How did Fred Hager beat the average Mutual Funds by more than 300% a
year for twelve years?
I believe this advice will be worth thousands of dollars to you if you
consider my points seriously and act on them.
If you think about the key to my investment record, you will realize it
is nothing but common sense based on familiarity with the computer
The strategy is very important, but what is more important is the kinds
of stocks you choose to buy.
Surely you are aware of the fact that the average mutual fund has lagged
the market. A recent study revealed that even the index funds beat their
average non-index brethren. Some of the best fund managers think it is
an achievement if they beat the market averages by a couple of points.
Why do you think the mutual fund industry as a whole has such a poor
record, and on average, the funds donít beat the market?
And how is it that I can beat the average fund by more than 300% over
It really is very simple. The Funds donít have it easy. The mutual fund
industry has to operate under difficult conditions with both hands tied
behind its back.
These restrictions and limitations usually imposed by their charters
vary widely, from the obvious restrictions of sector funds to specific
sectors, to specific geography, minimum diversification, maximum
percentage holding per security, minimum cash requirement, and so on. In
addition, the race for short-term performance has affected many funds
negatively. Moreover, in order to keep within their charter, which
permits only a certain percentage position in any security, most funds
are forced to cut down the positions of their big winners in order to
stay within their limit for individual holdings. Of course, the ugly
ducklings do not present a problem and can therefore be held. This is
especially true for index funds.
Since there is no meaningful performance difference over a period of
time between index funds and other mutual funds, lets look at index
If you buy an index fund, you buy a whole universe of stocks. You buy
the good the bad and the ugly.
Why, for heaven's sake, should you buy the bad and the ugly? In
addition, you are buying the same amount of a bad stock as you are
buying of a good stock. You are doing that with your hard-earned
savings, and that to me seems to make no sense at all. Of course, you
canít blame the index funds - they are doing exactly what they promised.
So why are there so many index funds? That also has a simple
explanation: they can prove they do as well as the average mutual fund.
The net effect is totally counter-productive.
While all the above points apply more or less to the non-index funds,
the non-index funds with their greater turnover, larger commissions,
higher expense ratio, etc. have an additional set of negatives affecting
their performance, not the least of which is a higher tax liability
created by the higher turnover.
On the other hand, my approach is relatively simple. Here are the keys:
Key One: Sector
- I only concentrate on the computer technology sector, which is the
fastest growing sector in the American economy. This gives me an
unfair advantage. It also is the sector with which I am the most
familiar. (see my background)
Key Two: Selection
- I concentrate on portfolio performance by picking only the securities
I believe to be among the best of the best, la crème de la crème. My
twenty-year background as an executive of a computer company helps me
greatly in assessing the long-term merits of the companies I select. I
only pick stocks with which I am totally familiar; stocks that are
market leaders or very special situations. I anticipate the earnings
of my stocks to grow at a rate of at least 25% per year for the next
five years. Special situations are only considered if growth can be
reasonably expected at a much higher rate, in order to increase my
overall performance rate. My target rate average for my two portfolios
is 35% per year, which to date has been exceeded. It is, however,
important to keep in mind that the past record in no way assures
success in the future, and that my anticipations may prove flawed.
Key Three: Minimum turnover
- I will trade very seldom in my model portfolios in order to minimize
tax consequences for investors. In spite of my track record, I have
made many mistakes, most of them were the result of too much trading.
The more you trade, the more chances you have to make mistakes. For
all of 1998, I did not make a single trade. In spite of that, I was up
100%, and no taxes were applicable.
Key Four: Concentration
- I will not have more than three to five stocks in my portfolios. I
have averaged over 35% per year since 1986. If I can do the same over
the next five years, a $10,000 investment, compounding at 35% for five
years, will grow to an amazing $44,840. What is wrong with that?
Key Five: Never try to time the market
- Nobody can time the market. There are no timing gurus that have a
long-term record of being right. The more arrogant they get, the
harder they fall when the law of averages catches up with them. Just
look at the awful recent records of "so-called" former greats like
Granville and Garzarelli.
Key Six: Donít let anybody chase you out of a good stock when it hiccups
- The secret is ignoring the pundits when they place the stock on a sell
list. Or when they downgrade it to hold or neutral and tell you there
are better opportunities elsewhere. Can you imagine the damage done by
these guys to investors chasing them out of good positions?
An example: Let us assume an investor has a position in Intel. He paid
$20 a share for it. Four years later, Intel hits $100, then slides
back to $75 because of some negative news (which is of little
long-term consequence). Now major brokerage houses reduce their
estimates and tell their customers there are better opportunities for
the near term. It works. Intelís daily volume reaches 75 million
shares. A lot of scared people are selling, and a lot of smart people
are buying. Of course, this creates millions of dollars in broker
commissions. A few days of these negative stories force the stock down
to $69. A lot of investors are worried about losing more money and
sell out. After all, as they say, you canít make a mistake by taking a
profit. Twelve months later, Intel is back at $100, reaches a new high
and breaks out to $110. At this time, all major brokerage houses come
out with a buy on Intel. It now trades at $115. The investors who sold
Intel at $69 always liked Intel, after all, it made lot of money for
them over the four years they held it. So, they buy it again at $115.
Letís analyze this recurring phenomena. The first thing they did is
created unnecessary income of $49 per share when they sold it. This
created a tax liability of about $13.50 (state and federal income tax
depending of where they live.) In addition, there are the commissions
and the spread.
The worst part is now they have to make 100% profit to be back where
they were before they lost the 50% by being out of Intel while it went
from $69 to $115.
Key Seven: Donít panic during a market break
- The same financial scenario applies as mentioned in the above example.
When the market dives 20% or more, it officially becomes a
bear-market. Investors are advised to lighten up their portfolios by
brokerage houses. 95% of the time, the market turns around at this
level, and investors, after taking their profits, and after missing
the first part of the new bull move, are now considering entering the
market with their reduced resources
Fred Hager offers an investment letter at Fredhager.com that I heard of
first years ago and which I found immediately interesting in the same way
I do today.
Under the millstones of the banks
Hoping for the trend and finding chaos
Above average? You will still lose!
The negative-sum game for investors