We were 'had' by fund bibles of the '90s

A decade ago, there were at least five or six mutual fund-ranking books released and updated annually. These books were promoted as being "comprehensive, rigorous and authoritative." This illustrates a key characteristic of human nature: People want things to be true so badly they convince themselves perhaps this time the snake oil salesman is on to something.

It seemed no one could get enough information about what mutual funds were, how they worked and how to build portfolios using them.

Looking back, the telltale signs were there all along. If the research was so rigorous, then why were there so many different books purporting to do the same thing? Why did most disagree on what were the best funds? And, if the books were so committed to a long-term perspective, why did so many of them recommend different funds from one year to the next?

The authors weren't selling investment information, they were selling books -- lots of them. We were had, my friends. I want to stress that I use the word "we" because I bought into the guru-de-jour ethos of fund picking for a few years myself.

The great thing about these books, of course, is their disposability. Why would any consumer bother to check the long-term track record of a book from, say 1995, to see how the recommended funds actually performed?

I took one of the prominent books from that year (with rankings based on June 30, 1994, results) to see how the 10-year numbers stacked up as of June 30, 2004. The results were less than pretty. Near the front of the book the authors wrote "we believe that good managers (and good funds) can be identified..." but by the end, they conceded "...research puts the contribution of security selection -- that is, choice of specific investments -- at only 2%."

Advisors are supposed to help clients focus on what is important, and so should have caught on to this logic, because stock and fund picking clearly are not that important.

Now to the results. The book identified 81 funds as being "recommended." One would think that over a reasonably long period of time, if superior funds could be reliably identified, at least half would generate returns in excess of their benchmark.

Before reading on, guess how many of the 81 funds listed actually had returns that outperformed during the decade?

Thirty-two of them no longer exist. If performance were a race, these funds would all receive a big, fat DNF for did not finish. Poor performance is usually the reason funds shut down or merge. Only 15 of the 81 funds "outperformed." Most of the funds recommended stated it was their mandate to offer "superior returns relative to the benchmark," or words to that effect, in their prospectuses. They clearly could not deliver on their expectations. Fewer than 20% of the funds recommended did what they set out to do.

Most people who bought products tracking the benchmarks did better than they would have with the recommended funds.

I would run tests on the recommendations in other books, but I can't find copies anywhere. If you have old fund-rating books, please send them to me for analysis. It seems we are all up against a case of built-in obsolescence.