Now That Would Be A Disclaimer

A reader left the following comment on the Seeking Alpha version of my post about the Fairholme Fund from the other day.

I'd be more impressed if these Monday morning quarterbacks had been around warning investors during Berkowitz's good times.

But that would be the hard part, wouldn't it?

I left sort of a smart alecky comment in reply;

Warning about what exactly? "Hey the manager might do a couple of really dumb things two years from now so you might want to avoid the fund."

I went on to mention that the type of blow up that has occurred this year at Fairholme can happen to any concentrated fund even if the backstory might be a little less sensational.

This brings up an important investing dilemma that I believe exists and contributes to why so many people complain about 401k plans. Berkowitz was a master of the universe for a decent amount of time (some believe he will regain that status again).

Unfortunately there is no way to know what an active manager will do in the future. You can know what the strategy is and hopefully likely to be but the exact trades are of course unknowable which makes the funds essentially impossible to analyze. With an actively managed portfolio you are expressing your belief in the strategy and that the past success can be repeated. You might draw the correct conclusion about a fund in that context but this is not really an analysis.

Most 401k plans are a mix of index funds which are simply asset class exposure and actively managed funds which might correctly fit into some Morningstar box or might not. I have seen some plans where the offerings are shockingly thin. I looked at one plan recently with only 12 choices of which there was only one international fund (there was also a global fund).

We have another client who has dozens of choices in his 401k. While too many choices can make the task daunting there are many plans that simply have a dreadful selection with not only funds but even asset classes. The one above has no choices for emerging markets or foreign fixed income.

Many times I have used the typical 401k results that get published every so often as the reason for why we should not have privatized Social Security accounts. Based on published studies, the 401k results are dreadful. Some of this is clearly attributable to the choices available.

More and more employers are moving to running their plans through brokerage firms such that employees have what amounts to a brokerage account with access to stocks, ETFs and traditional mutual funds. This is a boon for people interested enough to do some work but I do believe there is some burden on employers to provide access to at least some education on the subject.

The number of 401k-like plans that exist as brokerage accounts is pretty small at this point which leaves most plan participants having to make choices that amount to nothing more than guesses that some active manager won't make some sort of catastrophic move in the portfolio.

The good news is that most fund managers don't blow up the funds they manage, I say most but we know not all. If most of them underperform their benchmark that is unfortunate but it is not catastrophic. If you were in a plan with only one equity fund and it went up 7% per year versus 10% for the market then clearly that will compound into a big lag which I repeat is a bad thing but that type of scenario can be overcome with increased savings whereas recovering from a serious blowup might not be possible.

I doubt there are any one choice 401k plans but the numbers are understandable. A lag can be mitigated. Perhaps the education needs to be your employer is giving you crappy funds to choose from that you should expect will lag the market so you need to save more money than you are saving now.