Stock Pickers Beaten Badly

Three of the most highly regarded fund managers have recently lagged behind their peers and the market itself.

Investment News reports (Berkowitz, Heebner and Miller in tight battle — for last place) that Bruce Berkowitz, Kenneth Heebner and Bill Miller have posted results are all well behind the Standard & Poor's Index through June 9, 2011.

Mr. Berkowitz was Morningstar's fun manager of the decade. Mr. Miller beat the S&P 500 index 15 straight years through 2005. Mr. Heebner was manager of the best-performing diversified US stock fund over a 10-year period.

Here's the scorecard:

Manager - Fund - Return

Bruce Berkowitz - Fairholme Fund - 12%

Kenneth Heebner - CGM Focus Fund - 12%

Bill Miller - Legg Mason Capital Opportunity Fund - 11%

S&P 500 Index + 3.4%

Data source: Morningstar

What can we learn from the fall of these stock picking stars? We have more information that suggests that stock pickers are unable to beat the market indefinitely. Certainly some managers beat the market. We would expect some to beat the market and others to underperform the market. The problem is differentiating one from the other.

Moreover, we do not know whether managers who beat the market do so because of skill or luck. Certainly successful fund managers claim that their superior investing skills underlie their performance. But we also routinely hear from underperforming managers that bad luck has derailed their funds. So, is it skill or luck?

Some might suggest that the savvy investors should ride the stars as long as possible and then jump off when they start to falter. There are three challenges that must the investor must overcome to pull this off. First, the investor must be able to identify and invest with the stock picking star BEFORE he starts his winning streak. Second, the investor must have the conviction to stay invested with the star if/when a more compelling investing opportunity appears. Third, the investor must know when to fold 'em and move out of the fund BEFORE it becomes a losing fund.

We know that investors are rarely able to move in and out of mutual funds successfully. Dalbar's research shows that shareholders in mutual funds earn returns that are consistently lower than those of the funds in which they invest.

The lesson for intelligent investors: Waste no time searching for the next hot fund manager. Instead invest across asset classes and capture the returns of those asset classes using low cost, passive funds.