Key advice emerges when investment pros get together

Your Funds

July 11, 2006|By CHARLES JAFFE | CHARLES JAFFE,MARKETWATCH

Few individual investors go to the annual Morningstar Investment Conference. The audience is mostly financial advisers and money management pros, experts who in many cases are worried more about the latest trend than about the basics that make for investment success.

But if an average investor went to Chicago last week and listened carefully, he would have come away with five big lessons that seemed to come up in session after session. Since my job is to make that trip on your behalf, here are the most common points in my notes on the event.

Beware the attraction of short-term bets when you are looking for long-term outcomes.

There have been countless studies of fund investor behavior showing that typical consumers don't do as well as the funds they buy. The discrepancy is caused mostly by losing confidence in a fund and jumping around, constantly trying to make headway with whatever is hot today.

Michael Mauboussin, chief investment strategist for Baltimore's Legg Mason, compared it with the grocery checkout lines or changing lanes in the highway, always searching for what appears to be the fastest route to your destination.

"Very rarely does changing lanes get you there significantly faster," Mauboussin said during his keynote address, "but there are risks involved in making the change and you can wind up further behind - or worse - if you make the change at the wrong times."

When it comes to information, "availability bias" is a problem.

Morningstar is in the investment research business and has made its name helping investors see through the skin of securities - first mutual funds and then stocks and exchange-traded funds. Where old-time investors had to rely a lot more on blind faith, today's investors have tools - like Morningstar ratings, regular performance updates and much more - that they depend on.

But several speakers noted that investors tend to have a problem with "availability bias," where they confuse access to information with relevance. Think of it like the trial of the Knave of Hearts in Alice in Wonderland, where every bit discussed in court is decreed "very important!" although most of it is meaningless.

Investors frequently ascribe significance to short-term performance numbers, or watch the flow of money into various asset classes, thinking they say something important about long-term trends; frequently, this is how people wind up missing out on gains and buying into declines.

About half of all funds available today deserve to die.

No one actually says this on the podium at the Morningstar event, but they whisper it in the exhibit hall and in conference rooms.

The exhibit hall featured a number of companies whose best products could charitably be called mediocre, but realistically should be described as awful. Many firms created funds simply more for their ability to sell them than their capability for managing them well.

Thousands of laggards would be out of business if fund investing were a meritocracy. Since fund companies won't close these funds, it is up to investors to hold funds to a simple standard, namely that results are not disappointing over a long stretch of time.

Expect large-cap stocks to hit their stride in the next 12 months.

You can't go to an investment conference without getting some prognostications for where the market is headed, and the consensus among experts at the Morningstar event was that the big names are due for a pickup.

Large-cap stocks - particularly for value-oriented investors - are about as cheap as they have been in a long time, having lagged small-cap stocks for six to eight years (depending on which benchmarks you prefer). Stellar fund managers like Bill Nygren of the Oakmark fund or Bill Miller of Legg Mason Value Trust have been migrating toward large-cap names.

For buy-and-hold investors - as well as people who fled the bear market for the comfort of recognizable names - a boost in the large-cap arena would be good news indeed.

There's a balance between running with the herd and being so contrarian that you're wrong.

Many of the top managers at the event discussed how they like to go against popular thinking, with the basic idea being that when everyone on the deck of the ship tilts to one side, the safest place may be the other side.

But the only difference between a contrarian and a fool is that the contrarian tends to be proven right (eventually), while the fool who kept trying to beat the herd failed to even keep up with it.

In plain speak, that means that when all of the experts start loving, say, large-cap stocks, that doesn't mean it's time to bail out of everything else. Diversification allows you to participate in the best of the market, no matter which way certain asset classes are running.

Chuck Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or at Box 70, Cohasset, Mass. 02025-0070.

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