How To Pick A Quality Mutual Fund or Race Horse: More Than a Name

“In the business world, the rearview mirror is always clearer than the windshield.” -Buffett  

The summer weather is heating up, kids are out of school and people are breaking out their checkbooks and fancy hats to welcome in the tradition of the Kentucky Derby, Preakness and the Belmont Stakes, all part of the American Triple Crown. 

This year, the 142nd running of the Kentucky Derby had 20 horses running, each with unique names. In addition to the winner, Nyquist, there were many other colorful names including Mor Spirit, Danzing Candy, Gunrunner, Cherry Wine and Oscar Nominated.   

In a similar fashion, major investment companies on Wall Street are always coming up with catchy names to attract investors dollars into one of thousands of actively managed mutual funds with fancy jargon such as unconstrained, non-traditional, smart, opportunistic, dynamic, contrarian and enhanced. 

In most cases, the outcome of a race horse or a mutual fund’s performance does not always live up to its grandiose name. In fact, only 17.9% of active large-cap managers beat the S&P 500 over the 10-year period ending December 31, 2015. (SPIVA US Scorecard,12/31/15) 

“Mind Your P’s”  

Successful horse bettors go way beyond silly handicap factors and superstition when attempting to pick a winning horse. Betting on a race horse’s unique name, or on your own “lucky number” will not get you far. 

The race horse-betting veteran will methodically break down every piece of data to try to get an edge, including: the horse’s bloodline (breeding), form, class, speed, condition, trainer, jockey, the weather report, racetrack conditions and how fast the horse ran in previous races. 

At the same time, sophisticated investors and wealth managers go well beyond darts, tarot cards, intuition, water cooler talk, star-ratings or published “fund manager of the year” reports when selecting an actively managed fund.  

When evaluating a mutual fund, consider to utilize the five “P’s”: (1)Process (2) Performance (3) People (4) Parent and (5) Price. 

While a realtor’s mantra is ‘location, location, location’ a disciplined investor’s mantra should be: ‘process, process, process,’ as the most important evaluation criteria. Expenses do matter, but performance without process is just plain luck. 

Don’t just pick a race horse, stock, sector or actively managed mutual fund just because it recently outperformed over the past year, which is a case of “hindsight bias” and chasing returns. Past performance does not always indicate future results in any game. 

While you can utilize a fin-tech service such as Morningstar to quickly screen a mutual fund for many financial metrics and benchmarking comparisons, it is acutely more challenging to screen for an investment manager’s process (and philosophy). 

Investment companies provide specific guidelines and ranges for their fund managers to follow regarding various granular components such as the exposure to different countries, currencies, market caps, asset classes, sectors, industries, maturities, durations and credit quality factors along with a bevy of possible hedging tools such as futures, options and derivatives. 

An investment manager’s past behavior and track record utilizing provided parameters through different inclement market conditions can be a good indication of his or her future behavior and risk taking. A big issue we have is that many highly marketed actively managed strategies have only been around for a few years, and have not been fully tested. 

“Don’t Bet the Farm 

Sophisticated bettors and investors don’t worry about being “right” on one horse or one investment, they worry about “ROI” (return on investment) over time while managing risk. 

When race-horse betting, experienced investors put themselves in the best possible position to win by wagering on multiple horses to place, to choosing a winning horse for consecutive races which is indicated by terms like “daily double, pick 3, pick 4 or pick 6. 

For every race, each horse will have the odds of it winning next to its name in the program. Just remember, as hard as you try to beat the odds, the odds are against you. 

The favorite to win is the horse with the lowest odds. Betting the “race favorite” to win, may pay off 33.3% of the time. Sounds easy? Not really. You may not want to risk losing your money 66.7% of the time with a horse, stock or managed investment. 

This is not an argument over active and passive investing. While there is no such thing as a free lunch, the one strategy you can apply to try to improve your odds over time as an investor is through diversification across multiple asset classes and strategies according to your risk tolerance, not trying to pick individual winners. 

Smart money does not chase performance but instead looks for values, trends and opportunities from a macroeconomic perspective. The moral of this story is to consider diversification and not to “bet the farm” with your retirement savings. 

It’s highly more intelligent (and less stressful) to implement and manage a solid “all-weather” investment portfolio approach that matches your age, goals and time frame for the long run. This is the same principal as to not put all your eggs in one basket.

NOTE: For more information on our firm or to request a complementary portfolio stress-test and retirement check-up with Jon W. Ulin, CFP, please call us at (561) 210-7887.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  

All performance referenced is historical and is no guarantee of future results. The S&P 500 is an unmanaged index which cannot be invested into directly. 

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Loss of principal may occur.   

No strategy assures a profit or protects against a loss. Investing involves risks, including possible loss of principal. Investing in mutual funds involves risk, including possible loss of principal.