Andrew Hallam

Few people ever consider the effects of survivorship bias and taxes on actively managed mutual funds, but this study did.

According to a study in the Journal of Portfolio Management (26, no. 4, 2000) the average actively managed stock based mutual fund lost to the S&P 500 by 3.2% annually, after taxes, over a 20 year study, ending in 1998.

Considering that the S&P 500 index has a turnover ratio of 6.7%, it makes the index incredibly tax efficient, compared to actively managed mutual funds. …read more

Our investment club, despite being actively managed, has roughly the same, long term after tax efficiency that a S&P 500 index would have because our portfolio turnover is exceptionally low.  But instead of posting a 3.2% annual deficit to the S&P 500, we’ve given market (and especially the professionals) a thorough beating.

Although I’m cautious, our club is posting results (from June 10, 2009 to June 10, 2010) that have exceeded the S&P 500 by 4.7%.  We’ve seen a gain of 20.2% over the past 12 months, while the S&P 500 has gained 15.9%.

If I could credit our results with one thing, it would be a disciplined value approach.  We have the courage to buy great businesses on the cheap, and when they drop in value, we buy more of them.

How will we continue to do well?

We’re not accepting new investors, but for us to continue to do well, our current investors need courage and commitment.  Especially when the markets fall, they need to lump money in to the fund.

An investment club receiving funds only when the markets are growing higher is destined to be mediocre at best, and disastrous, in the worst case scenario.

What investment club psychology have I found interesting?

We’ve been operating this club for 11 years now.  And we have beaten the S&P 500 by roughly 6% annually with our stock selections (We’ve actually beaten the S&P 500 by roughly 5% annually, overall, because we lost money in a bonehead private venture a few years back).  We track all of our investments with Bivio and it does a dollar per dollar comparison between our investment club purchases and hypothetical purchases in the S&P 500.

Beating the market brings with it some interesting behaviours.  We have courageous members who have contributed during times of economic duress.  But the majority of our members become confident when we have done well.  During years when we make very high double digit returns, there’s often a flood of fresh money and confidence.  I wish it wasn’t so, but it is.  If every member could be committed to being greedy when others are fearful and fearful when others are greedy, we would do a lot better.

What were our favourite stock purchases during the financial meltdown of 2008/2009 and how has our portfolio changed?

Since publishing our holdings nearly three years ago, in the MoneySense article, How we Beat the Market, our holdings have changed very little.

We had Anheuser Busch scooped from under us when Inbev bought them out.  But we profited by roughly 60% on the shares—and the shares constituted 8% of our total portfolio.

During the downturn of 2008/2009, we bought Fastenal (FAST), lowered our cost on Simpson Manufacturing (SSD) and we bought United States Gypsum (USG).  Those building material businesses were definitely contrarian moves during a time when homebuilding supply companies were definitely out of favour.  We also bought more Berkshire Hathaway,(BRKB) more Coca Cola (KO) more Pfizer (PFE)and more of the first world international index (VEA).

Recently,  one of our investors moved to Europe and cashed out roughly $55,000, so we sold all of our Fastenal shares at roughly $50 each (we paid $32) and we sold nearly all of our USG shares at $17, after paying an average price of $11 for them.

How did I raise capital to make purchases when the market was down?

I’ll admit it.  I prostituted our investment record among my “non investment club friends” to get them excited.  Then I suggested that new investors must contribute a minimum of $10,000 for their initial deposit.  I did this in 2009.  I didn’t have fresh money in time to take advantage of fire sale prices, but I did get some reasonable deals that have proven to beat (short term, anyway) what an equal amount would have made if it was invested in the S&P 500.

What do I regret?

As much as I try, I don’t have the ability to coax large sums of money from our investment club members when stocks are cheap.  I beg, and I beg, and I beg, but I wish I was a better begger.  Those who seem wired to be greedy when others are fearful do their part to contribute.

As for the rest?  They’re just a little too “normal”.

Investors, our 12 month return, according to our Bivio portfolio tracker, has us ahead of the S&P 500 index by 4.2%.  *(using prices from market close for 05/10/2010)

We’re also ahead of the first world international index by 14.1% over the past 12 months.  Below, you can see the blue line representing the U.S. S&P 500 and the green line representing the first world international stock index.

If we can keep our advantage over the U.S. market by December 31, 2010, it will be the 8^th year in a row that we would have beaten the S&P 500.

Ironically, we could afford to lose 40% more than the S&P 500 this year, and still come out with a better 10 year track record than if we had invested in the S&P 500 instead.

I call that luck.

If you know any actively managed mutual funds that have beaten the index 8 years in a row, (May 2002 to May, 2010) let me know so we can properly salute them.

Of course, I’ll call them lucky too—at the same time.

This past January marked the 7^th year in the row that our investment club beat the S&P 500 index.

In the beginning (we began in 1999) we got crushed by the S&P 500 after a slew of tech stocks went south, but we clawed back.

Then a few years later, I spear-headed a bonehead decision to invest in a Vancouver Island based company called Instacash—which was eventually revealed as a Ponzi scheme. It cost us 12% of our total portfolio when the money “vanished”.

But despite our blunders, we’ve still been lucky enough to give the markets a good thrashing.   Nearly two years ago, I published “How We Beat the Market” in MoneySense magazine detailing our investment club’s successes and failures.

