By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) — One of my elementary-school teachers used to say that there are no stupid questions. Judging from the mail I get, she was wrong. Thankfully, I get a lot of smart questions too, and here are some of the best I have received from readers in the past few weeks.
Pete in Seattle: How long should I wait to buy a new exchange-traded fund?
Answer: I wrote a column recently warning investors away from new ETFs based on new, back-tested indexes. The problem there is that the “past performance” is fictional, more hypothetical than factual. Clearly, any new index concept should be given time — at least a year and probably two — to prove that it works and is better than established index products. Read related column on new ETFs.
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That said, there’s a second issue that goes beyond “new,” and it’s asset size.
For example, FocusShares opened a suite of funds based on Morningstar Inc. indexes last year. The funds looked good on paper, but never attracted assets and the firm announced it would close all of them before the end of August.
Even when investors are comfortable with the concept of a new ETF, there’s the risk — as FocusShares illustrates — that the fund sponsor won’t stick it out if it can’t raise enough assets to generate decent fee income.
Fund companies “give it a try” all the time in ETF-land, so treat newcomers with some wariness until they have $50 million or more in assets and an investment methodology that is proven in real life and not just in some hypothetical past.
Tom in Fort Worth, Tex.: Bruce Berkowitz has Fairholme Fund /zigman2/quotes/200889155/realtime FAIRX -0.97% on top again. Don’t you feel bad for telling investors to get out?
Answer: Not at all. Berkowitz is a fund manager with a great long-term record who suffered through a horrible 2011, losing 32% and ranking dead last in Morningstar’s large-cap value category. This year, the fund is at the top of that group, having gained almost 25% year to date.
Berkowitz’s record was never in question; long-term it is one of the best in the business. That record was not really jeopardized by his 2011 troubles; they would have had to continue much longer.
The problem is that as Berkowitz focused the fund more narrowly, it became more volatile and less like the product most investors wanted when they bought it. Like all good money managers, Berkowitz was going to stick to his guns, but that doesn’t mean investors should be comfortable with the risks.
Bill Miller, the former manager of Legg Mason Value Trust /zigman2/quotes/203623666/realtime LMVTX -1.11% , made his reputation by beating the market for a decade, and then ruined it by using mostly the same strategy when the market changed. The same could be said for Kenneth Heebner of CGM Focus Fund /zigman2/quotes/203752257/realtime CGMFX -1.91% , whose style has produced results, but with a ride that makes investors seasick.
For investors who feel they can trust and depend on a fund manager, there is no problem riding out the rough patches. But when a manager starts doing things that create performance surprises — as happened with Berkowitz — investors who feel they might be more comfortable elsewhere should make the move.
Once you become uncomfortable with a fund, it is hard to regain that confidence. Even shareholders who rode it out with Berkowitz are questioning whether they can trust that he’s “back.” Before the drama of his 2011 year, they had no real reason for discomfort.
William in New London, Conn. : I don’t really want to invest internationally. You’ve said that people who avoid foreign stocks will still be exposed to what is happening in foreign markets because they own stocks in companies that have a lot of foreign business. How can I invest if I want pretty much no impact from foreign businesses?
Answer: Many investors would say this kind of thinking misses out on opportunities — economic concerns have turned shares of some world-class companies into bargains, relatively speaking.
Moreover, finding pure domestic exposure is hard in a global economy. But if that's what you want, think small — as in small-cap funds.
Unlike large-cap issues that buy multi-national giants, many small-cap companies have little or no foreign business. (They may still be affected by foreign competition, but that’s to be expected in a global marketplace.)
Thus, a domestic small-cap fund avoids investments in foreign stocks, and the securities it holds generate most of their revenues at home.