Wednesday, May 8, 2013

Memo from Broker: Stop Trading

I received a surprising email from one of the brokers that covers my company earlier this week.

Brokers, of course, earn their keep by having their customers buy and sell securities.  However, whether this make sense from investment perspective is another matter.

My broker forwarded a copy of a recent "Buttonwood" column from last week's Economist magazine which noted that recent studies would suggest a direct correlation between high trading volumes and subpar returns.

Here's an excerpt:

The academics looked at the record of 1,758 American equity mutual funds between 1995 and 2006. They estimated trading costs by looking at changes in portfolio holdings (which are revealed every quarter), checking the bid-ask spreads for the stocks concerned and making an allowance for the price impact of trades....

Higher costs would not matter if the trading decisions of the fund managers were sufficiently astute. But that is not the case. When the academics compared the returns of the funds with their estimated trading costs, the funds with the highest costs had the lowest returns. The return gap between the highest- and lowest-cost quintile was 1.78 percentage points a year.

http://www.economist.com/news/finance-and-economics/21576683-fund-managers-trade-too-much-retail-investors-can-learn-not-dont-just-do?frsc=dg|a&fsrc=scn%2Ftw_app_ipad

The article goes on to note that managers seem to trade much more frequently than in prior periods.

In the 1950's, for example, the average fund turnover was 15%.  By 2011, however, the typical fund manager turned his portfolio holdings over by +100%.

Buttonwood puzzles as to why mutual fund trading seems to have increased in light of the evidence that it does little to improve returns.

In my experience, I would suggest that clients often confuse active management with active trading.

Walk into a client meeting with no transactions for the prior quarter will often raise questions, even if relative performance has been strong.  Somehow there is always the gnawing sense that the manager has been asleep at the switch if positions haven't been jumbled up.

The great growth stock investor Phillip Fisher used to say that his favorite holding period for a stock position was "forever".  His philosophy - which was laid out in his seminal investment volume Common Stocks and Uncommon Profits (pictured above) - was influential to many, including a fellow named Warren Buffett.

Fisher's philosophy of buying quality stocks that the investor had thoroughly researched and followed seems quaint today, but Fisher compiled an admirable investment record in his day.

However, I worry about a broker who sends her clients an article suggesting they stop trading - is she trying to tell us something?