Tortoise 1, Hare 0

Written by John Osbon on October 12, 2011

When the legendary “bond king” Bill Gross completely abandoned treasury bonds in his Pimco Total Return Fund earlier this year, he was applying decades of bond market experience and knowledge.

Unfortunately, he guessed completely wrong on the health of the economy and price of US debt. Which is why his fund is trailing a low-cost, low-profile Vanguard index by an embarrassing margin.

This Bloomberg article “Gross Trails Index Fund, Misses Treasuries Rally” describes how the Total Return Fund, the world’s biggest mutual fund, has returned 1.4 percent this year (through October 4), versus 8.9 percent for the Vanguard Intermediate Term Bond Fund.

Grossly underperforming

Gross isn’t alone in trailing the Vanguard fund, which tracks – rather than trying to beat – the performance of Barclays Capital U.S. Aggregate Bond Index. Year to date, the Vanguard fund has outperformed 99 percent of intermediate bond funds tracked by Morningstar.  Yes, 99 percent.

Perhaps this helps to dispel the notion that index investments produce only “average” returns. Index funds, both for stocks and bonds, frequently beat their actively managed counterparts. Indexes typically have two big advantages. First, lower management, research and transaction costs, and second, no egregious misses caused by guessing wrong.

Guessing wrong for all the right reasons

Gross guessed wrong. As he describes, it was a “mistake to bet so heavily against the price of U.S. government debt.” A good choice of words in calling it a “bet,” I’d say. As in gambling with billions of dollars of other people’s money.

Gross is certainly the most famous name at the bottom of the performance list this year. Bill Miller understands that feeling. For 15 years in a row, Miller, manager of Legg Mason’s Capital Management Value Trust, beat the S&P 500, even after fees. That unbelievable streak ended in 2005.

Since then the fund has, in a word, bombed.  According to a MoneyWatch article in 2010, Miller has “trailed the S&P 500 by more than 9 percent annually over the past five years, and by 2.6 percent annually over the past decade, which places his fund in the 99th and 94th percentile of all of its peers for the respective periods.”

The 15-year winning streak, perhaps the most impressive track record in modern investing, surely attracted many investors to Miller’s fund in 2005. What a price they have paid since.

Hares are human too

Miller and Gross are well known hares who earned their reputations by winning. But it turns out hares can be human too, and when they make mistakes, even unremarkable tortoises can leave them in the dust.

I know many investors will be attracted to the next generation of star managers, but I urge caution. Because no matter how much experience they have, backed by limitless knowledge and expensive research, they can still guess wrong on a stock, a sector, or the whole economy.

Call me crazy, but I just don’t think guessing is a sound investment strategy.


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