Does Muhlenkamp Add Value?
"Ron Muhlenkamp likes to bet against the market's conventional wisdom." So began an article and interview in the June 2011 issue of Money. Having met Ron many years ago at a convention in Boston, in which we were the protagonists in a debate on active versus passive investing, I know he's a smart man. However, as noted author Peter Bernstein stated: "The essence of investment theory is that being smart is not a sufficient condition for being rich." The markets are too efficient and the competition for alpha too tough.
The article reminded me of our debate and provided the idea to check to see how Ron's fund, The Muhlenkamp Fund (MUHLX) has performed. The fund is a large-cap value fund. According to Morningstar, the 10-year return through May was 2.6 percent. Over the same time period, the similar, but passively managed DFA US Large Cap Value Portfolio (DFLVX) fund returned 5.3 percent. In the quest for alpha, Muhlenkamp's fund had underperformed a passive alternative by 2.7 percent a year.
Some of the underperformance was because the fund returned just 6.1 percent in 2010, while DFLVX returned 20.2 percent. When Money asked about the poor performance in 2010, Muhlenkamp offered this explanation: "If this had been a normal cyclical recession, we would have been fully invested coming out of it. But we had the financial collapse, and lower interest rates did not encourage consumer spending. Then Greece hit the fan. We were cautious. And it hurt us."
What Muhlenkamp was saying was that they were wrong, only he couldn't get himself to say those words -- a pattern you see with most active managers when they're asked to explain their underperformance.
Money went on to ask Muhlenkamp his opinions on the outlook for the economy, what he looks for in a stock and what's passing his test now. My question is: Given the evidence, should you act on what he has to say?
I also checked the performance for the 15-year period ending May 2011. Here, MUHLX looks better. MUHLX's total return was 8.29 percent, essentially tying DFLVX's return of 8.30 percent. However, if you look closer, investors didn't fare so well.
MUHLX began 1996 with just $24 million in assets. Over the next nine years, the fund produced outstanding performances relative to DFLVX. MUHLX outperformed DFLVX in eight of the nine years. In 2000, the outperformance exceeded 15 percent. Muhlenkemp became a media star (which is how I ended up debating him), and assets flowed in. By the end of 2005, assets under management exceed $3 billion.
Then things changed. The fund underperformed DFLVX by 2.3 percent in 2005, by a whopping 16.1 percent in 2006 and by 7 percent in 2007. MUHLX outperformed DFLVX in both 2008 and 2009, but only by 0.4 and 1.3 percent, respectively, before underperforming by 14 percent in 2010. Through May 31, 2011, MUHLX had again underperformed by 6.1 percent versus 10.4 percent. And once again, cash flows followed returns. By the end of 2010, the fund had less than $650 million of assets under management.
Once again, we observe investors chasing returns, believing that past performance is a predictor of the future performance of actively managed funds -- despite the SEC's warning and an overwhelming body of evidence to the contrary. In an all-too-familiar pattern, the strong results of MUHLX came when the fund had a small amount of assets under management (so few investors benefited from the great results in the early years), and the weak results came when it had a large amount of assets.
You would think investors would learn to stop chasing performance. Unfortunately, in a triumph of hype, hope and marketing, the majority of investors still seek the holy grail of alpha, with all-too-predictable results.
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