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Don't Judge a Fund by Its Cover

Sam Patel

The top-performing hybrid funds for November reveal that this extraordinary market has shaken up past practices and long-held beliefs of the asset management industry.

The industry's biggest fallacy of all is the notion that a fund must be at least 95% invested in the markets at all times and therefore permitted a maximum allocation to cash of only 5%. But such thinking has made the entire asset-management system more rigid and less flexible in the event of a serious crisis such as the one now before us.

Built on 401ks, indexation and diversification and the notion that long-term investing serves as a cure-all for lack of investment knowledge, this rigid system is one that's crumbling before our very eyes, along with the retirement savings of this nation. It will take many years, perhaps decades, to rebuild all of the capital that will eventually be lost. Had cash allocations been allowed to grow to higher levels and managers of funds been more prudent in their management of others' money, the eventual toll would likely not have been as great.

Cash is flexibility in that it gives the investor the ability to take advantage of opportunities as they arise and further, and more importantly, in a time such as this -- avoid capital destruction.

The list of top-performing hybrid funds below shows that you can no longer judge a fund by its description. I have seen this in many other instances. Consider the Direxion 10-Year Note Bull 2.5X (DXKLX), which has a majority of its assets -- in this case 67% -- in cash and some 32% allocated to just one government security. There is no diversification in this fund, and its objective is stated as "seeking investment returns that correspond to 250% of the daily price movement of the benchmark 10-year note by taking long positions in 10-year US Treasury Note futures." The only thing that this fund is long is cash.

I am by no means making an example of DXKLX or any other fund that goes to cash -- I am focusing more on the structure and ethos of a failed ideology applied to asset management. There is nothing wrong with running to cash and ignoring your stated objectives at a time like this.

Other strategies being employed in some of the funds in the table below involve concentrating a fund's assets into just one, two or three main securities -- in other words shunning diversification altogether, which is generally the major underlying reason for investing in funds in the first place.