BlastInvest
Blast Investor Real-time Plus           by Henry Lu

2007 Mid-year Portfolio Review



2007 1st Half Year Performance Comparison

Oakmark Select Fund (OAKLX) is $6 billion size mutual fund that is also based on focused style of value investing strategy.  Oakmark fund manager Bill Nygren is a famous fund manager so that we picked his fund for comparison.  Although Blast Investor Real-time Plus (BIRTP) newsletter does not directly compete with Oakmark Select Fund, the comparison is still relevant in that probably many BIRTP subscribers are investing into BIRTP model portfolio passively,  and alternatively subscribers can also invest the same cash into OAKLX fund (or any other mutual fund). 

Table 1 shows the 2007 1st half year performance of BIRTP model portfolio verses Oakmark Select Fund and S&P500 index.

Table 1 performance comparison
performance
 04
 05
 06
 07 (1st Half)
 3.5 year average
S&P 500
 8.78%
 3.00%
 13.62%
 6.00%
 8.94%
Oakmark Select Fund I (OAKLX)
 9.73%
 4.84%
 13.60%
 7.83%
 10.30%
BIRTP Model Portfolio
 59.53%
 30.42%
 -2.65%
 24.70
 30.31%


Return Comparison


From table 1 we can find that in 2006, BIRTP model portfolio trailed either S&P 500 index or  OAKLX significantly. However, for the first half of 2007, BIRTP beat both S&P500 and OAKLX significantly.  Most remarkably, on the last 3.5 years average annual return comparison, OAKLX performance only beat S&P500 index by less than 2% per year while BIRTP performance beat S&P500 index by 21%.

In conclusion, for the last 3.5 years, BIRTP model portfolio performance beat both S&P500 index and Oakmark Select Fund I by wide margin.  For any subscriber following the BIRTP model portfolio passively for last 3.5 years, the investment results should be quite satisfactory.

Absolute Return verses Relative Return


It is quite popular in mutual fund world that fund managers design many ways to mimic the returns of S&P500 index and try to beat S&P500 index every year.  This is typically called "relative return", or a return relative to S&P500 index step by step.  If we carefully study table 1, we can find that OAKLX' performance was very close to S&P500 index for all 4 calendar years. In 04, 05, and 07  3 calendar years,  OAKLX beat S&P500 by a tiny margin while in 06 OAKLX performance almost tied with S&P500 index.  From the point of relative return, OAKLX is doing quite well.  We do not know whether the close performance between OAKLX and S&P500 for last 4 calendar years was coincident or not. One thing is for sure that huge amount of mutual funds managers have peer pressure and pressure on relative return in short time frame (typically a year or less). 

On the other hand, BIRTP has no interest on relative return concept and we do not have goal of relative return.  When we pick stocks, we only care about absolute returns over next several years with no concern on short term performance.   Our goal on model portfolio is to achieve as big return as possible for next 3 to 5  years without any concern of single year underperformance relative to S&P500 index.  The absolute return goal is adopted widely in hedge fund world, but not quite common in mutual fund world.  Therefore, from the point of operation goal on return, BIRTP model portfolio stock picking operation runs more like a hedge fund rather than a mutual fund.

Why Relative Return is Good for Mutual Funds, but Bad for Long Term Investors?


Mutual fund charges fees based on % of capital, not the performance.  For fund managers and mutual fund management company, the goal of mutual fund business is to attract as much investment dollar as possible from retail investors. Unfortunately by our observation, many or even most of retail investors chase short term performance. Whenever a fund under-performs S&P500 index for a year or 2, investor's capital will leave quickly and make the mutual fund business undesirable. In that sense, in order to attract large amount of stable dollar, in order to prevent investors leaving quickly, relative return or beating S&P500 index becomes much more important for mutual fund companies. The pressure on relative return is real pressure for most mutual fund managers in that fund managers are likely to be fired if they do not perform on this measure.  Pursuing relative return in mutual fund world also got a boost by constant media exposure. For example, in the past, financial newspapers and magazines touted Legg Mason Value Trust as No. 1 rated mutual fund because it used to beat S&P 500 index every year for quite long, a decade or more.

On the other hand, in our opinion, pursuing relative performance is not necessarily good for long term investors. Ultimately, for long term oriented investors who can stick with a fund for several years,  under-performance for 1 year is not a big deal as long as the 3 to 5 years overall return is significantly better than index. Further more, emphasizing relative return inevitably lead many mutual fund managers to focus on short term thinking only and short term mindset is the recipe for under-performance in the long run.  This short term thinking due to the pressure on relative return goal is one of reasons of massive overall under-performance for most of mutual funds.

The difference between relative return mindset verses absolute return was one reason behind the huge performance difference between BIRTP model portfolio and an average mutual fund.

10 Picks verses 100 Picks?

In the investing world, more picks or more frequent trades do not necessarily mean better investment return. In our opinion, focused style of value investing has a better odds of out-performance than a diversified portfolio with 100 value picks.

Warren Buffett argued for the concept of focused style of value investing frequently in his Berkshire Hathaway annual report. We share the similar philosophy as Buffett does on this focused style. Currently we have 9 excellent ideas as shown in BIRTP model portfolio and we don't need the No.10 idea. In fact, our philosophy is that if we can find great ideas year in and year out, we probably would not want the number of picks more than 10 in any given year.  By merely rejecting less attractive value picks, the performance can be boosted significantly.

If we would issue the next 10 stock picks outside the current 9 picks in BIRTP portfolio, our guess is that the performance on the next 10 picks will be much less impressive as the current 9 picks. Fortunately, in order to achieve high absolute return over 3 to 5 years, we do not need the next best 10 ideas.  We only need the current 9 top picks and we only need to find several top ideas per year to replace the positions in a low turnover portfolio operation.

Blast Investor Model Portfolio Update

(as of 6/30/2007)

Model Portfolio - Performance

BIRTP
 S&P 500
Portfolio inception date
 12/31/2003
 12/31/2003
Portfolio inception value
 $89,000
 1114.10
Portfolio 12/31/05 value
 $185,166.95
 1248.29
Portfolio 12/31/06 value $180,253.55
 1418.30
2004 Performance 59.53% 8.78%
2005 Performance
 30.42%
 3.00%
2006 Performance
 -2.65%
 13.62%
2007 YTD Performance
 24.70%
 6.00%
Total Return (Since Inception)
 152.6%
 34.9%