Barron's - USA (2021-02-08)

February 8, 2021 BARRON’S 33

FUNDS

More than two dozen actively managed funds

rose more than 100% last year. But was that

skill or luck? Let history be your guide.

When Great Returns

CanMeanBadNews:

More 2020 Perversity

C

hoosing a success-

ful actively man-

aged fund has

never been easy,

and 2020, with

its many quirks,

shined a light on

just how difficult it can be—even when

you think you have all the information.

Last year, more than two dozen

actively managed stock funds re-

turned more than 100%, versus the

Russell 3000’s 19% gain. That’s really

quite remarkable: In the past decade,

there hasn’t been even a single fund

that returned more than 100% in a

calendar year; it quite possibly never

happened before.

So, is this a sign that active man-

agement is “back?” Not quite.

“You see these incredible numbers

at the end of 2020 because of what

happened in that one-year period,”

says Daniel Wiener, chairman of Ad-

viser Investments. “But you shouldn’t

let that drive your investment deci-

sion, because these are one-offs.”

The top performers of 2020 are

mostly concentrated growth funds

from a handful of firms. The top three

funds are from ARK Investment Man-

agement, it has two others in the top

20; Morgan Stanley also has five

funds on the list. Baron Capital Man-

agement and Zevenbergen Capital

Investments each have a few funds

in the top 20.

While doubling your money is a

win for current investors, these out-

size gains pose problems for potential

investors trying to evaluate these

funds.

Now, savvy investors know that

one-year returns are problematic, as

they’re representative of a fairly short

piece of market history and not neces-

sarily indicative of manager skill.

The No. 4 best performer, $1.6 billion

Morgan Stanley Inception Port-

folio(ticker: MSSGX), for example,

lagged behind the Russell 3000 index

in four out of the nine years prior to

2020, and barely matched the bench-

mark in two other years. Yet in 2020,

it returned 151%, nearly 130 percent-

age points ahead of the broad market.

Why? Two small companies that

focus on cloud computing—Appian

(APPN) andFastly(FSLY)—returned

more than 300%. Those two stocks,

plus personal-styling serviceStitch

Fix(SFIX), contributed to roughly a

third of the fund’s gain last year.

Even assuming that a manager is

skillful—rather than just lucky—in

owning a stock that skyrockets and

pulls the rest of the fund along with it,

such wild outperformance can also

be a harbinger of problems.

Ron Baron, for instance, is a

longtime, renowned bull on electric-

vehicle-makerTesla(TSLA). In an

interview withBarron’sin early 2020,

Baron said he expected the electric-

vehicle maker to reach a $1.5 trillion

market value by 2030. Tesla stock

soared more than 740% last year and

is now halfway to that valuation. It

also is the single-biggest driver, by far,

of the 149% gain for the $7.1 billion

Baron Partnersfund (BPTRX),

which beat the Russell 3000 by 128

percentage points.

The Baron Partners fund began

buying Tesla in 2014; its last

purchase was in February 2016 for

less than $40 per share. The stock is

now at $850. Co-managers Ron and

Michael Baron have trimmed the

fund’s Tesla position since then. At

the beginning of 2020, it had grown

to about 17%. The fund sold 20% of

its stake throughout 2020—but the

stock rose so quickly that by the end

of the year, nearly half of the fund’s

assets were invested in Tesla. “We are

more confident in Tesla’s business

fundamentals than we were at the

time of our last purchase,” says

Michael Baron, adding that the firm

is nonetheless mindful of portfolio

concentration.

That concentration could leave the

fund vulnerable to any sharp move-

ments in the stock. “You are taking a

big leap of faith when somebody has

almost 50% of their money in one

stock,” says Wiener, “You are not buy-

ing a fund; you are really buying a

stock. Everything else in comparison

is a rounding error.”

ARK founder Cathie Wood is also

a firm Tesla believer, but her actively

managed, $25 billionARK Innova-

tionexchange-traded fund (ARKK)

has taken a more conservative ap-

proach. Tesla is the fund’s top holding,

but its weight is capped at roughly

10%, so it won’t overtake the portfolio.

The ARK ETF’s strong returns—it

was up 153% last year—can be attri-

buted to a wider range of stocks, in-

cludingSquare(SQ),Roku(ROKU),

andInvitae(NVTA).

ARK Innovation has beaten the

Russell 3000 for five of the six years it

has been in existence, usually by per-

centage points in the single digits, and

never by more than 100 points, as it

did last year. “I don’t think we expect

to deliver over 100% return next year,

of course,” says Ren Leggi, client port-

folio manager at ARK. The company’s

targeted annualized return for the

next five to seven years is about 15%.

S

trong conviction is a good

thing in an active manager,

but it must be consistent and

repeatable. Yet even for sea-

soned investors who know to look at

a fund’s longer-term history, some of

these outsize gains may skew those

figures for years to come.

The Morgan Stanley Inception

Portfolio fund, for instance, has

returned an average of 46% over the

past five years. Remove 2020’s run-

up and the fund’s rolling five-year

annualized return since its inception

three decades ago drops to 10%—

roughly in line with the Russell 3000

index.

This highlights another wrinkle in

evaluating a fund’s history: Returns

are measured at specific points to en-

able uniformity and make compari-

sons easier. These snapshots in time,

however, do not reflect how people

actually invest, Wiener says: “Most

investors don’t put their money in at

the beginning of a quarter and take it

out at the end of the quarter.” Your

own personal performance could be

very different—for better or, usually,

for worse.B

By Evie Liu

Too Good to Be Repeated

Active management seems to have had a good 2020, but the biggest winners reached heights never seen

before—and that probably won't be seen again.

Source: Morningstar

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150 (percentage points)

100

50

0

-50

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

ARK Innovation ETF

Morgan Stanley Inception fund

Baron Partners fund

Annual return relative to Russell 3000