In the mutual fund industry there is nothing new under the sun -- there's only a repeat of the history you're unfamiliar with. That truism comes to mind whenever you check in on the performance of Fairholme fund (FAIRX).
Prior to this year, the fund had long been one of the mutual fund industry's darlings. In the ten years ended 2009 the fund earned an average annual return of 13.2 percent, outperforming the S&P 500 by a stunning 14 percentage points. That performance prompted Morningstar to name Fairholme manager Bruce Berkowitz their domestic stock manager of the decade.
It also attracted the attention of fund investors, who poured cash into the fund. In 2002 the fund had but $49 million in assets. Three years later that figure stood at $1.6 billion. By 2010 assets peaked at nearly $19 billion.
Unfortunately, the vast majority of that money came just in time to partake not in the sort of stellar performance that attracted them, but in a fall from grace that must have most of the fund's investors questioning their judgement.
Through October of this year, the fund has lost more than 23 percent, trailing the S&P 500 by nearly 25 percentage points. Fairholme, which had consistently ranked in the top 25 percent -- if not the top 10 percent -- of its peers, now ranks in the bottom 1 percent for the past year, and the bottom 20 percent for the past three years.
That pattern -- in which assets pour in just in time to catch a decline -- is reflected in the fact that over the past three years, Morningstar reports that the return earned by the average Fairholme investor trails the return earned by the fund itself by more than two percentage points: 7.2 percent for the fund vs. 5 percent for the investors.
The remarkable reversal in fortune has generated a good deal of attention, with no lack of experts weighing in on whether Fairholme investors should throw in the towel or whether they should keep the faith.
What's little noted, as I alluded to earlier, is that this sort of pattern is anything but unusual in the mutual fund industry. In fact, history is rife with similar tales.
Legg Mason's Bill Miller was, until recently, regarded as an investing genius thanks to his 15 year streak of outperforming the S&P 500. He was profiled in countless newspaper and magazine articles, whose readers loved learning about his quirky investment style. For example, he regarded Amazon.com as a value stock.
Miller's streak ended abruptly in 2006 and his magic touch seems to have vanished. His fund, Legg Mason Capital Management Value (LMVTX), has trailed the S&P 500 by nearly 10 percentage points over the past five years, and 0.8 percent over the past 15 years. Miller finally threw in the towel, announcing last month that he would step down as lead manager of the fund in April.
The tech bubble of the early 2000s provided an embarrassment of such examples. Nearly every Janus fund zoomed to unbelievable heights as the bubble inflated, only to crash to earth after it popped. Ryan Jacobs, Kevin Landis, Garret Van Wagoner -- there's a seemingly endless list of managers who were presumed superstars but later turned out to be much lesser lights, their skills deserting them just as their funds peaked in popularity.
Go back even farther to the 1960s and we have Gerald Tsai, who was so popular that he was featured in The New Yorker magazine. His golden touch turned to dross and he eventually left the industry entirely.
These, of course, are just a handful of some of the industry's more spectacular flameouts -- stumbles by those who were thought to have demonstrated sufficient skill to tiptoe their way through whatever the market could throw at them. There are also the innumerable managers whose lucky streaks didn't last quite as long but whose ultimate failures left many fund shareholders frozen at the wheel.
Will Berkowitz and Fairholme buck the trend? Will the market eventually come back to Berkowitz, and prove his bets on the financial sector prescient, restoring both his reputation and his investors' accounts? Perhaps. But if history is any guide -- and it tends to be a fine one -- the odds on the story unfolding that way are on the long side.
Fairholme's struggles, and the pattern it seems to be following, underscore an important if often overlooked risk of active management. The list of managers and funds who were able to mount a multi-decade period of outperformance is, well, essentially non-existent. If you decide to cast your lot with active management, you're yoking yourself to years worth of the sorts of decisions that Fairholme's investors are facing now. Is this the end of the run or a mere blip? Should I sell or hang on? If I'm hanging on, for how much longer?
I don't know about you, but I find investing difficult enough without facing a constant stream of such questions and second-guessing.