From the date we started keeping records with bivio, (October 7, 1999) we have beaten the S&P 500 by more than 5% annually—despite doing some very silly things along the way.

Over the past 12 months (March 30, 2009 to March 30, 2010) we’ve gained 53.6%, beating the S&P 500 index by 5.9%

*(using prices from market close for 03/29/2010)

We were, however, given a good beating by the Vanguard small cap index over the past 12 months:

That said, our three, five and ten year overall performances have all beaten the Vanguard small cap growth index. As an example, here are our results from March 30, 2007 to March 30, 2010.

But we could still get hammered

We’re constantly aware of our fallibility, which is why we don’t want to forget the tech collapse ten years ago, and our “Instacash” ponzi blunder.

Smarter investors than us have failed to beat the market.  Beating the S&P 500 over a handful of years isn’t a big deal at all—but beating the market over a lengthy period of time is extremely tough—requiring loads of luck.

Proponents of finding active fund managers to beat the market used to look to Bill Miller as an example.  He beat the S&P 500 fifteen years in a row and optimistic head-line drunken investors across the U.S. poured money into his fund.  But something called a “reversion to the mean” ensured that Miller was destined to eventually have a year where the S&P 500 actually beat him.  And it happened.  Not only that, but he had a few bad ones in a row, leading the S&P 500 to overtake Miller.  If you had invested with Miller from 1986 until 2009, and if your brother had invested in the S&P 500 index instead, then who do you think would have made more money?  Your brother!  … more info

And he would have beaten you by more than 1% annually after taxes—because actively managed funds aren’t as tax efficient as broad, low turnover indexes.  The after tax element is rarely discussed.  But the great fund company, Tweedy Browne, demonstrates their pre-tax and after tax returns as they compare to the returns of the S&P 500.  You can read more about Tweedy Browne and my search for an index beating American mutual fund in my post: Can Anyone Find an Index-Beating Mutual Fund? Maybe!“

But have we just been lucky?

My heart says that our market-beating performance is a blend of skill and luck—while my head suggests that luck was the primary component.  If you’re interested in our investment strategy, we’ve followed Buffett’s principles, and you can read about them in my 2003 MoneySense magazine article,, “Invest like Warren Buffett”  or in my 2005 follow-up article, “World’s Greatest Investor Tells All”

We obviously followed a disciplined approach.  But a Chinese lady at a fortune telling Singaporean “Geomancy” once repeated over and over how I was born to be lucky.  Hmmm.  Mind you, these are serious fortune tellers—not the sort you meet at North American carnivals.  They spend ages doing mathematical equations based on your exact time of birth to reveal all sorts of serious things.  Maybe she saw the investment club returns.

At times, I faced a couple of dilemmas when pondering directions to lead our club.  We had money to invest, and I couldn’t choose between two or three different businesses.  I read their annual reports (many years worth, typically) and based my narrowing down to a few companies based solely on what I thought and figured—not based on what the media or any analyst was reporting.  Then, if I couldn’t decide between two or three businesses, I went with my gut and selected one to promote to the club.

I can’t tell you how many times that “gut” decision was right.  And let’s not be euphemistic about it.  A “gut” decision is a lucky decision.  One time, I bought Pier 1 Imports at $16, and shortly after, sold it because I had some kind of nauseous feeling about it.  If we still owned it, we’d be down about 60% on it.  Nobody minded my schizophrenic decision because many of our club members felt that I had my finger on the pulse of the company.   Or maybe they knew what the Chinese lady said.  I don’t know.  …more info

I missed another disaster when I was enamored by Trex, a company that makes artificial decking material (that looks like real wood).   I was set to buy it.  But nobody in our investment club deposited money that month—which was good.  We weren’t able to purchase it, and by the time I changed my mind (it might have been something I ate that morning) the urge had passed.  If we bought Trex five years ago, it would have been disastrous.  We would have lost half of our proceeds.   … more info

With the investment club money (as with my own portfolio) I’d love to beat the market indexes.  But the odds are slim, which is why a full 70% of my retirement account is in diversified equity indexes and bond indexes.

How about you?  Have you beaten the markets over a lengthy period of time?  And if you have, do you feel that you can keep it up?

I suppose it’s pretty easy to look at our one year investment returns and celebrate. 

We’ve gained 64.9% since March 1, 2009.  During the past 52 weeks, we’re ahead of the S&P 500 index by 12.5% on a dollar per dollar comparison.

 This comparison assumes that for every dollar we put in our club (or for every dollar we had in our club) we could compare it equally with the S&P 500 and brag about coming on top by 12.5%.

 In U.S. dollars, our account sits at $532,987.27 including cash.

Before getting too smug (or selective in what we’re looking at) we should take a look at our two year performance.  Considering the market’s hammering in 2008, a two year comparison doesn’t look as pretty.

And anyone speaking about how their investments have performed should really focus on their last two years, not their last year.  The stock market, after all, got smashed and then has partly recovered since then.

Our account has risen just 5% during the past two years.

That gives us a 25% advantage over the S&P 500 (which is still down 20%)  and roughly a 33% advantage over the VEA first world international index since March 1, 2008.

Investors, for details about the portfolio, please login with your password and read the Invest ment report - 1 MAR 10. Its the post immediately after this.