Beyond Greed and Fear by Hersh Shefrin

Author:Hersh Shefrin [Shefrin, Hersh]
Language: eng
Format: epub, pdf
ISBN: 0195161211
Publisher: Oxford University Press
Published: 1999-09-15T00:00:00+00:00

In putting their 1997 performances in the best light, many money managers will compare their funds with other mutual funds. That’s what Fidelity loves to do. “Your fund beat the average growth fund tracked by Lipper,” is how many annual reports will begin. This comparison holds dubious value because it measures a fund against mediocre competition.

It’s like a.260 hitter calling himself a star because he plays on a last-place team. The true comparison for the vast majority of funds should be the S&P 500.15

Another game is masking the risk—another concern that Gasparino mentions in his article about the SEC’s Levitt. There are different versions of this game. One involves including derivatives in the portfolio that affect the risk in ways investors do not understand. Another concerns the behavior of some managers halfway through the year. At this point, there will be some managers who find that their funds are underperforming relative to their benchmarks. What should they do? Remember chapters 3 and 9, which discussed how people behave when they perceive themselves in “loss territory”? These managers increase their risk exposure, hoping to at least break even. Keith Brown, Van Harlow, and Laura Starks (1996) report that fund managers finding themselves in the middle of their comparison group by midyear increase the risk of their fund’s portfolio during the second half of the year.

The final game, called come out with all guns blazing, involves managers of new funds. New funds tend to have riskier portfolios. Those that do well, thereby garnering attention, tend to reduce their risk exposure after becoming established. Consider the Technology Value Fund run by Firsthand Funds in San Jose, California. This fund concentrates in technology stocks; it is the only fund based in Silicon Valley, where most of the companies in which it invests are also located.

Firsthand Funds used to be called Interactive Investments. It was started in 1994 with very little money and produced very impressive returns in its first two years—61 percent in both 1995 and 1996. Investor’s Business Daily gave Technology Value a grade of A+, based on its cumulative three-year return of 216 percent, the highest for all funds.

The fund became available to the public in December 1994. One year later, it had $900,000 under management. In December 1996, this amount had grown tenfold to $9 million. By December 1997, the amount of assets under management was $195 million. Now what were we saying about whether investors base their decisions on past performance?

In mid-June 1997, Technology Value received a five-star rating from Morningstar, Inc. But the rating was ambivalent because Technology Value concentrates its holdings in just a few high-technology stocks, and this makes it more risky than even a sector fund. The following quotation, which appeared in a June 13, 1997, Wall Street Journal article, captures the ambivalence: “High risk accompanies Technology Value fund’s hot performance. ‘I don’t see why people should take a chance on them,’ says Russ Kinnel, head of equity-fund research at Morningstar. ‘If you buy a hot fund with high expenses with a high-risk approach, don’t be surprised when you get burned,’ Mr.

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