Give These Volatile Funds a Chance
One of the biggest mistakes you can make in investing is to bail out of a fund at the wrong time. The story is usually the same: You buy a fund that looks promising, performance sours, and you wait for its fortunes to turn. Exasperated, you finally pull the plug -- only to watch the fund take off.
Investors are especially prone to this sort of error when dealing with the most-volatile funds. It's difficult for even the hardiest investors to stay in the saddle of these bucking broncos. That's why many are better off avoiding such funds altogether.
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Bridgeway Aggressive Investors 2 (symbol BRAIX) and CGM Focus (CGMFX) are two funds that have thrown a lot of investors during the past year. Aggressive Investors 2 is about 50% more volatile than Standard & Poor's 500-stock index, and CGM Focus, a member of the Kiplinger 25, is nearly twice as volatile as the index. Those numbers tell you to expect the worst when trouble hits.
But I think this is the worst of times to sell either of these two funds -- and probably the best of times to hop aboard. Both funds were on my list of The Best Funds for 2009, and I still like them a lot (the other three on the list have excelled). Whether the market continues to climb or drifts sideways, both funds should be superb performers. Barring some unforeseen catastrophe, I don't believe the market will collapse again anytime soon.
Both the Bridgeway and CGM funds suffered gut-wrenching losses during the bear market. From October 9, 2007, through March 9, 2009, the S&P 500 tumbled 55%. But Aggressive Investors plunged 63%, and CGM Focus plummeted 58%, according to Morningstar.
To add insult to injury, both funds have lagged during the stock market's powerful rebound. CGM Focus gained 25% from March 10 through July 30 -- 13 percentage points less than the S&P 500. Aggressive Investors returned 32% over the same period, or six percentage points behind the index. The gains of both funds are disappointing considering what they cost investors on the way down.
Great long-term records
At times like this, it's crucial to keep the long term in mind. Over the past five and ten years, CGM Focus remains among the top 1% of large-company growth funds. Over the past ten years through July 30, it returned an annualized 17% -- an average of 19 percentage points more per year than the S&P. And CGM Focus manager Ken Heebner returned an annualized 17% running CGM Capital Development from 1976 through mid 2008, when it was folded into CGM Focus. That was an average of five percentage points a year better than the S&P.
Aggressive Investors 2 gained only 1% annualized over the past five years. But that's still one percentage point per year better than the S&P. But near-clone Bridgeway Aggressive Investors 1, which has been around longer and is closed to new investors, returned 7% over the past ten years -- 8 points per year better than the index.
John Montgomery, who steers the Houston-based Bridgeway funds, is nothing if not contrite. "Disappointed is not a strong-enough word," he says. "This is the first time we've underperformed in a down year. That's the thing I hate."
Montgomery, 53, says Aggressive Investors 2 was whipsawed. Last year, the fund loaded up on stocks of commodity companies, which had healthy earnings and balance sheets, only to watch them collapse as oil prices tumbled from $147 a barrel to $30. Then Montgomery and his colleagues bought a wad of health-care and other steady-Eddie consumer stocks, which trailed as the market rebounded.
Montgomery runs a so-called quant shop -- that is, he and his colleagues write sophisticated computer programs that sort through acres of market data in an effort to buy winning stocks and sell losers. The computer models look at fundamentals -- earnings, cash flow, earnings momentum, balance sheets -- things that Montgomery says normally drive stock prices.
Last year, the models trailed reality. Commodity stocks sold off before oil prices tumbled. This year, Montgomery says, "The companies that are the trashiest have gone up the most. That can't continue forever." He's talking largely about financial stocks and weakened companies that sell big-ticket items to consumers -- purchases that can be put off. Studies by other firms support Montgomery's conclusion.
Ken Heebner, 68, the fabled CGM manager, isn't talking, as is often the case when his fund is on the skids. Such bad patches are inevitable given Heebner's aggressive style. He generally concentrates Focus's assets in two or three sectors -- and 20 or so individual stocks. Usually it works, but every so often the fund does a spectacular belly flop. Given Heebner's rapid trading and occasional shorting (bets that stocks will decline), I think of the fund as a hedge fund in mutual fund's clothing.
Just as with Aggressive Investors 2, commodities crippled CGM Focus's performance last year. Then Heebner waded into financial stocks too early. In recent months, he has focused on consumer stocks, financials and health-care stocks -- and the fund has rebounded smartly.
Neither of these funds should be at the heart of your portfolio. They're simply too risky for that. But putting 10% of your stock money in one or both of these funds, I believe, will boost performance over the long term. The trick is to be patient enough to hold on during the inevitable dry spells.
Steven T. Goldberg (bio) is an investment adviser.