For every Warren Buffet there are a hundred Charlie Steadman’s in the investing world. While nearly every investor has heard of Buffett, few remember Charlie Steadman. Is there a reason for this short memory?
“Until he died at age 83 in 1997, Charlie Steadman burned through investors’ assets at a rate unseen in the fund business since the Great Depression–and, we hope, never to be seen again. His last years running inaptly named Steadman Technology & Growth are illustrative: returns of -5% in 1992, -8% in 1993, -37% in 1994, -28% in 1995, -30% in 1996 and -28% in 1997. (The overall stock market rose in each of those years.) Just one of his four funds had a positive long-term record–and only by a hair.” So writes Steven T. Goldberg in the May 1999 issue of “Kiplinger’s Personal Financial Magazine.“
Steadman was not alone in racking up a poor performance. He just did it with style. Robert Arnott, Andrew Berkin, and Jia Ye studied mutual fund returns over two decades ending in 1998. During the twenty years covered by the analysis, the average mutual fund underperformed the S&P 500 by an amazing 2.1% per year. The 15-year deficit was 4.2 percent per annum and the 10-year deficit was 3.5% per annum. Those numbers hurt.
Step back and think for a moment. Combine the Arnott et. al. study with the Fama-French and Heartland Advisors results and the problem compounds. How? 1) The S&P 500 is made up almost entirely of large-cap stocks and we know that is not the strongest performing asset class since it is a highly efficient sector of the total market. 2) The S&P 500 is a core or blend holding that includes both value and growth stocks. Remember that the Fama-French study told us to overweight value instead of growth.
Taking all this information into account, if one builds a passive portfolio where value is over-weighted compared to growth and small-cap is over-weighted compared to large-cap or the S&P 500, one increases the probability of outperforming the S&P 500 as well as more than 80% of actively managed mutual funds in any given year. With not too much effort, we can construct a portfolio that will do better than we can do by selecting a top performing mutual fund by chance.
We think applying some momentum model will enhance a passive portfolio and that is what we are testing with several portfolios..