1987 Magellan Fund Reminder: Your Advantage Over The Professional Investors

During the third week of October in 1987 when stock prices declined by over 30% in two days, Peter Lynch (the legendary mutual fund manager that generated 29% annual returns over a thirteen-year stretch) learned that the Magellan Fund had lost $2 billion (about 20% of the fund’s assets under management) and had to deal with a rush of redemptions on the fund. Even though Lynch was the best mutual fund manager in his day, and even though his Magellan Fund owned a mixture of the highest quality and fastest growing companies in the world (a total of over 1,000 of them!), he still had to deal with so many redemptions that he had to strategically sell off some of his stocks (for the record, Lynch sold off most of the Magellan Fund’s British holdings because the British stocks had not gotten hit as badly as the American counterparts).

This is a huge structural advantage that you can possess over the mutual fund industry. When stock prices fall 10%, 15%, 20% (or whatever), most investors in mutual funds have the knee-jerk response to “sell now and ask questions later.” This puts mutual fund managers in the dilemma of having to get rid of the best performers to meet redemptions, even if they have the wisdom and foresight to know that it is a great time to go on a buying spree. Managers like Lynch can’t go on buying sprees unless they have money coming in (or if they are like Seth Klarman and keep 40% of the fund in cash).

But you don’t have to be like them—there is no rule that says that you have to be the “average” investor that sells when times get rough. There is nothing to prevent you from being the person buying Procter & Gamble at $44 per share in 2009 from the person that is selling it. People say stuff like, “75% of professional money managers haven’t beaten a basic index over the past X amount of years.” If those statements are true, it’s not necessarily because the money manager is incompetent.  During times of crisis, money managers have their hands tied up to prevent them from buying stock because their investors are pressing the sell, sell, sell button with their mutual fund shares. The good news is that you don’t have to be like that—do whatever it takes to put yourself in the position of being a net buyer of stocks during times of 20%, 30%, and 40% declines. That is almost the entire battle. A focus on dividends and underlying profits is a great way to put yourself in a position to be a buyer during these times, but if you have some other technique that gets you the same results, then do it. Being a buyer during stock market declines is probably the single most important characteristic trait that you can possess as an investor.



Originally posted 2014-01-17 07:44:20.

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3 thoughts on “1987 Magellan Fund Reminder: Your Advantage Over The Professional Investors

  1. scchan_2009 says:

    In this article, there was an example the opposite side of the story (where managers were pressured to BUY something (dot coms) the manager did not like, and winded up being pink slipped: Google for "Criticism of short-term investing grows after Woodford departure" in Financial Times (FT)). As for the article itself, I think Tim you will like how Woodford pick his stocks – Woodford is a big dividend guy.

    I really pity Lynch for this mess. This happened to Bill Gross last year when people bailed on bonds when the pressure of ending of QE and interest rate increase hammered the bond market (I know bonds were rarely talked about there; nevertheless bonds are as big as stocks for the financial markets; nevertheless I do own some bonds – 10-yr T-Notes are yielding 3% now, so it is actually not too ugly to buy some bonds).

  2. scchan_2009 says:

    Actually about the same FT article: It basically highlights the greatest ills of modern financial markets and capitalism. Sometimes I wonder is it a good thing that it is so easy to pull money out from Lynch's and Gross' fund, companies are forced to report every 1/4, or those ultra-low trading costs from modern online brokers.

    Holding KO and PG for 30 years or going after stocks trading below book value and just wait seem like past art.

  3. Silvia Aguilar says:

    The article was really informative and well written. It seems to me that I know the author from the COMPACOM expert team. Have always enjoyed reading their detailed useful researches and comparisons. If I have any problems choosing the products I need I turn to compacom.com at once.

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