FORECASTS & TRENDS E-LETTER

By Gary D. Halbert

January 24, 2006

IN THIS ISSUE:

1. Barrons Top 20 Equity Mutual Funds

2. The Problems With Listing Hot Funds

3. Without The Drawdowns, What Good Is It?

4. Buying High & Selling Low

5. Big Bets On Small Cap Companies

6. The Snapshot In Time Problem

7. How We Select Mutual Funds For My Clients

Introduction

Every January, our mailboxes, inboxes and e-mail programs are bombarded with all sorts of forecasts, predictions and, of course, recommendations on how and where to invest your money. Investment magazines are loaded with their favorite picks and strategies for the New Year. Rarely, however, do these sources review their picks from last year not a pretty sight in many cases.

Most of these annual rankings and recommendations, as I have pointed out so often in the past, focus on the latest hot funds or strategies. Typically, they look at the highest performers over the last 12 months. As everyone reading this E-Letter should know, the latest hot performers can go cold just as quickly as they got hot, and the losing periods (drawdowns) among the latest hot funds are often huge.

Yet the January 9 issue of Barrons seemed to take a different approach for its New Years recommendations. The editors focused on the top 20 equity mutual funds over the last 15 years. It was their cover story and, at first glance, I thought I would be impressed. There was, of course, a table in the middle of the article which listed the top 20 funds, and most readers, Im sure, went straight to the table to see which funds had made Barrons top 20 list over the last 15 years.

Barrons list of the top 20 equity mutual funds is included in the pages that follow, but before you leap ahead, there are some problems you need to know about with these funds. I will point out the problems as we go along. The bottom line is, if you had owned Barrons top 20 mutual funds over the last 15 years, you would have had a very ROCKY ride along the way!

Keep in mind as you read on that the 15 year period Barrons considered, from 1991 to 2005, included the greatest equity bull market in history. Given that, you would expect some good returns. But as youll see, the losing periods were way beyond most investors tolerance levels. Unfortunately, Barrons failed to point that out, but as usual, I will.

After we dissect the Barrons study, I will explain to you how we go about selecting mutual funds at my firm. The bottom line is, we look for mutual funds that have a history of delivering good returns in up, down and sideways markets, with limited drawdowns along the way. Such funds are out there if you know how to find them, and Ill tell you how.

Barrons Top 20 Equity Mutual Funds

Let me begin by stating that I am a Barrons subscriber and have been for over 20 years. So, I like the weekly financial publication. As I have stated in the past, I wish I could write nearly as colorfully and animated as Alan Abelson. Barrons lead editor. Yet while I am a fan of Barrons, the January 9 cover story featuring the top 20 equity mutual funds over the last 15 years fell below my expectations in several areas.

Lets get right into it. The Barrons article touting the top 20 equity mutual funds over the last 15 years was indeed tantalizing even for me. The cover page had a huge headline that read: BETTER THAN BILL, a reference to Bill Miller who manages the Legg Mason Value Prime Fund, which has beaten the S&P 500 Index in each of the last 15 years. The cover page goes on to state: No question that Legg Masons Bill Miller is a superstar but weve found 19 funds that have done even better. I told you it was tantalizing, especially given that there are over 10,000 mutual funds out there.

I am going to include the exact list of equity mutual funds that Barrons picked below. But before you leap ahead to the table, we need to talk about a couple of key points.

First, performance reporting for investment products has become very standardized in the last decade or so for several reasons. Partly due to increased regulation, and partly due to credibility, there are certain criteria which are almost always included with the publication of a track record at least from reputable sources.

Obviously, there is the net performance, usually expressed as an average annual return. Then there is the time period over which the performance was generated (months or years). Next, you typically see something like standard deviation, a measure of how consistent the returns were. And then, you almost always see Worst Drawdown, which is typically the worst losing period during the entire performance record.

If youve been reading me for long, you know that avoiding big losses is the centerpiece of my investment philosophy. I am as focused on the losing periods as I am on the upside potential, if not more so. Why? Because it doesnt matter how much money you might make if you were scared out of the investment due to a big drawdown along the way.

This is not a typo: Because it doesnt matter how much money you might make if you were scared out of the investment due to a big drawdown along the way.

So, I was very disappointed to see that the Barrons editors chose to publish the glowing performance numbers for their top 20 equity mutual funds over the last 15 without also including the worst drawdowns for those same funds!

Without the information on the worst drawdowns, you have less than half of the story. Lots of mutual funds and other investment products have impressive upside returns, but their drawdowns can be huge. You need to know this upfront. Barrons, for whatever reason, elected to omit this critical information. But I didnt!

Heres the table included in the January 9 issue of Barrons, but with the addition of the Worst Drawdown in the far right-hand column. (For sake of space, I omitted the columns including the name of the current fund manager and when he or she started, etc.)