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Another top mutual fund loses its touch

(MoneyWatch) COMMENTARY Ken Heebner's CGM Focus Fund (CGMFX) was the number one performer among diversified U.S. stock mutual funds in the decade ending in 2007, seemingly making him royalty among fund managers. In June 2006, Fortune writer Jon Birger cited Heebner's "amazing history of making big winning bets on stocks and sectors," adding "there's no question Heebner is one of the all-time greats." His performance was so good that William Danoff, manager of the Fidelity's Contrafund (FCNTX), told Kiplinger's Personal Finance: "I want to be more like Ken Heebner -- he's my hero."

Naturally, investors piled into CGMFX. How were they rewarded? CGMFX's performance since 2007 has earned it a one-star rating from Morningstar. The table below presents the results. The 2012 data is through June 30.

In terms of performance relative to its peers, Morningstar placed CGMFX in the 96th, 99th, 35th, 100th, and 99th percentiles, respectively. For four of the past five years, the fund has been in the bottom 5 percent of all funds. That's hard to do. Very few funds produce such persistently poor results. Over the full period, it trailed 96 percent of mutual funds. While $100 invested in the S&P 500 at the end of 2007 would have been worth $102.55, $100 in CGMFX would have been worth just $54.59.

Predictably, investors have fled the fund. Morningstar estimates that CGMFX lost a net $2.6 billion to redemptions since the end of 2008. The fund now has assets of about $1.5 billion. Thus, even if Heebner's performance turns around, most investors won't be there to benefit.

How should investors interpret this outcome? Here are two possible explanations:

  • Heebner's pre-2008 outperformance was lucky, and his post 2007 performance was unlucky.
  • Heebner was a genius who took a "stupid pill" on Jan. 1, 2008.

Which seems more likely to you?

Benjamin Franklin said that the definition of insanity is doing the same thing over and over and expecting different results. Many investors keep using past performance to pick mutual funds. Almost inevitably, their choices underperform benchmarks. They then fire the underperformers and the search begins again, using exactly the same process. They rarely stop and think: "If the process is the same why am I expecting a different outcome?"

You don't have to do that. If you recognize yourself repeating this pattern you should do what all smart people do when they learn that they have made a mistake -- they change their behavior. It's better late than never to join the indexing/passive investing revolution.

Image courtesy of Flickr user 401(K) 2012.

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