annual revenue of more than $500 million (in today’s dollars).
  • GOOG’s valuation is now $119 billion. This meets Graham’s criteria of being a large-cap stock. Although if Google were valued at its book value of $9 billion it doesn’t look so big.
  • P/E ratio on trailing 12-month earnings is about 89. This is well above Graham’s recommended 15.

Google fails several of these basic criteria by such a huge margin that it makes me feel good about not owning Google, and somewhat worried about buying Bill Miller’s Fund. Apparently, in retrospect, Google’s IPO price of around $100 was a good value, and so was $200 3 months later. And it was still a good value earlier this year when it traded at $300. Google has certainly paid off for Bill Miller who apparently bought it at $85. I’m just not sure if he’s skilled or lucky. Some of his other tech stocks have not fared as well, such as Amazon and eBay, both among his top 10 holdings, and he is at risk of ending his 15 year beat-the-S&P500 streak. Miller’s Value Trust fund has only gained 1.82% this year so far, compared to 3.06% for the S&P 500.

Out of curiosity, I checked ABC Funds American Value Fund, a true value fund (no tech stocks here), and is up 6.34% year-to-date as of October 31, 2005. I am a bit more comfortable with ABC Funds’ true value investing approach, but the minimum required investment is just too high for me right now.

ABC Funds

I think I’ve found my dream mutual fund company: ABC Funds. From the introduction:

The most distinguishing characteristic of the ABC Funds is our firm adherence to true value investing. The funds use a “bottom up,” Graham and Dodd style in selecting securities. This style commands thorough, proprietary research on fundamentally undervalued Canadian and American securities and strong investor discipline. All three ABC Funds use this investment approach.

Before you go on and read about it, you should know that they require a minimum initial investment of $150,000 per fund (I assume that’s CAD). The MER is 2% on all their funds and they seem to have an excellent track record at beating the indexes. Some years they do worse than the indexes, but that shouldn’t worry the long-term investor.

Do not shy away from clicking on the “client area” link on the main page. It looks like everything there is publicly accessible.

It seems easy to find good active value management in Canada if you have lots of money. Another company that comes to mind is Strategic Advisors Corp (affiliated with Ross Healy).

Owning Too Many Mutual Funds a Bad Idea

I used to own many mutual funds in my account at TD Canada Trust. A glance at an old statement shows that at one time, I owned the following funds in the Canadian portion of my portfolio:

TD Canadian Equity Fund
TD Canadian Index Fund
TD Dividend Growth Fund
TD Blue Chip Equity Fund
TD Canadian Small Cap Equity

What is wrong with being invested in so many funds at once? The problem is that with 4 funds, primarily large-cap funds, I was over-diversifying and basically forming an index for myself. I was owning the entire market, which is what indexes do anyways, and diluting the active management within each of the funds. But I was not paying what I should have been paying for an index (MER <= 0.25%). These funds have MERs of at least 2%, except for the index fund. So basically I was buying the equivalent of an index, but paying through the nose for it. The effect of a high MER eating into your returns every year can be huge. Don't make the same mistake I made. Get an index for the large-caps, and no more than one other large cap fund. Perhaps owning an actively-managed small-cap fund as well. If I had to do it again at TD, I would have bought TD Canadian Index Fund and TD Canadian Small Cap Equity. The other large-cap funds (TD Canadian Equity, TD Canadian Dividend, and TD Blue Chip Equity) are not significantly better than the indexes themselves, so I would rather take the low-cost index fund. The small-cap fund gives me some exposure to smaller companies which are not owned by the index.

Selling ETFs to buy index funds a bad idea

A friend recently asked me:

I’m just about to switch my ETF‘s to mutual index funds so I can contribute monthly without the transaction fees associated with ETF’s. I found a few funds from Altamira that have MER fees of 0.54. That seems pretty good to me…not quite as good as the 0.17% that you get for the iShares S&P TSX 60 ETF’s, but I think the ability to automatically contribute monthly makes up for the additional 0.36% in MER fees.

They wanted my opinion on this before they went ahead and did it. My reply was:

I wouldn’t switch if I were you because you’ll pay commission on the sale. If you are already invested in an ETF I would just hold it and let it grow. . . Definitely if you want to contribute monthly you should put your money into a mutual fund. Obviously no one would recommend buying ETFs monthly with the kind of monthly amounts you’re probably putting in, so really you have no choice. Just don’t sell the ETFs you already own.

The only reason I could see for you wanting to sell your ETF is if the mutual funds you are interested in required some sort of initial minimum. That would have surprised me though, because all of TD‘s funds for example, only require a minimum RSP investment of $100, and minimum subsequent investment of $100.

Basically if you are putting in small amounts per month, use mutual funds, that’s what they are for, if you have large amounts, get stocks or ETF indexes. When the amounts in mutual funds are large enough, it might make sense to transfer them into an ETF. But it’s up to the individual, especially if the difference in MER is so small, you might as well just leave it in mutual funds.

The MER on those mutual funds are really low which is great, so I would say buy them every month, but just don’t sell the ETFs you already own.