CGM Focus: A Perfect Example of Why Chasing Returns is Foolish

by Kevin on September 19, 2008

A few months ago I read an article in Kiplinger’s magazine about “The Savviest Stock Picker in America“, Ken Heebner. He runs a mutual fund called CGM Focus.

Eye Catching Results for CGM Focus

The fund was in the news earlier in the year because it had earned in excess of 70% returns in one year. So if you had $10,000 invested with them at the beginning of the twelve month period you ended up with $17,000. That’s absolutely nuts.

It definitely caught my eye, but I would never considered investing with them. That sounds kind of cocky, and I don’t want you readers to think that I believe I could find better returns elsewhere.

I do hold the belief that while some fund managers are able to pick stocks to earn great 1, 3, or 5 year returns… in the long run those funds will return to average. It’s inevitable.

This is a problem for investors like you and I. I had never heard of CGM Focus until I read the report that it was up 70% in one year. That is definitely eye catching. Heck, it was all over the front of the magazine. Unfortunately it is also probably one of the worst times to invest your money with the fund. Why? Again, they had a great year. The likelihood that they generate another year of 70% returns is very, very low.

On top of that, even if they somehow manage to earn those returns for a second year, they won’t be able to maintain those returns for all of the years from today to your retirement. You would have to know when to sell your holdings in the fund at the top before returns drop to historical averages. Trying to time the market has been proven to be near impossible and timing what a mutual fund is going to do is just as difficult.

What Goes Up, Must Come Down

Here’s a shot of CGM Focus’ returns since the beginning of January 2006. From the beginning of 2007 to the first high point toward the end of 2007 the fund returned 80%. Notice if you had invested at the high point, it dropped going into 2008, but then rebounded.

Let’s assume you did invest toward the top, experienced that drop going into 2008, but stuck it out and it rebounded to where you invested in. You are feeling better and decide to stick it out.

If you stuck it out, you’ve seen your investment drop 28% in the last three months. Ouch.

But what about compared to the S&P 500?

Over the last 12 months, CGM Focus and the S&P 500 have very similar returns. CGM is down 17.82% and the S&P 500 is down 18.02%. Sure, CGM has been affected by the credit crisis and the turmoil in the markets. Their stock picks could rebound very quickly.

Then again, they could also trail the S&P 500 or just match the S&P 500’s return. And with an expense ratio of 0.99%… you are paying a high cost to be average.

The Better and Easier Path

Instead of chasing the hottest mutual fund returns, the easiest option is to grab some broad index funds that charge low expense ratios. You can get Vanguard’s S&P 500 Index (VFINX) for a mere 0.15% expense ratio. That ratio is 0.84% less than CGM Focus, and you are guaranteed to be average.

(Being content with being average is something I’ll discuss next week. Seriously, it’s a good thing.)

For now, what do you think? Had you heard of CGM Focus before reading this post? Did you invest?

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Matt @ Steadfast Finances September 19, 2008 at 11:05 am

You know I would have heard of CGM and Heebner wouldn’t ya! haha. Just for fun, toss up an overlay chart of CGMFX with the USO (oil ETF) or the KOL (coal ETF). They mirror each other in terms of price moves almost perfectly.

Heebner’s investments were affected more by the sell off in commodities b/c he was (and still is) heavy into the commodity sector. Stocks like Petrobras, US Steel, were heavy overweights. He’s known for having a down year, so it’s not surprising to see him fall off the mark this year after blowing everyone away for the last 5.

One thing I do to avoid situations like this is pull the stock charts like you did here. If you see a huge spike in price in the last 6 months… just avoid buying it. Wait for it to come back down to earth.

ravinsu September 19, 2008 at 11:57 am

Ken Heebner has been investing quite successfully for the last 38 years. If you haven’t heard of him before you saw him on the cover of Fortune, you have every right to complain about getting burned chasing hot returns in a “flash in the pan” mutual fund. But the fact of the matter is, Ken is a phenomenal investor who has generated amazing returns over the last so many years. Its not last 5 years I am talking about. Do your due diligence on him.

You have a point here though about getting into CGM focus well after an unusally phenomenal year for Ken after the commodity bull run. But his returns are way off the peak, so instead of blasting his returns, NOW would be a good time to get into this fund rather than running to Bogle crying foul.

Start-Up September 19, 2008 at 3:31 pm

The best part about average returns, is you’re getting the average stock market return, which happens to be higher than the average investor’s returns. Average really is above average when you talk to your neighbors and coworkers.

Paige September 19, 2008 at 8:26 pm

As I started reading the article I was thinking to myself, how can this one-off thing be written about in this blog. Started to make sense as I read more 🙂

Kevin September 26, 2008 at 11:55 pm

@Matt: Yea, I had read that he was playing against financials and into commodities. It may go back up into the stratosphere, but I’ll stick with my boring index funds.

@Ravinsu: I read the background on the guy and he has been a great investor, don’t get me wrong. But I stick by the fact that this is a good example of chasing returns. If you chased returns when you saw 70% annual gains for CGM, you’ve been sorely disappointed. I’m not saying he’s a bad guy at all. But it makes a good example. And if you had index funds, you wouldn’t have to worry about it. (I will grant that I would much rather have 70% annual returns than index funds, but not until someone can show me it will be consistent into the future. “Past performance is not indicative of future results” is the saying, no?)

@Start-Up: Yup! Exactly.

@Paige: Thanks for commenting.

Irv Small February 24, 2009 at 11:18 am

What do you do with a fund that was tops for a few years after it has gone thru a big down turn like CGMFX. Do you wait or go to an Index fund?

Kevin February 25, 2009 at 8:17 am

@Irv Small: I wouldn’t be in the fund in the first place. It’s actively managed. Granted, the management team has been right recently, but they are still charging you 0.99% of assets regardless of performance.

I would get out and put my money into an index fund or ETF for the broad market. Personally I would rather own the whole market than just what one management team thinks I should own.

But this isn’t professional advice. Do what you want. 🙂

If you sell now you are locking in a loss, but you can write off at least $3,000 of that loss this year on your taxes. Not much consolation if you’ve lost that much, but you can then turn around and invest in the index so when it goes back up, you get to have the gain.

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