What Happens When The Wizard Vanishes?
Jim O'Shaughnessy's 1996 best-selling What Works on Wall Street would have seemed too audacious if it weren't so alluring. From an ocean of data covering more than 40 years, O'Shaughnessy distilled the few indicators, such as a low price-sales ratio, that really seemed to pay. "Investors can do much better than the market," he wrote, "if they consistently use time-tested strategies that are based on sensible, rational methods." I read that and thought, Yes!
Am I a sucker for pitches proclaiming the virtues of cheap stocks, patience, and disciplined investing? Yes again, but I was hardly alone in loving O'Shaughnessy's stuff. His Greenwich (Conn.) firm flew past $800 million in assets and, even as day trading went hyperactive way past anything Ritalin might touch, he kept popping up on America Online and CNBC. Leading a countercult, he called his patented process "Strategy Indexing," a mechanical way to buy each year's best value or growth stocks. Before 1996 was out, he began inviting investors into four new mutual funds.
"ANTIQUATED" VEHICLE. Today, O'Shaughnessy is quitting them. In March, he collapsed the four funds into two. In April, he unveiled plans to sell his contract to run the funds. In May, investors received proxies and, if they say O.K., O'Shaughnessy will have washed his hands by June 30.
Why? It's not that he's lost confidence in stocks. Instead, O'Shaughnessy told me he is refocusing on private-client accounts, which he thinks can be tailored to an individual's need to manage taxes and risk better than a fund can--an "antiquated" vehicle, in his view. O'Shaughnessy is coy about the specifics of his next move, but the firm's new name, Netfolio, hints at a techie drift. "It would be a disservice to the fund holders for us to stay on," he said. "Our marketing dollars are going to be spent elsewhere."
Fair enough, I suppose, for O'Shaughnessy, who has every right to quit the fund biz. And, by insisting that Edward J. Hennessy, the Marin County (Calif.) firm that's buying him out, keep the funds' fees and investment policies steady, the funds' directors seem to be handling his exit with care. Yet the way I see it, O'Shaughnessy's investors have every right to cry like orphans.
That is, those who haven't been crying already. The author of What Works on Wall Street has had it tough getting his time-tested strategies to work in the funds (table). Of O'Shaughnessy's four original funds, only one beat either the Standard & Poor's 500-stock index or its average comparable fund, as measured by Morningstar. And that one, Cornerstone Growth, prevailed by a sole percentage point. Lately, that fund is clicking, an irony O'Shaughnessy was quick to note. "It's on fire," he said, up 50% in the past year as the S&P gained 10%.
The new manager, Hennessy, is set to license O'Shaughnessy's formulas. In theory, there's no reason it can't execute them well. And although the firm now manages just $55 million, it hopes to build its fund business smartly. If those hopes pan out, the $205 million in the funds could swell, creating an opportunity to lower expense ratios.
Just the same, some investors think that prospect ignores the reason why they bought the funds in the first place. "With Mr. O'Shaughnessy in charge of the fund, I knew it was his baby," Cornerstone Growth holder Chuck Jacot says. "I now have no assurance that Mr. Hennessy will not give up on this fund just as readily.... I am extremely disappointed." Another, Tim Dempsey of Montgomery, N.Y., told me: "If he was quitting for health or extreme personal hardship, O.K. But I feel deceived."
The trouble here--and it's a warning to anyone paying a professional to invest your money--is the inevitable conflict between what's good for the manager and what's good for you. What works on Wall Street in the end is what keeps a manager's profit growing.
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