Morningstar: Go-Anywhere Funds Beat The Market Heat

In a recent article, Morningstar writer Wenli Tan notes that many go-anywhere funds have for the most part side-stepped recent turmoil and evaded serious losses. Some of this success can be attributed to these funds’ ability to short stocks (a profitable move during a bear market), but I believe most of it can be attributed to the fact that these managers have such wide leeway in investing their fundholders’ money. For instance, in the current bear market, it’s financial stocks and homebuilders who’ve experienced the biggest declines while natural-resource and commodity-based stocks have soared.

In retrospect, the combination of easy credit and lax lending standards made the sub-prime crisis and thus the decline in financial stocks inevitable. Similarly, that same loose monetary policy is in large part responsible for the recent commodities boom (rapidly rising global demand is also responsible). Imagine yourself the manager of a large-cap value fund throughout all this. What choice do you have but to continue to hold high-yielding financial stocks and large-cap blue chips like General Electric (GE)? Mining stocks rarely meet the size or valuation requirements to meet the strict large-cap value mandates and one can only own so many oil stocks all at once. As I stated my my post on picking a winning mutual fund, actively-managed funds with narrow mandates have little to no chance of beating the broad market over long periods of time because they lack the flexibility to get in and out of promising sectors of the market. In short, you are doomed to look bad when your sector is out of favor. No amount of skill will help you avoid this.

Now imagine yourself the manager of a free-roaming go-anywhere fund. With no strict mandate to hold you back, you could have sold financials and bought miners when it became obvious the financial system was faltering and inflation picking up. Of course, this is easier said than done and one of my favorite go-anywhere funds, Third Avenue Value (TAVFX), has declined substantially more than the overall market this year.

I’m not telling you to go out and put all your money in a go-anywhere fund. Quite to the contrary, I advocate constructing a broadly-diversified, intelligently-allocated portfolio based on the principles of modern portfolio theory. The moral of the story is simply not to put all your eggs in one basket and thus back yourself into a corner. If you own all asset classes, chances are at least one or two of them will be performing well even if the rest are in the dumps. Recent market conditions only serve to reinforce this principle.